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P&TI Acquisition Co. Inc. v. Morgenthaler Partners VII, LP

Superior Court of Delaware

May 9, 2019

P&TI ACQUISITION COMPANY, INC. Plaintiff,
v.
MORGENTHALER PARTNERS VII, LP; and MORGENTHALER MANAGEMENT PARTNERS VII, LLC Defendants.

          Submitted: February 1, 2019

         Upon Defendants' Motion to Dismiss: Granted

          David A. Dorey, Esquire, Craig N. Haring, Esquire, of BLANK ROME LLP, Wilmington, Delaware, Steven J. Roman, Esquire, Adrien C. Pickard, Esquire, of BLANK ROME LLP, Washington, D.C., Attorneys for Plaintiff.

          Timothy Jay Houseal, Esquire, Jennifer M. Kinkus, Esquire of YOUNG CONAWAY STARGATT & TAYLOR LLP, Wilmington, Delaware, and Robert S. Faxon, Esquire, Michael A. Platt, Esquire of JONES DAY, Cleveland, Ohio, Attorneys for Defendant.

          MEMORANDUM OPINION

          LeGrow, J.

         In February 2012, Defendants and others sold a company to Plaintiff and executed a stock purchase agreement governing the sale. The stock purchase agreement precluded Defendants or their affiliates from soliciting or employing any of the acquired company's employees for a period of five years. Plaintiff contends that shortly after the stock purchase agreement's execution, Defendants' affiliates formed a new entity and solicted two key executives from the acquired company in violation of the stock purchase agreement. Plaintiff brought this suit for breach of contract and breach of the implied covenant of good faith and fair dealing. Moving Defendants contend all claims should be dismissed for failure to state a claim.

         The pending motion presents two questions: (i) whether Plaintiff adequately pleaded that Defendants and the newly-formed entity commonly are controlled by an individual who holds minority ownership interests and some level of managerial authority at both entities, and (ii) whether Plaintiff has pleaded a claim for breach of the implied covenant of good faith and fair dealing when the non-solicitation clause in the stock purchase agreement directly addresses what individuals or entities are precluded from soliciting the company's personnel.

         Here, Plaintiff has not sufficiently pleaded that an individual or "control group" commonly controls both Defendants and the newly-formed entity. Defendants and the newly-formed entity therefore are not affiliates under the terms of the stock purchase agreement, and Plaintiffs breach of contract claim must be dismissed. Additionally, the complaint fails to state a claim that Defendants breached the implied covenant of good faith and fair dealing because the stock purchase agreement directly addresses the conduct at issue.

         FACTS AND PROCEDURAL BACKGROUND

         The following facts are drawn from the complaint and the relevant entities' governing documents incorporated by reference therein.

         The Stock Purchase Agreement

         In 2012, Plaintiff P&TI Acquisition Company, Inc. ("Plaintiff) purchased PhilTem Holdings, Inc. ("PhilTem"), along with PhilTem's subsidiary, Phillips & Temro Industries, Inc. ("Phillips") from Defendant Morgenthaler Partners VII, LP ("Fund VII"), represented by its general partner, Defendant Morgenthaler Management Partners, VII, LLC ("Management VII") (collectively with Fund VII, "Defendants"). The parties executed a Stock Purchase Agreement (the "SPA") on February 9, 2012. The SPA includes a non-solicitation clause (the "Non-Solicitation Clause") that specifically provides:

During the Restricted Period, [Defendants] will not, and will cause each of his, her or its Affiliates not to, directly or indirectly, as employee, agent, consultant, director, equityholder, manager, co partner or in any other capacity without the prior written consent of [Plaintiff], employ, hire, engage, recruit or solicit for employment or engagement. . . any Person who is (or was during the one year period preceding the Closing Date) employed or engaged by [PhilTem or its subsidiaries] . . . [1]

         The Non-Solicitation Clause prohibited Defendants and their "Affiliates" from directly or indirectly soliciting or employing any of PhilTem's or Phillips's employees before February 2017. The SPA defines an "Affiliate" as "any other Person that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, such Person."[2] Additionally, the SPA defines "Control" as "the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise."[3]

