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JJS, Ltd. v. Steelpoint CP Holdings, LLC

Court of Chancery of Delaware

October 11, 2019

JJS, LTD., PPS INVESTORS, LTD. L.P., and JOHN SARKISIAN, Plaintiffs,
v.
STEELPOINT CP HOLDINGS, LLC, PRO PERFORMANCE SPORTS, LLC, JAMES CACCAVO, GARRETT POTTER, TIMOTHY BROADHEAD, TIMOTHY WISEMAN, and DOES 1 through 20, Defendants.

          Submitted: July 8, 2019

          Stamatios Stamoulis, STAMOULIS & WEINBLATT LLC, Wilmington, Delaware; William J. Caldarelli, CALARELLI HEJMANOWSKI PAGE & LEER LLP, San Diego, California; Counsel for Plaintiffs JJS, Ltd., PPS Investors, Ltd. L.P., and John Sarkisian.

          Matthew W. Murphy, Nicole M. Henry, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Counsel for Defendants Pro Performance Sports, LLC, James Caccavo, Garrett Potter, Timothy Broadhead, and Timothy Wiseman.

          Bradley R. Aronstam, R. Garrett Rice, ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Counsel for Defendant Steelpoint CP Holdings, LLC.

          MEMORANDUM OPINION

          McCORMICK, V.C.

         In July 2018, the Pro Performance Sports, LLC Board of Managers approved an asset sale for $40 million in cash. Under the LLC Agreement, the company's senior preferred unitholder would receive the entirety of the sale consideration, and the common unitholders would be "out of the money." Three common unitholders commenced this litigation challenging the transaction. Their primary gripe is that the defendants breached the LLC Agreement by failing to subject the transaction to the approval of the common unitholders voting as a separate class. Alternatively, the plaintiffs seek reformation of the LLC Agreement to impose a separate class voting right. They further claim that the defendants breached their fiduciary duties in structuring and approving the transaction.

         The defendants have moved to dismiss the complaint for failure to state a claim. They argue that the plaintiffs' voting rights claims falter under the plain language of the LLC Agreement, the reformation claims lack any well-pled factual support, and the fiduciary duty claims are duplicative of the contractual claims and fail for that reason. This decision concludes that the defendants' interpretation of the LLC Agreement carries the day and that the plaintiffs have not adequately pled a basis for reformation. Yet the plaintiffs have managed to sufficiently plead a claim for breach of fiduciary duty that is not foreclosed by their contractual claims. In what ultimately amounts to a pruning exercise, this decision denies the defendants' motion to dismiss as to a limited claim and grants the remainder of the motion.

         I. FACTUAL BACKGROUND

         The background facts are drawn from the operative complaint (the "Complaint") and exhibits to the Complaint.[1]

         A. The Voting Rights Provisions

         In 2012, Steelpoint Capital Partners, LP ("Steelpoint") expressed an interest in investing in Pro Performance Sports ("Pro Performance" or the "Company"), a company formed by Plaintiffs John Sarkisian and JJS, Ltd. to market and sell sports and fitness training products. Beginning in 2013, Steelpoint agreed to invest cash at various times in exchange for Pro Performance units. Ultimately, Steelpoint acquired Pro Performance Series A Preferred Units, Series B Preferred Units, Series C Preferred Units, and Series B Common Units. Steelpoint held these investments through affiliates.[2]

         The terms of Steelpoint's initial equity investment were memorialized in a July 2013 term sheet (the "Term Sheet").[3] The parties then formalized their agreement in October 2013 by executing the Limited Liability Company Agreement of Pro Performance Sports (the "Original LLC Agreement").[4] The LLC Agreement was amended in March 2016 (resulting in the "First Amended LLC Agreement"), [5]and again in early 2017 (resulting in the "Operative LLC Agreement").[6]

         Each of these agreements contain provisions governing the voting rights of classes of Pro Performance unitholders, as described below.

