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Stone & Paper Investors, LLC v. Blanch

Court of Chancery of Delaware

May 31, 2019

STONE & PAPER INVESTORS, LLC, individually and derivatively on behalf of CLOVIS HOLDINGS LLC, Plaintiffs,
v.
RICHARD BLANCH, VIVIANNA BLANCH, RED BRIDGE & STONE, LLC, BRIAN SKINNER, and SKINNER CAPITAL, LLC, Defendants, and CLOVIS HOLDINGS LLC, Nominal Defendant.

          Date Submitted: February 15, 2019

          Blake Rohrbacher, Brian F. Morris, and John M. O'Toole, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; David Lackowitz and Zaid Shukri, MOSES & SINGER LLP, New York, New York; Attorneys for Plaintiff.

          Catherine Damavandi, NURICK LAW GROUP, Wilmington, Delaware; Attorney for Defendants Richard Blanch, Vivianna Blanch, Red Bridge & Stone, LLC and Nominal Defendant Clovis Holdings LLC.

          MEMORANDUM OPINION

          MONTGOMERY-REEVES, VICE CHANCELLOR.

         The dispute in this action centers on the management of a small limited liability company created to produce and sell stone-based paper products. The company's business did not take off the way that the founders hoped it would. The plaintiff alleges that the defendants, who were supposed to manage the company, breached fiduciary and contractual duties by spending the company's capital on personal expenses while doing nothing to advance the company. The defendants disagree, arguing that they worked tirelessly for years on the company's behalf and that the company has not prospered because of one of the manager's serious health issues. The defendants move to dismiss on multiple grounds. For the reasons that follow, I deny the Motion to Dismiss.

         I. BACKGROUND

         I draw all facts from the Verified Complaint (the "Complaint"), the documents attached to it, and the documents incorporated by reference into it.[1] At this stage of the proceedings, I must take all of Plaintiff's well-pled facts as true and draw all reasonable inferences in its favor.

         A. The Operating Agreement

         Nominal Defendant Clovis LLC ("Clovis" or the "Company") is a Delaware limited liability company.[2] Clovis has three members: Plaintiff Stone & Paper Investors, LLC ("Stone"), a preferred member; Defendant Skinner Capital, LLC ("Capital"), a common member; and Defendant Red Bridge & Stone, LLC ("Red Bridge"), a common member.[3] Defendant Brian Skinner is and at all relevant times was a manager of Clovis and the sole member of Capital.[4] Defendant Richard Blanch is and at all relevant times was a manager of Clovis.[5] Defendant Vivianna Blanch, who is married to Richard Blanch, is and at all relevant times was the sole member of Red Bridge.[6]

         The Limited Liability Company Operating Agreement of January 1, 2014 (the "Operating Agreement"), governs Clovis.[7]

         Section 4.3 of the Operating Agreement, regarding the duties of managers, provides that "[a] Manager shall perform his duties hereunder in good faith and in a manner consistent with the requirements of the Act."[8]

         Section 4.9 of the Operating Agreement, discussing reimbursement of expenses, mandates that "[t]he Managers will receive from the Company reimbursement for all reasonable out-of-pocket expenses incurred upon submission of receipts for such expenses; provided that the reimbursement of any expense item in excess of $5, 000 shall require board approval."[9]

         Section 4.10 of the Operating Agreement, laying out rules for financial reporting to members, provides that

[t]he Company shall use commercially reasonable efforts to provide to each of the Members as soon as practicable after the end of any Fiscal Year (i) a statement of cash flows for such fiscal year, (ii) as to each Member, a report setting forth the closing Capital Accounts of each such Member and a description of the manner of their calculation, and (iii) to each Member of the Company and to each Person (or such Member's or Person's legal representative) who was a Member during any part of the Fiscal Year in question, a copy of the Member's Schedule K-1 thereto.[10]

         Section 5.2 of the Operating Agreement, discussing interested-party transactions, mandates that

[t]he Company shall not enter into an Interested Transaction (as defined below) unless it has first fully disclosed the terms and conditions of such Interested Transaction to the Board and the Members and the Board determines that the Interested Transaction is fair and reasonable to the Company and the terms and conditions are at least as favorable to the Company as those that are generally available from persons capable of similarly performing them and in similar transactions between parties operating at arm's length. An "interested transaction" means any transaction between a Member, a Manager or a member of the Board, or any Affiliate thereof, on the one hand, and the Company, on the other hand . . . .[11]

         B. The Complaint's Factual Allegations

         The Complaint sets out a detailed account of misconduct. Stone, Capital, and Red Bridge formed Clovis in 2013 to pursue a business based on making paper out of stone.[12] Stone contributed $3.5 million to the Company; the other members did not contribute capital.[13] Clovis had no revenue, so the $3.5 million represented all of the money available to the Company.[14] Richard[15] and Skinner served as the board of managers for Stone.[16]