         The Alleged Solicitation of Phillips Executives

         At the time the parties entered the SPA, Harry Sumpter was Phillips's CEO and Michael Ramsay was Phillips's CFO. Plaintiff alleges that in 2014 the Defendants, through their affiliate MPE Partners, LP ("MPE"), began soliciting Sumpter and Ramsay for various positions with MPE or one of its portfolio companies. Specifically, Plaintiff alleges Defendants began soliciting Sumpter to act as an acquisition consultant for MPE, a board member of dlhBOWLES (an MPE portfolio company), or a senior advisor to MPE. Additionally, Plaintiff avers Defendants began recruiting Ramsay to take a position as CFO of a company MPE planned to acquire. In 2015, MPE acquired Bowles Fluidics Corporation and DLH Industries, and Sumpter took a position on the Bowles Fluidics board of directors. Those entities merged to form dlhBOWLES, and in July 2015, Ramsay took a position as dlhBOWLES's CFO. Also in 2015, Sumpter began working as a senior advisor for MPE. Plaintiff claims MPE is Defendants' "Affiliate" under the SPA because MPE and Defendants commonly are controlled by the same individuals. Plaintiff therefore contends Sumpter and Ramsay's solicitation, recruitment, and employment by MPE before February 2017 violated the Non-Solicitation Clause.

         On August 6, 2018, Plaintiff filed a two-count complaint (the "Complaint") for breach of contract and breach of the implied covenant of good faith and fair dealing against Defendants. Defendants moved to dismiss the Complaint under Superior Court Civil Rule 12(b)(6), arguing Defendants are not MPE's "Affiliates" under the SPA and therefore did not violate the Non-Solicitation Clause.

         The Relevant Entities' Structure and Ownership

         In the Complaint, Plaintiff relies on the entities' organizational documents to prove that MPE and Defendants commonly are controlled.[4] Plaintiffs theory, repeatedly restated in the Complaint, is that Fund VII, Management VII, MPE, and dlhBOWLES "are under the common control of Taft, Tuleta, Machado, Yohe and others . . . ."[5] A brief discussion of the relevant entities' structure and ownership therefore is necessary.

         A. The Morgenthaler Defendants - Fund VII and Management VII

         Defendant Fund VII is a limited partnership and Defendant Management VII is Fund VII's general partner.[6] Management VII manages and controls all Fund VII's business decisions.[7] Management VII has Class A, B, and C members, but only Class A members have management rights. Peter Taft and seven other individuals are Management VII's Class A members. The Class A members have the power to "carry out any and all of the objects and purposes of [Management VII]" and enter into contracts on Management VII's behalf, but only in accordance with "policies established by a [m]ajority of the [m]embers."[8] Management VII's board of managers are the same eight Class A members and make decisions by majority vote. The Board of Managers' role is limited to performing specific organizational tasks, such as determining contribution amounts, admitting additional members, valuing assets, and making distributions.[9] Eight different individuals therefore manage and control Management VII, and in turn, manage and control Fund VII. Between his Class A and B units, Taft controls 9.5628% of Management VII's voting interests. Karen Tuleta is one of more than twenty Class B members and owns 0.1483% of the Class B units.

         B. MPE

         Peter Taft, Karen Tuleta, Joseph Machado, Matt Yohe, and others formed MPE in April 2012. Some or all those individuals previously held roles at Fund VII or Management VII. MPE GP, LLC ("MPE General Partner") is MPE's general partner and manages and controls all MPE's business decisions.[10] MPE also has limited partners who do not participate in MPE's management.[11] Taft, Tuleta, Machado, and Yohe do not hold any individual interest in MPE. MPE General Partner has Class A and Class B members, and Taft, Tuleta, Machado, and Yohe are among the individuals holding Class A and B units. No individual owns a majority of the units. Six other individuals or entities also own Class A units. Taft, Tuleta, and Machado are MPE General Partner's three officers, who are subject to the supervision of MPE General Partner's manager.[12] MPE General Partner delegates the authority to make business decisions to its manager, MPE Mgt. Co., LLC ("MPE Management").[13] MPE General Partner's LLC agreement allows any MPE Management member to execute documents on MPE General

          Partner's behalf, but subject to the terms of MPE Management's LLC agreement.[14]According to MPE Management's LLC agreement, all MPE Management's business decisions must be made by a unanimous vote of the board of managers.[15]Taft, Tuleta, and Machado comprise the board of managers and also are one-third members of MPE Management.

         In summary, Defendants themselves do not hold any ownership interest or managerial power in MPE or vice versa. Peter Taft and Karen Tuleta are the only individuals with any ownership interest in both Defendants and MPE. Taft is the only individual with any managerial authority at all the relevant entities. Taft, however, is only one of eight individuals with control over Defendants and one of three individuals with control over MPE.