         1. The Term Sheet

         The Term Sheet reflects an intent to grant each class of units separate class voting rights. It provides that "[a]pproval by the holder of each class of Units, voting as a separate class, will be required" to accomplish certain member actions.[7] The Term Sheet further provides that "[o]ther issues subject to voting rights of the Common Units shall be determined by the majority of the outstanding Common Units with the Preferred Units voting together with the Common Units on an as converted basis."[8]

         2. The Original LLC Agreement

         Compared to the Term Sheet, the voting rights provision contained in Section 9.13 of the Original LLC Agreement varies in one important respect: it does not include the comparable provision calling for the various unit classes "voting as a separate class" as to certain member actions.

         Instead, the Original LLC Agreement contains detailed provisions governing voting rights to be held by the various unit classes related to "Major Member Decisions."[9] As to Major Member Decisions, Section 9.13 provides:

The Company shall not, without the approval of the Series A Preferred Unitholder and the majority of the holders of the Series A Common Units and Series B Common Units . . . (e) authorize any action that would result in the Company making Liquidating Distributions if the Series A Preferred Unitholder would, in the aggregate, receive less than three (3) times the Series A Preferred Investment Amount . . . .[10]

         This change to the parties' voting rights was made in Section 9.13 concerning Major Member Decisions only; it was not made applicable to all voting matters under the Original LLC Agreement. As to most other voting matters, a majority vote of all unitholders voting together was required;[11] as to some, the "voting as a separate class" language set forth in the Term Sheet was adopted.[12]

         3. The First Amended LLC Agreement and the Operative LLC Agreement

         Between March 2016 and early 2017, Steelpoint acquired Series B Preferred Units and Series C Preferred Units (each a newly created unit).[13] These additional investments were memorialized in the First Amended LLC Agreement[14] and then the Operative LLC Agreement.[15]

         Beyond the new classes of Preferred Units, the fundamental structure of the intervening and ultimate LLC agreements does not differ from that of the Original LLC Agreement.[16] The only change to the voting structure in each agreement is the inclusion of the holders of the newly authorized and issued equity following the "majority of the holders" phrase under Section 9.13.

         Thus, Section 9.13 of the First Amended LLC Agreement provides:

The Company shall not, without the approval of the Series A Preferred Unitholder and the majority of the holders of the Series B Preferred Units and the Voting Common Units . . . (e) authorize any action that would result in the Company making Liquidating Distributions if the Series A Preferred Unitholder would, in the aggregate, receive less than three (3) times the Series A Preferred Investment Amount . . . .[17]

         And Section 9.13 of the Operative LLC Agreement provides:

The Company shall not, without the approval of the Series A Preferred Unitholder and the majority of the holders of the Series B Preferred Units, the Series C Preferred Units and the Voting Common Units . . . (e) authorize any action that would result in the Company making Liquidating Distributions if the Series A Preferred Unitholder would, in the aggregate, receive less than three (3) times the Series A Preferred Investment Amount . . . .[18]

         B. The Implus Transaction

         In April 2018, following a failed advisor-led process, the Company received an indication of interest from Implus Footcare, LLC ("Implus"). The Pro Performance Board of Managers (the "Board") approved engaging in negotiations with Implus during an April 2018 call.

         In May 2018, Implus expressed interest in pursuing a transaction in which it would purchase the inventory and most of the operating assets of Pro Performance for $40 million. Despite the efforts of the Company's financial advisor to solicit other potential bidders, Implus's $40 million offer remained the "highest bidder on the list."[19]

         At a July 2018 meeting, the Board voted to proceed with the Implus transaction by a vote of four-to-two. At the time, the Board comprised: the Company's CEO, Timothy Wiseman; Steelpoint's three Board nominees, James Caccavo, Garrett Potter, and Timothy Broadhead (with Wiseman, the "Individual Defendants"); Plaintiff Sarkisian; and non-party Baron Hurdelin-Doherty (an appointee of the Series A Common Unitholders). Wiseman, Caccavo, Potter, and Broadhead voted in favor of the transaction. Sarkisian and Hurdelin-Doherty opposed.

