Auriga Capital Corp. v. Gatz Props., LLC

• Decision Date: 27 January 2012
• Docket Number: No. C.A. 4390–CS.,C.A. 4390–CS.
• Citation: 40 A.3d 839
• Parties: AURIGA CAPITAL CORPORATION, a Delaware corporation, Paul Rooney, Hakan Sokmenseur, Don Kyle, Ivan Benjamin and Glenn Morse, Plaintiffs, v. GATZ PROPERTIES, LLC, a Delaware limited liability company, and William A. Gatz, Defendants.
• Court: Court of Chancery of Delaware

40 A.3d 839

AURIGA CAPITAL CORPORATION, a Delaware corporation, Paul Rooney, Hakan Sokmenseur, Don Kyle, Ivan Benjamin and Glenn Morse, Plaintiffs,

v.GATZ PROPERTIES, LLC, a Delaware limited liability company, and William A. Gatz, Defendants.

No. C.A. 4390–CS.

Court of Chancery of Delaware.

Submitted: Dec. 21, 2011.Decided: Jan. 27, 2012.

John L. Reed, Esquire, R. Craig Martin, Esquire, K. Tyler O'Connell, Esquire, DLA Piper LLP, Wilmington, Delaware, Attorneys for Plaintiffs.

Steven L. Caponi, Esquire, Elizabeth A. Sloan, Esquire, Blank Rome LLP, Wilmington, Delaware; Collins J. Seitz, Jr., Esquire, Seitz Ross Aronstam & Moritz LLP, Wilmington, Delaware, Attorneys for Defendants.

OPINION

STRINE, Chancellor.

I. Introduction

The manager of an LLC and his family acquired majority voting control over both classes of the LLC's equity during the course of its operations and thereby held a veto over any strategic option. The LLC was an unusual one that held a long-term lease on a valuable property owned by the manager and his family. The leasehold allowed the LLC to operate a golf course on the property.

The LLC intended to act as a passive operator by subleasing the golf course for operation by a large golf management corporation. A lucrative sublease to that effect was entered in 1998. The golf management corporation, however, was purchased early in the term of the sublease by owners that sought to consolidate its operations. Rather than invest in the leased property and put its full effort into making the course a success, the management corporation took short cuts, let maintenance slip, and evidenced a disinterest in the property. By as early as 2004, it was clear to the manager that the golf management corporation would not renew its lease.

This did not make the manager upset. The LLC and its investors had invested heavily in the property, building on it a first-rate Robert Trent Jones, Jr.—designed golf course and a clubhouse. If the manager and his family could get rid of the investors in the LLC, they would have an improved property, which they had reason to believe could be more valuable as a residential community. Knowing that the golf management corporation would likely not renew its sublease, the manager failed to take any steps at all to find a new strategic option for the LLC that would protect the LLC's investors. Thus, the manager did not search for a replacement management corporation, explore whether the LLC itself could manage the golf course profitably, or undertake to search for a buyer for the LLC. Indeed, when a credible buyer for the LLC came forward on its own and expressed a serious interest, the manager failed to provide that buyer with the due diligence that a motivated seller would typically provide to a possible buyer. Even worse, the manager did all it could to discourage a good bid, frustrating and misleading the interested buyer.

The manager then sought to exploit the opportunity provided by the buyer's emergence to make low-ball bids to the other investors in the LLC on the basis of materially misleading information. Among other failures, the manager made an offer at $5.6 million for the LLC without telling the investors that the buyer had expressed a willingness to discuss a price north of $6 million. The minority investors refused the manager's offer. When the minority investors asked the manager to go back and negotiate a higher price with the potential buyer, the manager refused.

This refusal reflected the reality that the manager and his family were never willing to sell the LLC. Nor did they desire to find a strategic option for the LLC that would allow it to operate profitably for the benefit of the minority investors. The manager and his family wanted to be rid of the minority investors, whom they had come to regard as troublesome bothers.

