Zohar III Ltd. v. Stila Styles, LLC
| Decision Date | 31 May 2022 |
| Docket Number | C. A. 2021-0384-JRS |
| Parties | ZOHAR III Limited, Plaintiff, v. STILA STYLES, LLC and LYNN TILTON, Defendants. |
| Court | Court of Chancery of Delaware |
ZOHAR III Limited, Plaintiff,
v.
STILA STYLES, LLC and LYNN TILTON, Defendants.
C. A. No. 2021-0384-JRS
Court of Chancery of Delaware
May 31, 2022
Date Submitted: February 18, 2022
C. Barr Flinn, Esquire, Emily V. Burton, Esquire, Lauren Dunkle Fortunato, Esquire, Alberto E. Chávez, Esquire and Kevin P. Rickert, Esquire of Young Conaway Stargatt & Taylor, LLP, Wilmington, Delaware, Attorneys for Plaintiff Zohar III Limited.
Patricia R. Urban, Esquire, Elizabeth Wilburn Joyce, Esquire and Megan Ix Brison, Esquire of Pinckney, Weidinger, Urban & Joyce LLC, Wilmington, Delaware, Attorneys for Defendant Stila Styles, LLC.
Kathleen M. Miller, Esquire and Robert K. Beste, III, Esquire of Smith, Katzenstein & Jenkins LLP, Wilmington, Delaware and Monica K. Loseman, Esquire of Gibson, Dunn & Crutcher LLP, Denver, Colorado, Attorneys for Defendant Lynn Tilton.
MEMORANDUM OPINION
SLIGHTS, VICE CHANCELLOR
The parties to this dispute have been locked in litigation in various courts, including this one, for nearly a decade regarding control over portfolio companies of Plaintiff, Zohar III Limited ("Zohar"), a collateralized loan obligation ("CLO") vehicle formed years ago by Defendant, Lynn Tilton. This chapter of the saga involves disputed claims of control over one of those portfolio companies, a Delaware limited liability company called Stila Styles, LLC ("Stila" or the "Company"). The parties have lobbed allegations of bad faith and breach of fiduciary duty back and forth towards one another throughout their litigation history and have repackaged those allegations for use in this case. At bottom, however, the relationship between these parties is contractual, and their disputes, therefore, historically have been resolved as a matter of contract. This case is no different. Stila, like all Delaware LLCs, is a "creature[] of contract."[1] That contract, Stila's LLC Agreement as amended (and later defined), clearly sets forth the parties' rights and obligations with respect to the governance and control of Stila.
Tilton caused the formation of Zohar in 2007. She also owns 100% of Zohar's "Preference Shares" and, until 2018, was Zohar's sole director. Through another
affiliate, Tilton served as Zohar's "Collateral Manager" until she resigned from that role in 2016.
Through affiliated entities, Tilton was the initial "Class A Member" of Stila upon its formation and remains so today. At various times, Tilton also served as Stila's Manager. According to Tilton, in 2017, she orchestrated a transaction that caused her to be appointed as Stila's sole Manager answerable only to a new class of units she created (the "2017 Transaction"). That transaction is the subject of the dispute sub judice.
As central features of the 2017 Transaction, Tilton purported to: (1) create a new class of Stila units; (2) grant the newly created units the sole right to remove and replace an existing Manager or appoint additional Managers (among other rights); (3) issue the newly created units to an entity she controlled; and (4) admit that entity as a new Member of Stila. Tilton purported to take these steps in her capacity as Manager of Stila without seeking or obtaining Zohar's consent as Stila's sole Common Member. That was a mistake. The 2017 Transaction effectively amended Stila's LLC Agreement, which expressly provides that "[e]xcept for any amendments otherwise contemplated herein and except as otherwise provided by law, this Agreement and the Certificate [of Formation] may be amended or modified from time to time only by the Members." Prior to the 2017 Transaction, the LLC Agreement explicitly granted either the Common Members or the Series A Preferred
Members the right to remove and replace Stila's Manager. Unlike other provisions of the LLC Agreement that could be amended at the sole discretion of Stila's Manager, the contractual right to remove and replace the Manager could not be amended without the Members' consent. Tilton did not obtain that consent. Consequently, the 2017 Transaction is invalid as a matter of contract, at least as relates to the removal and replacement of Stila's Manager.