         Shortly before the Board approved the Implus transaction, the Board authorized and distributed to Wiseman a severance package of $600, 000. Plaintiffs allege that this one-time severance payment was equivalent to two years of Wiseman's salary and "outside the historical norm of severance payments ever made by the Company at any time in its history."[20]

         Steelpoint, as the sole Series A Preferred Unitholder, approved the Implus transaction. Joining Steelpoint were the holders of more than 55% of the combined Series B Preferred, Series C Preferred, and Voting Common Units (representing the Series A Common and Series B Common Unitholders).[21]

         C. Plaintiffs' Inspection Demand

         On November 8, 2018, Sarkisian, individually as a member of the Company's Board and on behalf of JJS, Ltd. and PPS Investors, Ltd., L.P., as unitholders of the Company, sent to Pro Performance a demand to inspect eight specific categories of documents related to the Implus transaction. Pro Performance responded through a letter from outside counsel on November 15, 2018. The November 15 response identified numerous deficiencies in the demand but stated that the Company was willing to produce certain categories of documents.

         D. This Litigation

         While Pro Performance was in the process of collecting and reviewing the documents in response to Plaintiffs' books-and-records demand, Plaintiffs commenced this litigation against Steelpoint, Pro Performance, and the Individual Defendants (collectively, "Defendants").[22]

         The Complaint asserts six causes of action.

• First, breach of fiduciary duties in connection with the Implus transaction;
• Second, breach of Section 9.13 of the Operative LLC Agreement;
• Third, declaratory relief that the Implus transaction required the approval of the majority of the Voting Common Units;
• Fourth, breach of the Operative LLC Agreement's implied covenant of good faith and fair dealing in connection with the structure, approval and fairness of the Implus transaction as well as the Board's response to Plaintiffs' books and records demand;
• Fifth, reformation of the Operative LLC Agreement to impose the voting rights Plaintiffs seek to enforce; and
• Sixth, breach of Section 18-305 of the LLC Act and Section 7.3 of the Operative LLC Agreement concerning inspection of books and records.

         Defendants moved to dismiss the Complaint on February 25, 2019, pursuant to Court of Chancery Rule 12(b)(6). The Court heard oral arguments on Defendants' motion on July 8, 2019.

         II. LEGAL ANALYSIS

         Under Rule 12(b)(6), the Court may grant a motion to dismiss for failure to state a claim if a complaint does not allege facts that, if proven, would entitle the plaintiff to relief.[23] "[T]he governing pleading standard in Delaware to survive a motion to dismiss is reasonable 'conceivability.'"[24] When considering such a motion, the Court must "accept all well-pleaded factual allegations in the [c]omplaint as true . . ., draw all reasonable inferences in favor of the plaintiff, and deny the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof."[25] The reasonable conceivability standard asks whether there is a possibility of recovery.[26] The Court, however, need not "accept conclusory allegations unsupported by specific facts or . . . draw unreasonable inferences in favor of the non-moving party."[27]

         In applying the Rule 12(b)(6) standard, this decision first tackles Plaintiffs' core claim-that Defendants violated the Voting Common Unitholders' alleged right to a separate class vote on the Implus transaction (the Second and Third Causes of Action). This decision then turns to the remaining claims for breach of information rights (Sixth Cause of Action), breach of the implied covenant (Fourth Cause of Action), reformation (Fifth Cause of Action), and, finally, breach of fiduciary duties (First Cause of Action).

         A. Breach of Plaintiffs' Voting Rights

         Plaintiffs claim that the Implus transaction was a Major Member Decision subject to Section 9.13 of the Operative LLC Agreement. They further claim that Defendants breached Section 9.13 by failing to obtain the approval of the majority of the holders of the Voting Common Units (the "common unitholders") before consummating the Implus transaction. For the purpose of their motion to dismiss, Defendants do not dispute that the Implus transaction was a Major Member Decision subject to Section 9.13.[28] Rather, they argue that Section 9.13 does not grant a separate class vote to the common unitholders on Major Member Decisions.