Using the coming expiration of the golf management corporation's sublease as leverage, the manager eventually conducted a sham auction to sell the LLC. The auction had all the look and feel of a distress sale, but without any of the cheap nostalgic charm of the old unclaimed freight tv commercials. Ridiculous postage stamp-sized ads were published and unsolicited junk mail was sent out. Absent was any serious marketing to a targeted group of golf course operators by a responsible, mature, respected broker on the basis of solid due diligence materials. No effort was made to provide interested buyers with a basis to assume the existing debt position of the LLC if they met certain borrower responsibility criteria. Instead, interested buyers were told that they would have to secure the bank's consent but were given an unrealistic amount of time to do so. Worst of all, interested buyers could take no comfort in the fact that the manager—who controlled the majority of the voting power of the LLC—was committed to selling the LLC to the highest bidder, as the bidding materials made clear that the manager was also planning to bid and at the same time reserved the right to cancel the auction for any reason.

When the results of this incompetent marketing process were known and the auctioneer knew that no one other than the manager was going to bid, the auctioneer told the manager that fact. The manager then won with a bid of $50,000 in excess of the LLC's debt, on which the manager was already a guarantor. Only $22,777 of the bid went to the minority investors. For his services in running this ineffective process, the auctioneer received a fee of $80,000, which was greater than the cash component of the winning bid. Despite now claiming that the LLC could not run a golf course profitably and pay off the mortgage on the property, the manager has run the course himself since the auction and is paying the debt.

A group of minority investors have sued for damages, arguing the manager breached his contractual and fiduciary duties through this course of conduct. The manager, after originally disclaiming that he owed a fiduciary duty of loyalty to the minority, now rests his defense on two primary grounds. The first is that the manager and his family were able to veto any option for the LLC as their right as members. As a result, they could properly use a chokehold over the LLC to pursue their own interests and the minority would have to live with the consequences of their freedom of action. The second defense is that by the time of the auction, the LLC was valueless.

In this post-trial decision, I find for the plaintiffs. For reasons discussed in the opinion, I explain that the LLC agreement here does not displace the traditional duties of loyalty and care that are owed by managers of Delaware LLCs to their investors in the absence of a contractual provision waiving or modifying those duties. The Delaware Limited Liability Company Act (the “LLC Act”) explicitly applies equity as a default ¹ and our Supreme Court, and this court, have consistently held that default fiduciary duties apply to those managers of alternative entities who would qualify as fiduciaries under traditional equitable principles, including managers of LLCs. Here, the LLC agreement makes clear that the manager could only enter into a self-dealing transaction, such as its purchase of the LLC, if it proves that the terms were fair. In other words, the LLC agreement essentially incorporates a core element of the traditional fiduciary duty of loyalty. Not only that, the LLC agreement's exculpatory provision makes clear that the manager is not exculpated for bad faith action, willful misconduct, or even grossly negligent action, i.e., a breach of the duty of care.

The manager's course of conduct here breaches both his contractual and fiduciary duties. Using his control over the LLC, the manager took steps to deliver the LLC to himself and his family on unfair terms. When the LLC had a good cushion of cash from the remaining years of the lease, it was in a good position to take the time needed to responsibly identify another strategic option to generate value for the LLC and all of its investors. Although the economy was weakening, the golf course was well-designed and located in a community that is a good one for the profitable operation of a golf course. With a minimally competent and loyal fiduciary at the helm, the LLC could have charted a course that would have delivered real value to its investors. Had the manager acted properly, for example, the buyer he rebuffed could have entered into a new lease or purchased the LLC on terms that would have at least gotten the LLC's minority investors back what they had put in and some modest return.

The manager himself is the one who has created evidentiary doubt about the LLC's value by failing to pursue any strategic option for the LLC in a timely fashion because he wished to squeeze out the minority investors. The manager's defense that his voting power gave him a license to exploit the minority fundamentally misunderstands Delaware law. The manager was free not to vote his membership interest for a sale. But he was not free to create a situation of distress by failing to cause the LLC to explore its market alternatives and then to buy the LLC for a nominal price. The purpose of the duty of loyalty is in large measure to prevent the exploitation by a fiduciary of his self-interest to the disadvantage of the minority. The fair price requirement of that duty, which is incorporated in the LLC agreement here, makes sure that if the conflicted fiduciary engages in self-dealing, he pays a price that is as much as an arms-length purchaser would pay.

The manager is in no position to take refuge in uncertainties he himself created by his own breaches of duty. He himself is responsible for the distress sale conducted in 2009. Had he acted properly, the LLC could have secured a strategic alternative in 2007, when it was in a stronger position and the economy was too. A transaction at that time would have likely yielded proceeds for...