         The Complaint alleges that soon after formation Richard and Skinner began stealing money from the Company. They charged approximately $1 million to the Company's American Express card.[17] They caused the Company to loan $240, 000 each to Red Bridge and Capital in December 2015, with no supporting documentation.[18] Richard and Skinner also caused the Company to loan them $600, 000 in July 2016.[19] The Company loaned a total of $1.02 million in 2016.[20] In or around October 2016, Skinner and Richard asked the Company's accountant to reclassify additional previous payments as loans.[21] Defendants took a total of $2, 481, 500.[22] Plaintiff alleges that Richard and Skinner did no work for the Company in exchange for those payments, loans, and American Express charges.[23]

         The Complaint also alleges that Vivianna and Red Bridge participated in the theft. From some point in 2014 through September 2015, the Company paid Red Bridge $20, 000 per month, but neither Red Bridge nor Vivianna, its sole member, provided any services to the Company.[24]

         Skinner and Richard also repeatedly reclassified loans as guaranteed payments and vice versa.[25] Skinner and Richard initially classified some $891, 500 of the money that went to Red Bridge as "guaranteed payments," but later reclassified that $891, 500 as loans.[26] In January 2018, Skinner forgave $310, 000 in loans to Capital by instructing the new accountant to recharacterize the loans from 2016 as payments.[27] In February 2018, Skinner instructed the Company's accountant to recharacterize another $295, 000 in loans to Capital as payments.[28]

         In addition to stealing from the Company, Defendants attempted to conceal their actions from other members. For instance, Skinner and Richard withheld information from Stone in contravention of the terms of Section 4.10 of the Operating Agreement.[29] They also carried out interested-party transactions without disclosing that to the members, including Stone, in contravention of the terms of Section 5.2 of the Operating Agreement.[30] They provided Stone with misleading tax documents.[31] These documents reflected loans as assets but failed to disclose that the assets were largely comprised of loans to Richard and Skinner.[32] To further hide the theft, Richard and Skinner fired the Company's accountant for refusing to reclassify some guaranteed payments as loans.[33]

         On May 18, 2018, Stone sought additional financial documents from Clovis, which Clovis declined to provide.[34] This litigation soon followed.

         C. Procedural History

         On May 31, 2018, Stone filed its Complaint. The Complaint asserts multiple claims: a direct claim against Richard and Skinner for breaches of contract based on Sections 4.9 and 5.2 of the Operating Agreement (Count One); a derivative claim against Richard and Skinner for breaches of contract based on Sections 4.3, 4.9, and 5.2 of the Operating Agreement (Count Two); a derivative claim against Richard and Skinner for breaches of fiduciary duty (Count Three); and a derivative claim against Capital, Red Bridge, and Vivianna for aiding and abetting breaches of fiduciary duties (Count Four).

         On July 3, 2018, Richard, Vivianna, Red Bridge, and Clovis (collectively, "Movants") moved to dismiss the Complaint (the "Motion to Dismiss").[35] On February 15, 2019, I held oral argument on the Motion to Dismiss.

         II. ANALYSIS

         Movants move to dismiss for failure to make demand or plead demand futility, for failure to state a claim under Court of Chancery Rule 12(b)(6), for false and misleading allegations under Court of Chancery Rules 3(aa) and 41(b), and for unclean hands.

         A. Demand Is Excused as Futile

         1. Count One states both direct and derivative claims

         In Count One, Plaintiff alleges that Richard and Skinner breached Sections 4.9 and 5.2 of the Operating Agreement. Plaintiff alleges that Richard and Skinner failed to fully disclose interested transactions as Section 5.2 requires and failed to obtain board approval for out-of-pocket expenses as Section 4.9 requires. Movants argue that Count One states a derivative claim, although it is pled as a direct claim, and that the Complaint fails to meet the pleading standards for asserting a derivative claim.

         When analyzing whether a claim is direct or derivative, "[t]he Court will independently examine the nature of the wrong alleged and any potential relief to make its own determination of the suit's classification. This determination is for the Court to make based upon the body of the complaint; plaintiffs' designation of the suit is not binding."[36]

         In order to determine the nature of the claim, the Court must first assess whether a claim belongs to the plaintiff personally or to the entity. As the Delaware Supreme Court has recently stated,

Tooley and its progeny deal with the narrow issue of whether a claim for breach of fiduciary duty or otherwise to enforce the corporation's own rights must be asserted derivatively or directly. Before evaluating a claim under Tooley, "a more important initial question has to be answered: does the plaintiff seek to bring a claim belonging to her personally or one belonging to the corporation itself?" Because the . . . claims at issue here belong to the holding stockholders under the state laws that govern the claims, . . . Tooley does not affect our [decision].[37]

         If the claim belongs to the entity, the Tooley test applies. In order to determine whether a claim is direct or derivative, the Delaware Supreme Court held in Tooley that the Court must apply a two-part test: "(1) who suffered the alleged harm (the company or the suing stockholder, individually); and (2) who would receive the benefit of any recovery or other remedy (the company or the stockholder, individually)."[38] The same principles apply in the context of an alternative entity such as a limited liability company.[39]

         Stone attempts to assert direct claims for purported breaches of Sections 5.2 and 4.9 of the Operating Agreement. Section 5.2 requires the Company to disclose terms and conditions of any interested transaction to its members, including Stone, before carrying it out. This is a personal right belonging to the members, and Stone may bring its claim directly.

