Walker v. FRP Investors GP, LLC

• Court: Court of Chancery of Delaware
• Writing for the Court: ZURN, Vice Chancellor.
• Citation: 336 A.3d 542
• Docket Number: 2022-0816-MTZ
• Decision Date: 15 April 2025
• Parties: Cornelius T. WALKER, Jr., Plaintiff, v. FRP INVESTORS GP, LLC, Defendant.

336 A.3d 542

Cornelius T. WALKER, Jr., Plaintiff,
v.
FRP INVESTORS GP, LLC, Defendant.
C.A. No. 2022-0816-MTZ

Court of Chancery of Delaware.

Date Submitted: October 16, 2024

Date Decided: April 15, 2025

336 A.3d 546

Catherine A. Gaul, ASHBY & GEDDES, Wilmington, Delaware; Nicholas A. Casto, ICE MILLER LLP, Chicago, Illinois; Aneca E. Lasley, ICE MILLER LLP, Columbus, Ohio, Attorneys for Plaintiff Cornelius T. Walker, Jr.

Andrew L. Cole, Jack M. Dougherty, Nathaniel J. Klepser, Austin R. Nigge-brugge, COLE SCHOTZ P.C., Wilmington, Delaware; W. Braxton Gillam, IV, MILAM HOWARD NICANDRI & GILLAM, P.A., Jacksonville, Florida, Attorneys for Defendant FRP Investors GP, LLC.

MEMORANDUM OPINION

ZURN, Vice Chancellor.

This post-trial opinion concludes the general partner of a partnership breached the contractual standard for valuing newly issued partnership units, and awards damages for that breach. The plaintiff and his friends built an insurance brokerage company, then entered a lucrative partnership with a private equity sponsor. As the founding CFO, the plaintiff received incentive units allowing him to share in the company’s value. The general partner had the right to issue incentive units and buy back units from departing employees. The partnership agreement required the general partner to establish a “threshold value” for newly issued units based on the general partner’s reasonable determination of the company’s enterprise value. New unitholders would only share in the company’s growth above their units’ threshold value. Existing unitholders who were not issued more units had their stakes diluted; a low threshold value Would exacerbate that dilution.

The sponsor became frustrated with the plaintiff’s performance as CFO and replaced him. The general partner issued the new CFO incentive units and contemplated repurchasing the plaintiff’s units. But because the plaintiff’s friends stuck up for him, the general partner gave him a vanity title and allowed him to retain his incentive units with almost no strings attached.

In anticipation of an acquisition, the general partner issued the remaining authorized incentive units. The plaintiff claims the general partner set the threshold value too low, repressing his share of the incentive pool in breach of the general partner’s contractual obligations. The plaintiff contends that when the company eventually achieved an exit and cashed out the incentive unit holders, he should have received

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two million dollars more than the fifty million he received.

Trial demonstrated that despite the general partner’s relative generosity toward the plaintiff, it indeed breached its obligations in determining the threshold value, which harmed the plaintiff to the tune of $416,248.93.

I. BACKGROUND¹

Plaintiff Cornelius T. Walker, Jr., who goes by Cory, worked in the insurance business for years alongside Charlie Lydecker and Tom Tinsley, who became his friends. In 2016, Walker formed a new insurance agency called Walker & Associates, and recruited Lydecker and Tinsley to invest as partners.² By late 2016, Walker & Associates had acquired two small insurance agencies and had begun interviewing private equity firms for support to launch nationwide.³ In January 2017, Walker, Lydecker, and Tinsley partnered with private equity firm Warburg Pincus to create a new nationwide insurance brokerage, Foundation Risk Partners Corp. (“FRP”), which purchased Walker & Associates.⁴

FRP was held by FRP Investors, L.P. (the “Partnership”).⁵ The Partnership’s general partner was defendant FRP Investors GP, LLC (“GP”).⁶ FRP was created to operate a commercial insurance brokerage business and to grow both organically and through acquisitions.⁷ FRP’s business strategy involved acquiring other insurance agencies and integrating their administrative and agency management functions.⁸ From the outset, the founders’ goal was to sell FRP at a significant multiple.⁹ GP and Warburg were incentivized to grow FRP as quickly as possible,¹⁰ but FRP faced substantial competition for targets.¹¹

Warburg controlled GP’s board and used that power to take an active role in FRP’s operations and strategy.¹² Warburg’s goal was to build the business in partnership with the management team.¹³ It generally viewed the management team

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as “best in class,”¹⁴ and it made decisions collaboratively with management.¹⁵ FRP’s primary Warburg contacts were Jeff Stein, Warburg’s head of U.S. financial services, and Michael Dimitrief, a Warburg principal.¹⁶ Under Section 8.1(a) of the Partnership’s limited partnership agreement (the “LPA”), GP had “full and complete discretion to manage” the Partnership’s business.¹⁷ Section 9.1(b) provides that whenever GP makes a determination, it is “entitled to consider only such interests and factors … it desires.”¹⁸

