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Composecure, L.L.C. v. Cardux, LLC

Supreme Court of Delaware

November 7, 2018

COMPOSECURE, L.L.C., Plaintiff/Counterclaim Defendant-Below/Appellant,
CARDUX, LLC f/k/a AFFLUENT CARD, LLC, Defendant/Counterclaim Plaintiff-Below/Appellee.

          Submitted: October 10, 2018

          Court Below: Chancery Court of the State of Delaware C.A. No. 12524-VCL

         Upon appeal from the Court of Chancery. AFFIRMED in part, REVERSED in part and REMANDED with jurisdiction retained.

          Myron T. Steele, Esquire, Arthur L. Dent, Esquire, (argued), Andrew H. Sauder, Esquire, Potter Anderson & Corroon LLP, Wilmington, Delaware. Of Counsel: Steven M. Coren, Esquire, David M. DeVito, Esquire, Kaufman, Coren & Ress, P.C., Philadelphia, Pennsylvania for Appellants.

          David J. Margules, Esquire, (argued), Elizabeth A. Sloan, Esquire, Jessica C. Watt, Esquire, Ballard Spahr LLP, Wilmington, Delaware; Burt M. Rublin, Esquire, Ballard Spahr LLP, Philadelphia, Pennsylvania for Appellees.

          Before VALIHURA, VAUGHN and SEITZ, Justices.


         Appellant CompoSecure, L.L.C. ("CompoSecure") appeals from a nearly $17 million judgment in the Court of Chancery for past-due commissions, legal fees and expenses, pre-judgment interest, and contract damages arising out of a sales agreement (the "Sales Agreement") with Appellee CardUX, LLC ("CardUX"). On appeal, CompoSecure contends that the Court of Chancery erred by holding that (1) the Sales Agreement was voidable, not void, under CompoSecure's Amended and Restated Limited Liability Company Agreement (the "LLC Agreement"), and (2) CompoSecure impliedly ratified the Sales Agreement. CardUX argues that, even if CompoSecure were correct, we should enforce the Sales Agreement based on a provision in the LLC Agreement that addresses reliance by third parties on certain company actions, or based upon quantum meruit.

         While he was a CompoSecure director, Kevin Kleinschmidt co-founded CardUX for the purpose of marketing on CompoSecure's behalf. CompoSecure hired CardUX to promote and sell its metal cards. To govern their relationship, CompoSecure and CardUX entered into the detailed Sales Agreement. Because it is a conflicted transaction, the Sales Agreement is subject to Section 5.4 of the LLC Agreement (the "Related Party Provision"), which requires approval from the Board, the Investors, and the Class A Majority.[1] On appeal, CompoSecure argues that the Sales Agreement is also subject to Section 4.1(p)(ix)(A) of the LLC Agreement (the "Restricted Activities Provision"). The Restricted Activities Provision contains an important clause, namely, that Restricted Activities are "void and of no force or effect whatsoever" if they do not receive approvals from the Board, the Investors, and the Class A Majority.[2] It is undisputed that CompoSecure did not obtain the approvals needed for compliance with either the Related Party or the Restricted Activities Provision.

         Following four days of trial, the Court of Chancery held that the Related Party Provision applied to the Sales Agreement. Because CompoSecure was capable of authorizing the Sales Agreement, even though it had failed to properly do so, the court held that it was a voidable transaction subject to equitable defenses.[3] Applying New Jersey law, the Court of Chancery held that CompoSecure had impliedly ratified the Sales Agreement.[4]

         We largely agree with the Court of Chancery's analysis as far as it goes. However, the court considered the Related Party Provision and the Restricted Activities Provision to be cumulative. Accordingly, the court only assumed, without deciding, that the Restricted Activities Provision applied.[5] It did not separately consider, as a factual matter, whether the Sales Agreement falls within the Restricted Activities Provision, and it did not analyze whether the Sales Agreement was "void and of no force or effect whatsoever" in the event it did apply. CompoSecure is partly to blame for the trial court's failure to focus on the impact of this provision as CompoSecure only weakly raised the issue below, but, on appeal, elevates the issue to its lead argument. Even so, after examining the record below, we decline to hold that the issue has been waived.

