Leone v. Owsley

• Citation: 810 F.3d 1149
• Decision Date: 25 November 2015
• Docket Number: No. 14–1185.,14–1185.
• Parties: Charles D. LEONE, II, Plaintiff–Appellant, v. Steven C. OWSLEY; Drew M. Hayworth, Defendants–Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (10th Circuit)

810 F.3d 1149

Charles D. LEONE, II, Plaintiff–Appellant,

v.Steven C. OWSLEY; Drew M. Hayworth, Defendants–Appellees.

No. 14–1185.

United States Court of Appeals, Tenth Circuit.

Nov. 25, 2015.

Sean Connelly (Tess Hand–Bender with him on the briefs) of Reilly Pozner LLP, Denver, CO, for Plaintiff–Appellant.

Shannon Wells Stevenson (Brett C. Painter and Nathalie A. Bleuzé with her on the brief) of Davis Graham & Stubbs LLP, Denver, CO, for Defendants–Appellees.

Before MATHESON, SEYMOUR, and McHUGH, Circuit Judges.

SEYMOUR, Circuit Judge.

In 2012, appellant Charles D. Leone II resigned his position as a principal of Madison Street Partners, LLC ("MSP"). Pursuant to the terms of MSP's Operating Agreement, fellow principals Steven Owsley and Drew Hayworth elected to buy Leone's interest in MSP. The agreement required the purchase price to be set at fair market value, as determined in good faith by MSP's managers, Mr. Owsley and Mr. Hayworth ("Managers"). After receiving valuations from two independent valuation firms, the Managers proposed a purchase price of $135,850, which Mr. Leone rejected.

Mr. Leone sued the Managers in federal district court, contending the proposed purchase price was far below market value and asserting claims for breach of contract and breach of the implied covenant of good faith and fair dealing. The Managers moved for summary judgment on both claims, arguing Mr. Leone's claims were barred by their good faith reliance upon the value set by the independent valuation firms. The district court granted the motion.

On appeal, Mr. Leone contends (1) the district court misapplied the law regarding express and implied good faith obligations, (2) the court also held, incorrectly, that bad faith requires a tortious state of mind, and (3) he presented sufficient evidence of bad faith to survive summary judgment. We conclude the district court erred in granting summary judgment. Accordingly we REVERSE and REMAND for further proceedings.

I

MSP, a Delaware limited liability company with its principal place of business in Denver, is a registered investment advisor that manages hedge funds. MSP is compensated for this service in two manners: First, it charges fixed fees on the "Assets Under Management" or "AUM." Aplt. App. at 448. Second, it earns incentive fees based on the performance of those assets. Id.¹

At all times relevant to this dispute, MSP was governed by an Operating Agreement. The original members of MSP were Mssrs. Leone, Owsley, Hayworth, Christopher J. Rule, John Elway, and an LLC. Mssrs. Leone, Owsley, Hayworth and Rule were principals and Mssrs. Owsley and Hayworth were the firm Managers. Mr. Leone held a 19.75% interest in MSP. Pursuant to its terms, the Operating Agreement is governed by Delaware law.

When a member's status as a principal terminates, the Operating Agreement gives MSP the right, but not the obligation, to acquire the member's interest in whole or in part. If MSP opts not to purchase the interest, the other members may elect to do so at a repurchase price "equal to the amount that the owner of the [interest] would receive if the assets of [MSP] were sold for their fair market value, as determined in good faith by the Managers ... and the proceeds of the sale were distributed to the Members." Id. at 537 (emphasis added) (citing Art. 10, Sec. 10.2(d) of the Operating Agreement). The Operating Agreement does not further define the process for valuing a member's interest.

Troubled by alleged mismanagement of MSP, Mr. Leone tendered his resignation on August 2, 2012. Mr. Owsley and Mr. Hayworth, acting in their capacity as Managers, elected not to exercise MSP's option to repurchase Mr. Leone's interest. Instead, they exercised their option as members to repurchase the interest. Under the Operating Agreement, they were responsible as Managers for determining the repurchase price.

The Managers hired two independent valuation firms: St. Charles Capital, LLC ("St. Charles") and INTRINSIC (collectively "the Valuation Firms"), having had no previous relationship with either firm. The Managers provided all documents and information the firms requested. Mr. Leone does not contend the firms were unqualified to value a company such as MSP.

In 2009, Duff & Phelps had performed a valuation of MSP, but that valuation was not intended for use in determining the fair market value of a member's interest. The Duff & Phelps report valued MSP at between $50–$65 million. The Managers were reluctant to give the Duff & Phelps report to the Valuation Firms and, after they did, argued that the report was not relevant. The Valuation Firms were aware of the Duff & Phelps report at the time they conducted their analysis.

