In R&R Capital, LLC v. Merritt, No. 3989-CC (Del. Ch. Sept. 3, 2009), read letter decision here, the Court: (i) granted plaintiffs’ motion for summary judgment on their claim that defendant Merritt was properly removed as the manager of the several limited liability companies (“LLC”); and (ii) entered an order appointing a receiver to wind up the business and affairs of those LLCs.
Kevin Brady, a highly regarded Delaware litigator, provides the synopsis for this case.
A prior opinion in this case by the Court of Chancery, highlighted on this blog here, discussed the contractual flexibility of the LLC Act and detailed the public policy analysis regarding the LLC Act. That opinion is recommended reading for the Court’s view of the “theoretical underpinnings” that set the parameters for drafting an LLC agreement.
Defendant Linda Merritt was the manager of various Delaware limited liability companies (the “Entities”). Merritt was a member and the manager of the Entities since they were formed. Plaintiffs also are members of the Entities. Merritt was the only manager of the Pandora Entities and PDF Properties, LLC was its sole member. Plaintiffs had certain contractual rights under the operating agreements of the Pandora Entities. However, as characterized by the Court, “the working relationship of the Entities’ members is, to put it mildly, dysfunctional and beyond repair or reconciliation.”
In 2007, Merritt allegedly told plaintiffs that she was selling real estate for approximately $300K and that plaintiffs would receive approximately $130K and Merritt would get approximately $150K from that sale. Plaintiffs contested the distribution of the sale proceeds, but Merritt sold the property without plaintiffs’ consent and without making any distribution to plaintiffs. Although Merritt claimed that the sale proceeds were used to pay LLC expenses, Merritt did not provide an accounting to show these payments. In addition, the parties disagreed over Merritt’s management of Grays Ferry Properties, LLC and the Pandora Entities.
Plaintiffs claimed that:
(1) Merritt failed to timely pay city, state and/or federal taxes related to the Entities, (2) there are outstanding judgments and/or liens against the Entities as a result of Merritt’s conduct, and (3) many of the Entities have had their certificates of formation cancelled by the State of Delaware for failing to pay their required annual taxes or for failing to maintain a registered agent for service of process.
In turn, Merritt brought a number of grievances with respect to plaintiffs’ conduct.
Notice of Removal Sent
In August 2008, Plaintiffs sent Merritt a notice of removal as manager of the Entities under the “for Cause” section of the Entities’ operating agreements, which permitted removal for cause where the manager “(a) engaged in fraud or embezzlement, (b) committed an act of dishonesty, gross negligence, willful misconduct, or malfeasance that has had a material adverse effect on the Company or any other Member, or (c) been convicted of any felony.”
The notice of removal was sent because of allegations that Merritt had committed fraud in a transaction involving the sale of thoroughbred horses to R&R Capital, LLC (“R&R”). At the time, this alleged fraud was the basis of a lawsuit in the Eastern District of Pennsylvania brought by R&R. At the time of the notice, Merritt was not immediately removed, but was allowed to remain as the manager pending the decision of the Eastern District, which ultimately held that Merritt had committed fraud.
Court Rejects Merritt’s Defenses
In granting Plaintiffs’ motion for summary judgment, the Court rejected Merritt’s three arguments. First, the Court disagreed that the Plaintiffs were estopped by res judicata, collateral estoppel, or judicial estoppel. While the Plaintiffs had raised fraud allegations in another matter in New York, that issue was not decided and thus the finality requirement for these three defenses was not satisfied.
Second, the Court held that in the straightforward unambiguous reading of the operating agreements, the material adverse effect clause represented an individual basis for removal, separate from the fraud basis. Merritt alleged that for cause removal was permissible only if the fraud was accompanied by a material adverse effect. However, the Court disagreed in favor of the plain language of the Operating Agreements.
Finally, the Court discarded Merritt’s “last ditch effort” to claim that “the August 2008 notice was not immediately effective because there was never a judicial finding of ‘cause’ when the notice was sent to her. . . .” The Court held that the notice was proper and effective because Merritt was not removed immediately but rather remained as manager pending a finding of fraud by the Eastern District.
Summary Judgment Granted and Receiver Appointed.
The Court noted that the removal of Merritt as the manager would not be the end of the problem. The Court stated that because Merritt was still a member of the Entities and given the lack of any relationship among the members, the Court required the parties to submit the name of a potential receiver to wind up the Entities.