         Section 4.9 provides for reimbursement for reasonable expenses, with board approval required for expenses above $5, 000. The Company holds this right; therefore, the Tooley test applies. Under Tooley, the Court must first determine who suffered the alleged harm. Here, the Company suffered harm by reimbursing expenses without assessing whether they were reasonable and without board approval for large expenses. Second, the Court must determine who would receive the benefit of a recovery. Any recovery related to improperly paid expenses would flow to the Company. Thus, the claim for breach of Section 4.9 of the Operating Agreement is derivative.

         2. Demand is futile

         Plaintiff asserts Counts Two, Three, and Four, for breach of contract, breaches of fiduciary duties, and aiding and abetting breaches of fiduciary duties, derivatively on behalf of the Company. In addition, I held above that the portion of Count One claiming breach of Section 4.9 of the Operating Agreement is derivative.

         The Delaware Limited Liability Company Act requires that a member may only pursue claims derivatively on behalf of the company if the member can demonstrate that "managers or members with authority to do so have refused to bring the action or if an effort to cause those managers or members to bring the action is not likely to succeed."[40] Delaware Court of Chancery Rule 23.1(a) provides that a derivative complaint must "allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort."[41] Case law applying Rule 23.1 in the corporate context has been deemed instructive in interpreting the LLC Act's demand requirements.[42]

         The demand requirement serves to "insure that a stockholder exhausts his intracorporate remedies, "[43] "provide a safeguard against strike suits, "[44] and "assure that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation and to control any litigation which does occur."[45] Where, as here, the plaintiff has failed to make a pre-suit demand on the board, [46] the Court must dismiss the complaint "unless it alleges particularized facts showing that demand would have been futile."[47]

         Two Delaware Supreme Court cases articulate the tests for demand futility. Rales v. Blasband[48] applies when the plaintiff challenges an action not taken by the board that would consider the demand; Aronson v. Lewis[49] applies when the plaintiff challenges an action taken by the board that would consider the demand. Here, because the claims relate to purported board actions, Aronson applies. Under Aronson, to successfully plead demand futility a plaintiff must allege particularized facts sufficient to raise a reasonable doubt that "(1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment."[50]

         A board member is considered "interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders. Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders."[51] The Court will deem a board member "'interested' for purposes of this analysis when he stood on both sides of the transaction at issue or stood to receive a material benefit that was not to be received by others."[52]

         Here, Richard and Skinner comprise the board. Stone pleads that Richard and Skinner breached their obligations under the Operating Agreement and their fiduciary duties by stealing millions of dollars from the Company for their own financial benefit and to the detriment of the Company. The Complaint alleges with specificity that Richard and Skinner stood on both sides of the challenged transactions. Stated differently, the complaint alleges that the entire board took money from the Company for their own benefit to the detriment of the Company and the other members. The Complaint's facts regarding theft fall into four categories: (1) Richard and Skinner stole money for themselves; (2) Richard and Skinner stole money for their companies; (3) Richard and Skinner stole money for Richard's spouse; and (4) Richard and Skinner stole money for Richard's spouse's company. Thus, the board is interested for all four categories. Demand, therefore, is futile as to all of the derivative claims.

         B. All Counts in the Complaint State Claims Under Rule 12(b)(6)

         Movants also move to dismiss all counts under Rule 12(b)(6), arguing that dismissal is appropriate because "the Complaint does not state any claims upon which relief may be granted. None of the claims contain specific allegations of a date or time when the wrongful actions occurred."[53] When considering a motion to dismiss under Rule 12(b)(6), this Court must "accept as true all of the well-pleaded allegations of fact and draw reasonable inferences in the plaintiff's favor."[54] While the Court must draw all reasonable inferences in the plaintiff's favor, it is not "required to accept as true conclusory allegations 'without specific supporting factual allegations.'"[55] "[D]ismissal is inappropriate unless the 'plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof."[56]

         Because I found above that demand is futile due to well-pled allegations that the entire board stole millions of dollars for its benefit and to the detriment of the Company and other members, Movants' Motion to Dismiss fails as to the derivative claims against the board members.[57] This is consistent with general guidance, which directs that "[t]he standard for pleading demand futility under Rule 23.1 is more stringent than the standard under Rule 12(b)(6)."[58] Further, "[b]ecause the standard under Rule 12(b)(6) is less stringent than that under Rule 23.1, a complaint that survives a motion to dismiss pursuant to Rule 23.1 will also survive a 12(b)(6) motion to dismiss, assuming that it otherwise contains sufficient facts to state a cognizable claim."[59]

         The Complaint also adequately alleges a direct claim for breach of Section 5.2 of the Operating Agreement. Section 5.2 provides that "[t]he Company shall not enter into an Interested Transaction (as defined below) unless it has first fully disclosed the terms and conditions of such Interested Transaction to the Board and the Members and the Board determines that the Interested Transaction is fair and reasonable to the Company."[60] "An 'interested transaction' means any transaction between a Member, a Manager or a member of the Board, or any Affiliate thereof, on the one hand, and the Company, on the other hand . . . ."[61] The Complaint alleges a series of ...


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