         Whether the Sales Agreement falls within the Restricted Activities Provision requires factual findings that the Vice Chancellor is better equipped to make. The answer to this question is important because, if the Restricted Activities Provision applies, the Sales Agreement would be void, as opposed to merely voidable, and, therefore, would be incapable of being ratified. Accordingly, we will remand to allow the trial court to determine whether the Sales Agreement is a Restricted Activity and to make any necessary related determinations. We will retain jurisdiction.

         We do so reluctantly, as the trial court made a persuasive case that the equities do not favor CompoSecure. CompoSecure admitted at oral argument that the Sales Agreement was a "bad contract, "[6] and the Vice Chancellor's opinion is rife with findings suggesting that CompoSecure consistently attempted to avoid its obligations under that agreement.[7] Nevertheless, we agree with the parties that, if it applies, the Restricted Activities Provision would render the Sales Agreement void.

         In the event the trial court concludes that the Restricted Activities Provision does not apply, to be as helpful as possible and to narrow the potential issues going forward, we have considered the parties remaining arguments on appeal. As to those issues, we find no error and affirm the Vice Chancellor's conclusions. In particular, we agree with the Court of Chancery's conclusions that: (1) the Related Party Provision (leaving aside the Restricted Activities Provision) renders the Sales Agreement voidable, not void, and is therefore subject to equitable defenses; (2) the parties impliedly ratified the Sales Agreement under New Jersey law; and (3) the Third Party Reliance Provision (described below) does not save the Sales Agreement from a failure to comply with the Related Party or Restricted Activities Provisions.

         Accordingly, we AFFIRM in part, REVERSE in part, and REMAND for further proceedings consistent with this opinion.

         I. Background

         A. CompoSecure's Founding and Outside Financing

         In 2000, Michelle Logan and her father, John Herslow, co-founded CompoSecure to manufacture and sell metal and composite credit cards. [8] Logan took over the business in 2004 and became CEO in 2012.[9] CompoSecure is one of the only companies in the business of manufacturing metal cards. It manufactures the cards at a high cost and markets them to affluent customers through initiatives like the JP Morgan Chase ("Chase") Sapphire Card program.[10] CompoSecure also sells cards at a fifteen percent discount to "personalization partners," who buy metal cards, add personalized details, and sell them to issuing banks.

         In 2013, CompoSecure's owners began exploring a potential sale of CompoSecure. One interested investor was LLR Partners ("LLR"), a private equity firm. Mitchell Hollin led LLR's investment in CompoSecure and recruited Kleinschmidt, a former credit card executive, to help with LLR's due diligence. Kleinschmidt had experience with so-called co-brand relationships, in which an issuing bank partners with an entity, such as an airline, to create specialized cards that bear the mark of both the issuing bank and the partner. In his evaluation, Kleinschmidt flagged several concerns regarding CompoSecure, including its heavy reliance on Chase, small sales staff, lack of established relationships with key decision-makers at issuing banks, and lack of a strategy to educate co-brand partners about metal cards.

         On May 11, 2015, LLR purchased sixty percent of CompoSecure's equity for $100 million. At Hollin's request, Kleinschmidt agreed to serve as a member of the Board. As a part of the transaction, CompoSecure converted from a New Jersey LLC to a Delaware LLC. Immediately after closing, the Board consisted of LLR designees Kleinschmidt, Hollin, and Justin Reger, and Class A designees Logan and Herslow. All of CompoSecure's post-transaction Board members, including Kleinschmidt, signed the LLC Agreement.[11]

         B. Kleinschmidt and Frantz form CardUX

         In the months preceding LLR's May 11, 2015 investment in CompoSecure, Kleinschmidt and another former credit card executive, Paul Frantz, formulated a plan to boost sales for CompoSecure. To accomplish this objective, they contemplated a separate entity that would focus on convincing co-brand partners to demand metal cards from their partnering banks. That entity became CardUX.[12] In March 2015, Kleinschmidt proposed this marketing strategy to Hollin, who liked the idea, and raised it with Logan, who also thought it was a "good idea."[13]

