In a “bout between sophisticated, experienced parties who have woven a complex web of overlapping contracts, agreements, and duties,” the Court of Chancery was left to “untangle and interpret [the agreements] in order to make sense of who among these sophisticated parties owes whom what.” Kuroda v. SPJS Holdings, L.L.C., C.A. No. 4030-CC (Del. Ch. Mar. 16, 2010). read opinion here.
Kevin Brady and Ryan Newell of the Connolly Bove firm prepared this synopsis.
In so doing, the Court granted the Plaintiff’s motion to dismiss the Defendants’ counterclaims for breach of fiduciary duty, breach of contract, and breach of implied covenant of good faith and fair dealing. This decision follows a prior decision of April 15, 2009 where the Court dismissed many of plaintiff’s claims against defendants. That prior decision at 971 A.2d 872 (Del. Ch. 2009), was highlighted on this blog here.
The Complex Web
In 2001 a Feeder Fund and Master Fund (the “Funds”) were formed “to bring their investment experience and activist investor strategy to Japan.” The Feeder Fund funneled American investors to make investments in the Master Fund. The Master Fund made investments in Japanese companies. After the Funds were established, an investment banker with no fund experience, Plaintiff Kenzo Kuroda (“Kuroda”), was brought in as a consultant.
The relationship between the Funds’ founders and Kuroda was governed by the complex web of agreements among various interrelated companies and partnerships. SPJS Holdings, LLC (“SPJS Holdings”) was the Funds’ General Partner. Kuroda was a non-managing member of SPJS Holdings and had no decision-making authority for either SPJS Holdings or the Funds. Steel Partners Japan Asset Management (“SPJAM”) was the Funds’ investment manager. Steel Partners Japan, K.K. (“SPJ-KK”) – a corporation in which Kuroda was a 50% shareholder – was a consultant to SPJAM in connection with SPJAM’s role as investment manager to the Funds.
SPJ-KK was Kuroda’s vehicle for providing consulting and investment analysis to SPJAM. In this role, Kuroda had access to “high-level proprietary and confidential information relating to [SPJS Holdings] . . .” – information that Kuroda would not be privy to but for his consultancy position. In light of the exchange of information, SPJAM and SPJ-KK drafted a Consulting Agreement with a confidentiality agreement binding SPJ-KK.
In 2006, Kuroda announced that he was resigning as a consultant to SPJAM. He then formed Fugen Capital Management LLC (“Fugen”), a fund with an investment strategy similar to that used by the Funds. Allegedly, Kuroda acquired the requisite information and strategies for Fugen while consulting for SPJAM. Kuroda also hired employees from SPJAM and SPJ-KK and also downloaded a list of contacts. Moreover, SPJS Holdings soon learned that Kuroda had solicited investors before and after leaving his consultant role. Ultimately, several investors left the Funds and Kuroda received a cease-and-desist letter.
Following an action brought by Kuroda, Defendants filed counterclaims. Three of those counterclaims were the subject of Kuroda’s motion to dismiss: breach of fiduciary duty, breach of contract, and breach of implied covenant of good faith and fair dealing.
No Fiduciary Relationships, Then No Breach
In dismissing the claim for breach of fiduciary duty, the Court noted that the Defendants’ argued that fiduciary duties stemmed from the consulting agreement between SPJAM and SPJ-KK, as well as Kuroda’s role within the Funds. The Court held that the Defendants’ argument that a fiduciary relationship and related duties arose from Kuroda’s “central role” in the LLC agreement was baseless. Kuroda did not have “control, power, or authority over a single investor’s assets or the actions that SPJS Holdings took.” Nor was he a manager or controlling manager. Accordingly, there were no fiduciary duties and any duties owed were contractual.
The Court, citing a Disney reference — Alice’s Adventures In Wonderland And Through The Looking Glass, stated “[t]o believe that the parties in this complex web of contractual arrangements intended to superimpose fiduciary duties upon a nonmanaging, non-controlling LLC member would require me to surpass even the White Queen’s ability to believe six impossible things before breakfast.” See, footnote 30 (citations omitted).
If Not a Party to a Contract, Then No Breach
In dismissing the claim for breach of contract, the Court noted that the Defendants’ were relying on the operating agreement for the Funds for the alleged breach of the provisions prohibiting the disclosure of trade secrets and proprietary information. Specifically, the Defendants alleged that Kuroda used confidential information for his own benefit, including confidential market and trading strategies.
Reasoning that limited liability companies are “creatures of contract,” the Court held that the allegedly breached sections of the contracts do not allow non-managing members of SPJS Holdings to be bound to any contract. The agreements could have included language to bind members, but they did not and thus the contracts did not govern Kuroda.
Implied Covenant May Not Override Express Language in a Contract
In dismissing the claim for breach of the implied covenant of good faith and fair dealing, the Court noted that express terms of the various Funds-related agreements governed. The Defendants alleged that through the LLC Agreement that Kuroda impliedly promised, “1) not to misappropriate trade secrets; 2) not to cause SPJ-KK to commit a material breach of the Consulting Agreement’s confidentiality provision; 3) not to commit a material breach of the Fund Agreements’ confidentiality provisions; 4) not to cause SPJS Holdings to commit a material breach of the Fund Agreements’ confidentiality provision; and 5) not to engage in conduct destructive to the business of SPJS Holdings and the Funds.”
While the implied covenant “inheres in every contract,” it “cannot be invoked to override the express terms of the contract.” “[R]arely invoked successfully” the implied covenant has a “narrow purpose” and “can only be used conservatively ‘to ensure the parties ‘reasonable expectations’ are fulfilled.’” Whereas the LLC Agreement specifically excluded duties related to confidentiality and whereas other related agreements did not, there was no specific implied contractual obligation of confidentiality for Kuroda to honor.
SUPPLEMENT: Professor Larry Ribstein comments here on the fiduciary duty aspects of the case, and compares it with another case from a federal court in PA, as well as addressing the general concept of whether non-managing or non-controlling members of LLCs have fiduciary duties generally, absent clear waivers in agreements.