         This decision's factual background section excerpted Section 9.13 to track the relevant amendments to its language. For the purpose of interpreting Section 9.13, the full text is useful. In full, Section 9.13 of the Operative LLC Agreement provides:

Major Member Decisions. The Company shall not, without the approval of the Series A Preferred Unitholder and the majority of the holders of the Series B Preferred Units, the Series C Preferred Units and the Voting Common Units (with Units held by the Company or any Subsidiary not being considered to be outstanding for this purpose) (a) amend, restate or otherwise modify the Certificate, (b) amend, restate or otherwise modify this Agreement, (c) purchase, redeem or otherwise acquire any Series B Common Units, (d) declare or pay Operating Distributions (other than Tax Distributions) with respect to the Series A Preferred Units (however, item (d) will terminate if and when the Series A Preferred Unitholder no longer has the right to elect a majority of the Company's Board of Managers), (e) authorize any action that would result in the Company making Liquidating Distributions if the Series A Preferred Unitholder would, in the aggregate, receive less than three (3) times the Series A Preferred Investment Amount (however, item (e) shall terminate eight years after the Securities Purchase Effective Date).[29]

         The emphasized language-"majority of the holders"-contains no inherent distributive instructions, nor is it followed by a distributive phrase. Each side seeks to impose a distributive phrase. Plaintiffs argue that Section 9.13 requires approval of Major Member Decisions by: (a) the Series A Preferred Unitholder; and (b) the majority of the holders of each of the Series B Preferred Units, the Series C Preferred Units, and the Voting Common Units. Defendants argue that Section 9.13 requires that Major Member Decisions be approved by: (a) the Series A Preferred Unitholder (Steelpoint); and (b) the majority of holders of the combined total of the Series B Preferred Units, the Series C Preferred Units, and the Voting Common Units.

         Limited liability companies are creatures of contract and are thus subject to "applicable rules of contract interpretation."[30] Delaware courts follow the objective theory of contracts, giving words "their plain meaning unless it appears that the parties intended a special meaning."[31] In practice, the objective theory of contracts requires that a court "give priority to the parties' intentions as reflected in the four corners of the agreement, construing the agreement as a whole and giving effect to all its provisions."[32] In so doing, the court evaluates the relevant provision's semantics, syntax, and context, aided by interpretive canons.

         Three contextual canons of interpretation are particularly useful in revealing the meaning of Section 9.13. The first canon in play is the whole-text canon, or the overarching principle that context is the primary determinant of meaning, and that the structure and relationship of the parts of a contract reveal the drafters' intent.[33]The second canon is the surplusage canon, which instructs that "[c]ontractual interpretation operates under the assumption that the parties never include superfluous verbiage in their agreement, and that each word should be given meaning and effect by the court."[34] The third canon is the presumption of consistent usage, which provides that "absent anything indicating a contrary intent, the same phrase should be given the same meaning when it is used in different places in the same contract."[35]

         Evaluating the whole text of Section 9.13 shows that the drafters intended to convey special rights concerning Major Member Decisions to the Series A Preferred Unitholder. In addition to language of the first clause, Section 9.13 singles out the Series A Preferred Unitholder two other times in Subsections (d) and (e). Subsection (d) provides that the Company may not "declare or pay Operating Distributions (other than Tax Distributions) with respect to the Series A Preferred Units" absent the requisite vote. Subsection (e) provides that the Company may not authorize "Liquidating Distributions if the Series A Preferred Unitholder would, in the aggregate, receive less than three (3) times the Series A Preferred Investment Amount" absent the requisite vote. Because two of the Major Member Decisions listed in Section 9.13 provide unique rights concerning the Series A Preferred Unitholder, it is sensible that the first clause be interpreted to vest the Series A Preferred Unitholder with unique class voting rights, as Defendants argue.

         The surplusage canon compels the same conclusion. Under Plaintiffs' interpretation of Section 9.13, the approval of a majority of each class of Unitholders, voting as separate classes, is required for all Major Member Decisions.[36] But, again, the structure of the first clause of Section 9.13 singles out the Series A Preferred Unitholder, providing that "[t]he Company shall not, without the approval of the Series A Preferred Unitholder," do certain things. Reading Section 9.13 to render all classes of unitholders entitled to a separate class vote would impermissibly reduce this emphasized language to "mere surplusage."[37] By contrast, reading Section 9.13 to convey class voting rights uniquely to the Series A Preferred Unitholder, as Defendants urge, gives meaning to all aspects of the provision.

         The presumption of consistent usage further supports Defendants' interpretation. While the phrase "voting separately as a class" appears nowhere in Section 9.13, that phrase (or substantively identical language) appears in numerous other sections of the Operative LLC Agreement where the parties intended ...


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