         After negotiations concerning the commission rate and the marketing efforts required of CardUX, the parties tentatively agreed to a flat fifteen percent commission for any order by an approved prospect and perpetual commissions for subsequent orders from the same customers as long as CardUX was "meaningfully involved" in the order.[14] The term sheet did not include any requirement that CardUX show that its efforts led directly to a particular sale, and the Vice Chancellor found that "[t]he concept of being 'meaningfully involved' did not apply to initial commission."[15] Rather, "[i]t applied to continuing commissions for subsequent orders from the same customer."[16] In a July 1, 2015 meeting, CompoSecure's Board members evaluated and generally expressed support for that plan, but did not cast a formal vote.[17]

         Shortly after the July 2015 meeting, Hollin took over negotiations for CompoSecure because Logan's mother had been diagnosed with terminal cancer. As negotiations progressed, CardUX objected to CompoSecure's insistence on "efforts" clauses, which limited CardUX's commissions to sales resulting from CardUX's marketing efforts, and to limitations on the length of time it would be entitled to commissions.[18] Hollin did not object to Kleinschmidt's deletion of the efforts requirement. He did push back on paying commissions "forever and unconditionally," and the parties compromised on that point by agreeing that CardUX would receive commissions for a period of fifteen years.

         C. CompoSecure and CardUX Sign the Sales Agreement without the Required Approvals

         Following further negotiations, on November 4, 2015, an execution version of the proposed sales agreement was circulated among the parties. The parties executed the Sales Agreement on November 9, 2015, with Logan signing as CEO for CompoSecure and Kleinschmidt signing for CardUX.[19] Although both were CompoSecure directors, they did not obtain any of the approvals required by the Related Party Provision contained in Section 5.4 of the LLC Agreement, which provides:

Section 5.4 Transactions Between the Company and the Members. Notwithstanding that it may constitute a conflict of interest, each of the Members, the members of the Board and their respective Affiliates, or any other Related Party, may engage in any transaction or other arrangement (including the purchase, sale, lease or exchange of any property or the rendering of any service or the establishment of any salary, other compensation or other terms of employment), whether formal or informal, with the Company (and/or any of its Subsidiaries), and the Company may engage in any such transaction, only if such transaction is at arm's length and approved by the Board, the Investors and the Class A Majority. The Company shall not, and shall cause its Subsidiaries to not, enter into, amend, alter or otherwise modify such agreements unless such amendment, alteration or modification is at arm's length and approved by the Board, the Investors and the Class A Majority.[20]

         In this case, the Related Party Provision applies to the Sales Agreement because CardUX is an Affiliate of Kleinschmidt, who was a member of the CompoSecure Board.[21]

         Further, although the parties dispute whether it applies, the Restricted Activities Provision, contained in Section 4.1(p) of the LLC Agreement, similarly requires approval of certain Restricted Activities by "[t]he Board and Investors (and during the Earnout Period, the Class A Majority)." It also defines Restricted Activities and sets forth the consequences of failing to obtain those approvals:

(p) Restricted Activities. In the third or fourth quarter of each fiscal year (and in any event by December 31 of such year), the Board shall enact an annual budget and annual business plan for the Company and its Subsidiaries for the following fiscal year, which budget and business plan shall be subject to approval by the Investors and the Class A Majority. The annual budget for each fiscal year shall include all material anticipated expenditures, including with respect to compensation (including incentive compensation, bonuses payable and bonus opportunities for that fiscal year), new hires, marketing costs, and commissions and other amounts payable to vendors and other contractors as well as budgeted EBITDA for that fiscal year. Except as set forth in such annual budget or annual business plan previously approved by the Investors and the Class A Majority, neither the Company nor any of its Subsidiaries shall undertake, nor shall agree to undertake, any of the following actions without the prior approval of the Board and Investors (and during the Earnout Period, the Class A Majority), and any action taken in contravention of the foregoing shall be void and of no force or effect whatsoever:
. . . .
(ix)(A) enter into, terminate or amend any contract, agreement, arrangement or understanding requiring the Company or any of its Subsidiaries to make expenditures in excess of $500, 000 during any fiscal year, other than in the ordinary course of business consistent with past practice . . . .[22]

         Thus, a transaction requiring expenses in excess of $500, 000 during any fiscal year and not in CompoSecure's ordinary course of business is "void and of no force or effect whatsoever," absent the requisite approvals.