The Managers told the Valuation Firms that a partner was leaving MSP, the situation was not amicable, there was a high probability of conflict or dispute, and the report was intended to serve as a tool in the context of a negotiation. They portrayed MSP as financially struggling. Although MSP had been in business for about eight years and had no debt, its AUM had declined from $405 million in September 2008 to $150 million in 2012. The Managers told St. Charles one reason the AUM had declined was that Mr. Leone took business from MSP when he left. A reasonable jury could infer this statement was untrue. While Mr. Leone and his parents had withdrawn their money from MSP funds, an amount totaling almost $1 million, Mr. Leone did not take clients with him when he left MSP. Mr. Owsley told INTRINSIC that Mr. Leone's departure from the firm had been an "adverse development" because he was "pretty involved in the day-to-day operations" and it was "just another negative signal to the market that things weren't going right." Id. at 456.

The Managers told the Valuation Firms to consider the poor performance of other small hedge funds in the current market. They did not tell the Valuation Firms that MSP sent monthly newsletters to its clients, nor did they provide copies of the newsletters to the firms. MSP's July 2012 newsletter, sent just prior to the valuation, contained detailed information about the performance of its investment funds and stated MSP's portfolio had posted a net gain of 2.65% since the start of the month. It also stated MSP anticipated a "very choppy and volatile investment climate for the balance of the year," but it did not indicate that MSP was "struggling." Id.

St. Charles' valuation report was based on the information MSP provided, publicly available information, and its expert assessment of MSP's likely future performance. The report assumed total revenue for 2011 of $5.892 million and total net income of $2.21 million. In contrast, MSP's internal profit and loss statement listed total revenue of $7.289 million and a net income of $3.398 million.

INTRINSIC was instructed to perform a calculation report, a rougher financial assessment which did not provide an opinion of the value of MSP. INTRINSIC's first draft of the calculation report was based on a 10–year time frame. After reviewing the draft, Mr. Owsley told INTRINSIC he was not certain MSP would be around for more than two years and instructed the firm to use a two-year time frame. Mr. Owsley also told INTRINSIC to take into account only incentive fees and to disregard management fees. Additionally, INTRINSIC provided the Managers an electronic spreadsheet that allowed them to plug in different numbers for relevant variables to demonstrate how changing the variables would alter the calculated value of the company.

The Valuation Firms reached similar conclusions: St. Charles valued Mr. Leone's interest in MSP as of August 10, 2012, in the range of $126,400 to $158,000; INTRINSIC valued it in the range of $109,000 to $150,000. The Managers set the repurchase price at $135,850, the average of the midpoints of the two ranges.

In the fall of 2012, Mr. Leone's expert witness, Mitchell Hoffman, performed an initial calculation valuing Mr. Leone's interest in MSP as of August 2012 at $1.5 million. Later, after reviewing MSP's financials, he prepared a report concluding Mr. Leone's interest was worth $2.1 million. Robert Shields, a professional securities trader who had previously worked with Mr. Hayworth, testified in his deposition that, "based on his knowledge of MSP's ‘returns since they opened,’ assets under management, and the growth of the company, he believes the buyout price offered to Mr. Leone is ‘just extremely low’ and ‘not even a realistic ballpark.’ " Id. at 458.

On September 11, 2012, shortly after telling the Valuation Firms he did not believe MSP was doing very well, Mr. Hayworth sent an email telling his father: "I wish I could buy the stake because for once in a long time the firm is on stable grounds." Id. at 458–59. Insider Monkey, an investment publication, subsequently "published an analysis indicating MSP was in the top 50 out of 400 hedge funds for value-weighted returns in the second and third quarters of 2012." Id. at 459. On June 27, 2013, Mr. Leone sent a letter to Mr. Owsley stating he was part of a consortium willing to pay $1 million to purchase Mr. Owsley's 50.875% interest in MSP. Mr. Owsley did not respond to the offer. A performance review released by Hedge Weekly declared that as of October 2013, MSP's investment funds were up 19.18% for the year.

II

In November 2012 Mr. Leone sued the Managers in the District Court of Colorado, claiming (1) they breached Article 10, Section 10.2(d) of the Operating Agreement by failing to act in good faith in valuing his interest in MSP, and (2) they breached the implied covenant of good faith and fair dealing by unreasonably attempting to force him to sell his interest for a price far below fair market value and by refusing to produce MSP tax returns and other financial records for the years 2007 through 2012.

In their Answer, the Managers asserted as an affirmative defense that Mr. Leone's claims were barred by their "good faith reliance on advice of one or more third p...