         The Parties' Contentions

         In their motion to dismiss, Defendants contend they did not breach the Non-Solicitation Clause because they are not MPE's "Affiliates" within the meaning of the SPA. Defendants argue the organizational documents demonstrate that Defendants and MPE have separate entity structures and Defendants have no ownership interest in MPE, controlling or otherwise. According to Defendants, the Complaint also fails sufficiently to plead that some person or entity commonly controls MPE and Defendants. Defendants do not dispute that Plaintiff otherwise has pleaded a breach of contract claim, but Defendants contend the failure to sufficiently plead control is fatal to that claim. Defendants further argue the Court should dismiss Plaintiffs implied covenant claim because the contract's express terms govern the conduct at issue.

         In response to Defendants' motion, Plaintiff argues it sufficiently has alleged facts permitting a reasonable inference that Taft, Tuleta, Machado, Yohe, and others control both Defendants and MPE. Plaintiff contends the issue of control is a fact-intensive inquiry that cannot be resolved on a motion to dismiss, and Plaintiff therefore is entitled to proceed to discovery to further explore this issue. Finally, Plaintiff argues Defendants breached the implied covenant because their conduct "frustrated the central purpose" of the Non-Solicitation Clause.

         ANALYSIS

         On a motion to dismiss, the Court must determine whether the "plaintiff 'may recover under any reasonably conceivable set of circumstances susceptible of proof."[16] "If [the plaintiff] may recover, the motion must be denied."[17] A court may grant the motion if "it appears to a reasonable certainty that under no state of facts which could be proved to support the claim asserted would plaintiff be entitled to relief."[18] When applying this standard, the Court will accept as true all non-conclusory, well-pleaded allegations.[19] In addition, "a trial court must draw all reasonable factual inferences in favor of the party opposing the motion."[20] The Court, however, is not required to accept every "strained interpretation of the allegations proposed by the plaintiff and "a claim may be dismissed if allegations in the complaint or in the exhibits incorporated into the complaint effectively negate the claim as a matter of law."[21]

         A. Because no individual or entity owns a majority interest in Defendants and MPE, Plaintiff must plead that one or more individuals dominates or controls those entities with voting or managerial power that effectively precludes the other managers or members from acting independently.

         Plaintiffs breach of contract claim turns on whether some individual or entity commonly controls Defendants and MPE. The SPA defines "Control" as "the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise."[22] The parties agree this contractual definition effectively adopts the meaning of control Delaware courts apply when deciding whether a corporation has a controlling stockholder.

         Under Delaware law, a controlling stockholder exists when "(1) [the stockholder] owns more than 50% of the voting power of a corporation or (2) owns less than 50% of the voting power of the corporation but 'exercises control over the business affairs of the corporation.'"[23] If the stockholder does not own more than 50% of the voting power, the complaint must contain well-pleaded facts showing the minority stockholder "exercised actual domination and control over . . . [the] directors" and the minority controller's power must be "so potent that independent directors . . . cannot freely exercise their judgment."[24] Allegations suggesting the purported controller has power over day-to-day management are not enough; the plaintiff also must allege facts to support a reasonable inference that the individual controls the board of directors or an equivalent governing body.[25] The alleged control may exist over the entire entity or over a specific challenged transaction.[26] Although control ultimately is a factual issue that can be difficult to resolve on the pleadings, the Court will dismiss the Complaint if the well-pleaded allegations do not permit a reasonable inference of control.[27]

         At oral argument, Plaintiff acknowledged that the Court must apply the applicable pleading standard under Superior Court Civil Rule 12(b)(6) and Delaware precedent examining control. Plaintiff noted, however, that most of the cases the parties cited involved corporations subject to public disclosure requirements, and the plaintiffs in those cases therefore had access to substantially more information regarding control, individual relationships, and the internal workings of the companies at issue. The Defendants in this case, on the other hand, are private entities, and Plaintiff therefore contends it is unreasonable to expect more detailed allegations without an opportunity for discovery.

         The Court rejects the principle that the pleading standard for control differs depending on whether an entity is public or private. A pleading standard that varied based on an entity's status as public or private would be arbitrary and unworkable. For example, even Plaintiff conceded at oral argument that the depth of companies' public filings greatly differs. Plaintiffs proposed pleading standard effectively would require the Court to measure the specificity of a company's public filings before deciding whether the complaint sufficiently pleaded a claim. In short, it is axiomatic that Plaintiff must meet the existing pleading standard for control under Rule 12(b)(6) and sufficiently state a claim before being given an opportunity for discovery.[28]

         B. Plaintiff has not sufficiently pleaded that Defendants and ...


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