         The Board never formally approved the Sales Agreement, though the Board met and discussed it in July and December 2015. Further, the "Investors"-the funds managed by LLR that held CompoSecure units-did not formally approve the Sales Agreement either, though Hollin (an LLR partner and its representative on the Board) supported the Sales Agreement.[23] Finally, Logan, who held the Class A Majority, signed the agreement in her capacity as CEO, but the record does not contain a written document, executed by Logan, reciting that the Class A Majority approved the Sales Agreement for the purpose of the LLC Agreement. Given the absence of those formal approvals, CompoSecure argues on appeal that the Sales Agreement is void.[24]

         Despite the lack of formal approvals, at least three of the four disinterested Board members-Logan, Herslow, and Hollin-believed that Logan had the authority to bind CompoSecure to the Sales Agreement. In fact, Section 11 of the LLC Agreement contained representations and warranties that the Sales Agreement had been properly authorized and executed. In commenting on the executed version, the Vice Chancellor found that, "[a]fter the parties signed the Sales Agreement, both sides treated it as valid."[25] He also found that "[t]he Sales Agreement did not contain any provisions conditioning CardUX's receipt of a commission on a link between its efforts and the sale."[26]

         D. The Amazon Sale and CompoSecure's Refusal to Pay Commissions

         After executing the Sales Agreement, CardUX began its marketing efforts with at least forty-eight approved prospects-including Amazon. Unbeknownst to CardUX, Amazon had already issued a request for a proposal for metal cards from its potential co-branding partners: Bank of America or Chase. In response to that news, Logan acknowledged, in an email to Hollin, the possibility of enormous commissions for CardUX: "Yikes. [Kleinschmidt] and [Frantz] would get 15%."[27] Logan also lamented to Hollin that CompoSecure "didn't insist on a lower commission," and Hollin replied that CompoSecure should "live with the deal as agreed."[28] Although CompoSecure enlisted CardUX's help in steering the business to Bank of America, Amazon had already agreed to a partnership with Chase by the time CardUX met with Amazon representatives.[29]

         After CompoSecure finalized the Amazon order in January 2016, Logan asked Kleinschmidt to consider taking a lower commission. Kleinschmidt refused and maintained that CardUX was entitled to a commission under the Sales Agreement. Without paying any Amazon commissions to CardUX, CompoSecure removed Kleinschmidt from the Board in May 2016 and hired litigation counsel who, for the first time, asserted that CompoSecure had not properly authorized the Sales Agreement under the Related Party and Restricted Activities Provisions.[30] Before the dispute over the Amazon Sale, Hollin and Logan had never questioned the validity of the Sales Agreement.

         CompoSecure sought a declaratory judgment in the Court of Chancery that the Sales Agreement was invalid. CardUX counterclaimed for breach of contract, alleging that CompoSecure owed it a commission for the Amazon Sale and alleging that CompoSecure failed to use commercially reasonable efforts to support CardUX's sales activity. Following a four-day trial in February 2018, the Court of Chancery held that the Sales Agreement was voidable because CompoSecure had not complied with the Related Party Provision's approval requirements contained in the LLC Agreement, but held the Sales Agreement to be enforceable, nonetheless, because it had been impliedly ratified. It held that CardUX was entitled to a commission under the plain language of the Sales Agreement, which did not require any link between CardUX's efforts and a particular sale to an "approved prospect" (as defined in the Sales Agreement).

         Shifting its "dominant narrative" in the proceedings below, which centered on the Related Party Provision, CompoSecure's central argument on appeal is that, under the Restricted Activities Provision, failure to obtain prior approval of the Sales Agreement renders the Sales Agreement void, as opposed to voidable, and as such, incapable of being ratified. [31] It also contends that the trial court erred in holding that CompoSecure ratified its failure to comply with the Related Party Provision.

         II. Analysis

         A. Standard of Review

         This Court "will uphold the trial court's factual findings unless they are clearly erroneous."[32] We review questions of law and contractual interpretation, including the interpretation of LLC agreements, de novo.[33] Since the parties do not challenge the relevant factual findings on appeal, the issues before us involve legal questions or issues of contractual interpretation, which we review de novo.

         B. The Restricted Activities Provision Is Not Merely "Cumulative"

         Although the Court of Chancery's analysis is correct as far as it goes, it did not consider whether the Sales Agreement is a "Restricted Activity," nor did it attempt to address whether the Sales Agreement would be "void and of no force or effect whatsoever" if it were a Restricted Activity. Unfortunately, the answer to this question could be a ...

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