Walker, Lydecker, and Tinsley held roles at the FRP level. Walker was FRP’s first CFO.¹⁹ Lydecker is FRP’s CEO, having held that role since the company’s founding. At all relevant times, he was on GP’s board, its only member not affiliated with Warburg.²⁰ He had a “collaborative relationship” with GP and served as GP’s corporate representative at trial.²¹ Tinsley is FRP’s chief administrative officer, reporting to Lydecker.²²

A. The Partnership’s Ownership Structure

The LPA provides for three ownership classes: A Units, B Units, and C Units.²³ There are two subclasses of A Units: A-l Units and A-2 Units.²⁴ A-l Units were issued to Warburg and FRP’s initial management team, including Walker, Lydecker, and Tinsley.²⁵ A-2 Units were mainly used as currency for acquisitions.²⁶ B Units were meant to reward management for building FRP’s enterprise value.²⁷ These different purposes are reflected in the units’ different valuation parameters.

1. A-2 Units

When FRP acquired other agencies, it issued A-2 Units as part of the purchase price.²⁸ A-2 Units served “to entice other acquisition owners to come on board.”²⁹ The LPA placed no limitations on GP’s discretion to value A-2 Units issued to targets.³⁰

Since the LPA did not specify any valuation parameters, Warburg team members could “decide what they thought the value was” for A-2 Units.³¹ Warburg set A-2 Unit prices quarterly “so that [it] could avoid having individual negotiations” about

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valuation.³² Stein could not recall any “time when there was actually a negotiation” over A-2 Unit value.³³

Warburg’s method for quarterly valuations began with EBITDA: earnings before interest, taxes, depreciation, and amortization.³⁴ EBITDA is a measure of a company’s “free cash flow profile.”³⁵ Warburg’s valuations started with “base EBITDA” derived from financial statements.³⁶ Warburg then made quality of earnings (“QoE”) adjustments for nonrecurring items that affected prior-year earnings (e.g., one-time severance expenses or extraordinary one-time legal fees) to arrive at “adjusted EBITDA.”³⁷ Then, it made upward adjustments for (1) any future acquisition under a letter of intent (“LOI”)³⁸ and (2) the projected annual results of mid-year acquisitions.³⁹ These adjustments, loosely called “LOI credit,” yielded “adjusted pro forma EBITDA.”⁴⁰ Finally, Warburg calculated enterprise value by applying a multiple, based on transactions involving comparable companies, to adjusted pro forma EBITDA.⁴¹

2. B Units

B Units allowed unitholders to participate in value creation above the point at which they were issued.⁴² The LPA authorized 3,000,000 B Units, which GP could issue at its discretion.⁴³ Warburg viewed B Units as a management incentive plan or “sweat equity.”⁴⁴ They were meant to align

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the management team’s interests with Warburg’s.⁴⁵ Newly issued B Units were assigned a “Threshold Value” based on FRP’s enterprise value, which rewarded unitholders based on the company’s growth during the period they held units.⁴⁶ As FRP’s enterprise value grew, so did the amount that would be paid to B Unit holders in the event of an acquisition, called the “B Pool.”⁴⁷

[1] The LPA specified that B Units were to constitute “Profits Interests,” defined as equity units that are “classified as [ ] profits interest[s] within the meaning of Internal Revenue Service Revenue Procedures 93-27 and 2001-43.”⁴⁸ Those revenue procedures explain that profits interests are intended to compensate for future growth, and should not offer any standalone value at the time of issuance.⁴⁹ Warburg’s principals testified similarly: profits interests are not taxed upon receipt, as they have no standalone value at that time, but rather are taxed when the unitholder “realizes” a gain.⁵⁰ Accordingly, when issuing profits interests, “you’d want to do your best to value [them] in line with what you thought the value of the company was at that time.”⁵¹ Stein reiterated that “if you

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received new units at a value that was too low, you’d essentially be getting credit for value that was created before” the issuance.⁵²

To effectuate the B Units’ purpose as Profits Interests, Section 3.2(c)(iii) provides that GP must set a Threshold Value for newly issued B Units “to the extent necessary to cause such … B Units to constitute Profits Interests.”⁵³ Section 3.2(c)(iii) sets forth the requirements for establishing the Threshold Value:

The Threshold Value … shall equal the amount that would, in the reasonable determination of [GP], be distributed pursuant to Section 6.1 with respect to each then outstanding [B] Unit if, immediately prior to the issuance … the assets of the Partnership were sold for their Fair Market Values, and the proceeds were used to satisfy all liabilities of the Partnership … and any excess proceeds were distributed pursuant to Section 6.1.⁵⁴

In setting the Threshold Value, GP must make a “reasonable determination” of the amount that would be distributed to the B Unit holders pursuant to Section 6.1 if “immediately prior to the issuance,” the Partnership’s assets were sold for their “Fair...