I. BACKGROUND
The following facts were either stipulated to by the parties or proven by a preponderance of the credible, competent evidence presented during trial.[2]
A. The Parties and Relevant Non-Parties
Plaintiff, Zohar, is an exempted company organized under the laws of the Cayman Islands.[3] It is currently a debtor in bankruptcy along with its sister funds, Zohar CDO 2003-1, Limited and Zohar CDO 2003-1, Corp. (together, "Zohar I"), and Zohar II 2005-1, Limited and Zohar II 2005-1, Corp. (together, "Zohar II") (collectively with Zohar, the "Zohar Funds").[4] The Zohar Funds are all CLO
vehicles that hold debt and equity interests in a number of operating portfolio companies.[5]
Defendant, Lynn Tilton, is a Florida resident and the founder of Zohar.[6] She was also Zohar's sole director from January 2017 until May 2018 and, through Octaluna (defined below), has owned 100% of Zohar's preference shares since its formation.[7]
Defendant, Stila, is a Delaware limited liability company and one of Zohar's portfolio companies.[8] It develops, produces, markets and distributes cosmetics under the Stila brand.[9] When Stila was formed, it acquired, through Tilton, substantially all of the assets of non-parties Stila Corp., Stila International, Inc. (and its affiliates), Stila UK Limited and Stila Holding Corp. (the "Stila Assets") from banks that had foreclosed on pledged collateral.[10] Tilton indisputably was Stila's Manager from its formation until November 2017.[11]
Non-party, Octaluna III, LLC ("Octaluna"), is a Tilton affiliate that owned 100% of Zohar's preference shares and was the initial "Class A Member" of Stila.[12]Non-party, Ark II CLO 2001-1, Ltd. ("Ark"), is also a Tilton affiliate and the current "Class A Member" of Stila following a transfer of those interests from Octaluna.[13]
B. The Formation of Zohar
Tilton formed Zohar on April 6, 2007.[14] On the same day, another Tilton affiliate, Patriarch Partners XV, LLC ("Patriarch XV"), was appointed as Zohar's Collateral Manager.[15] Patriarch XV remained Zohar's Collateral Manager until it resigned from that role on March 3, 2016. Alvarez & Marsal Zohar Management, LLC ("AMZM") was appointed as Zohar's new Collateral Manager upon Patriarch XV's resignation.[16]
C. The Formation of Stila and the LLC Agreement
The 2008 financial crisis created significant challenges for Stila Corp.[17]Those challenges led Stila Corp.'s principal lender, Wachovia Bank, to foreclose on the Stila Corp. assets that had been pledged to secure the debt.[18] Upon initiating foreclosure, Wachovia informed Tilton of its immediate plans to liquidate the collateral and asked Tilton if she was interested in acquiring those assets.[19]In response, Tilton submitted a letter of intent to acquire Stila Corp.'s assets from Wachovia (and other lenders), [20] and designated Zohar as the affiliate through which she would consummate the transaction. On April 17, 2009, Tilton executed the Limited Liability Company Agreement of Stila Styles, LLC (as properly amended, the "LLC Agreement") as Stila's Manager on the one hand and as manager of Patriarch XV on behalf of Zohar as Stila's "Common Member" and "Series A Preferred Member" on the other hand.[21]
The LLC Agreement created two classes of equity interests in Stila: "Common Interests" and "Series A Preferred Interests." Zohar has always been and remains the only holder of Stila's Common Interests.[22] Zohar also held all of Stila's Series A Preferred Interests from the creation of those interests until they were redeemed in February 2016.[23]
Following the execution of the LLC Agreement, on April 22, 2009, Zohar and Stila entered into a credit agreement under which Zohar issued Stila a $7 million senior secured term loan note and a $5 million revolving credit note.[24] Stila then used the proceeds of these loans to acquire the Stila Assets.[25]
In May 2011, the LLC Agreement was amended via Amendment No. 1 to the LLC Agreement[26] and Amendment No. 2 to the LLC Agreement.[27] The parties do not dispute the validity of either amendment.[28] More than four years later,
in September 2015, Tilton executed Amendment No. 3 to the LLC Agreement.[29]Although Zohar disputes the validity of that amendment the parties have elected not to litigate that dispute in this action.[30] Accordingly, consistent with the approach taken by the parties, I have not considered Amendment No. 3 in my analysis.
D. The Bankruptcy Proceedings
On March 11, 2018, Zohar filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware.[31] Near the outset of the bankruptcy, Tilton, Zohar and certain Zohar creditors entered into a settlement agreement, including a standstill that halted litigation and paused efforts to terminate Tilton's control (the "Standstill Agreement").[32] The Standstill Agreement provided that "no action shall be taken to remove Tilton" from her position "as director, manager,
and officer."[33] On May 21, 2018, the Bankruptcy Court entered an order approving the settlement agreement, including the Standstill Agreement.[34]
As part of the bankruptcy proceedings, in September 2018, Tilton's counsel provided Zohar's bankruptcy counsel with approximately 100 documents, among which were the organizational documents of various portfolio companies, including Stila.[35] Through this production, Zohar received two of three documents that collectively compromise the 2017 Transaction-the Joinder Agreement and the Subscription Agreement were produced but the 2017 Written Consent approving the 2017 Transaction was not.[36] These three documents are defined and discussed in more detail below.
On March 9, 2020, the Zohar Funds...
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