Opinion
603184-2005.
Decided June 5, 2006.
David Leichtman, Esq., Edward Hornstein, Esq., Morgan Lewis Bockius, LLP, New York, NY, Mark A. Srere, Esq., Brian M. Privor, Esq., Washington, D.C. Attorneys for the Plaintiffs.
Theodore Altman, Esq., Michael R. Hepworth, Esq., Aron E. Weiss, Esq. Piper Rudnick Gray, New York, NY, Attorneys for the Defendants.
Plaintiffs Arthur H. Lerner and Brahman Real Estate Investors LLC brought this Complaint seeking a declaratory judgment of their rights as against Defendants Anthony E. Westreich ("Westreich") and Max 260 Park Avenue South, LLC ("Max 260"). Plaintiffs, which are investors in a company that holds an interest in Max 260, allege that Westreich breached his fiduciary duty to Plaintiffs and engaged in self-dealing when he resigned as manager of the company in which Plaintiffs were investors and failed to loan it funds, with the result that its interest in Max 260 was diluted.
Plaintiffs, with other parties, have also sued Westreich in two related actions, Purchase Partners II, LLC v. Westreich, Index No. 604219/04, and Purchase Partners II, LLC v. Max Capital Management Corp., Index No. 604218/2004.
Defendants now move to dismiss the Complaint, alleging that Westreich breached no duty by resigning and that the Plaintiffs have no standing to bring this action against Max 260. For the reasons that follow, Defendants' motion is denied in part and granted in part without prejudice.
By way of background: The Complaint alleges that Westreich is the president of Max Capital Management Corporation ("Max Capital"), a real estate investment company that develops real estate. Around April 2002, Westreich acquired a 49% interest in Max Capital; the other 51% interest was owned by his then business partner, Adam Hochfelder.
Around July 2002, Max Capital and other investors acquired a property at 260 Park Avenue and an adjoining property (the "property"), for development purposes. Max Capital held a one-third interest in the property. Westreich and Hochfelder created Defendant Max 260 to hold Max Capital's interest in the property. Westreich was and is, at all relevant times, the manager of Max 260. The Complaint alleges that Westreich and some of his family members, the latter through an entity called DTT Park Avenue South ("DTT"), own about 50% of Max 260.
In January 2003, Westreich and Hochfelder formed a company called MNY 260 Park Avenue South, LLC ("MNY"), to hold a 35.8% interest in Max 260, and thereby an indirect interest in the property. The initial managers of MNY were Westreich and Hochfelder.
Plaintiffs and some of their family and friends invested $3.5 million in MNY to hold its 35.8% interest in Max 260. Plaintiffs thus became "members" of MNY, under the Limited Liability Company agreement of MNY ("MNY Agreement").
The MNY Agreement provides:
The Management, operation and control of the Company and its day-to-day business and affairs shall vest solely in one or more managers. . . . The initial Managers of the Company shall be Hochfelder and Westreich. No Manager may be removed at any time with or without cause. Upon the death or resignation of a Manager, a successor Manager shall be appointed by the remaining Manager or Managers, or their duly appointed successors. (MNY Agt. § 3.1.1.)
The MNY Agreement states further that "[t]he Managers shall use ordinary care and reasonable diligence in carrying out the affairs of the Company. The Managers shall not be liable to the Members for any . . . action or [omission] taken in good faith on behalf of the Company." (MNY Agt. § 3.1.2.) "Each Manager shall carry on, manage and conduct the Company business and devote so much of his time thereto as shall be reasonably necessary." (MNY Agt. § 3.1.3.)
Section 3.2 further provides that "[t]he Members (other than the Managers) . . . shall have no voice or participation in the management of the Company business, and no power to bind the Company or to act on behalf of the Company in any manner whatsoever, except as specifically authorized by this Agreement."
The MNY Agreement provides that "[n]o Member shall be required to contribute any additional cash or property to the capital of the Company. In the event the Managers determine that the Company requires additional funds, the Managers shall loan such additional funds to the Company." (MNY Agt. § 2.2.5.)
Thus, when Max 260 requests additional investment funds from MNY, or makes a "capital call," if MNY's managers do not loan the requested funds, and another investor does loan those funds, the interest of that investor in Max 260 would be increased, and MNY's interest would be diluted.
The MNY Agreement also provides:
[The Members and Managers] shall have the right to engage in any other business . . . and to compete directly or indirectly, with the business of [MNY]. The Members hereby waive any and all rights and claims which they may otherwise have against the other Members, the Managers and their affiliates as a result of any of such activities. (MNY Agt. § 3.5.)
Around mid-2004, Westreich and Hochfelder negotiated a business separation of their interests in a variety of business entities, including Max Capital. In the midst of these negotiations, on July 15, 2004, Max 260, of which Westreich was the sole manager, issued a capital call to MNY for about $185,000. Neither Westreich nor Hochfelder loaned the funds to MNY. The Complaint alleges that Hochfelder was insolvent and unable to fulfill his obligation to loan the funds, and that Westreich, who did not lack the funds, knew that Hochfelder was insolvent and unable to loan the funds. Four days later, in a letter dated July 19, 2004, Westreich resigned as manager of MNY, leaving Hochfelder as the sole remaining manager. In November 2004, Hochfelder and Westreich signed a separation agreement, in which Hochfelder formally relinquished his interest and managerial control over Max Capital. On December 17, 2004, Max 260 issued another capital call to MNY of about $119,000. Neither Hochfelder nor Westreich loaned funds to MNY to meet the capital call. The Complaint alleges that Westreich, acting as manager of Max 260, paid MNY's share of both capital calls, which served to increase Max 260's share at the expense of MNY. (Compl. ¶ 38.) On March 17, 2005, Westreich notified MNY that he had done so and that, as a result, MNY's distribution rights with respect to Max 260 had been diluted.
The Complaint contains two causes of action. The first, against Westreich, seeks a declaration of Plaintiffs' right to enforce Westreich's obligation under the MNY Agreement to loan funds to MNY to meet the two capital calls, and a declaration that his purported resignation has no effect. In this cause of action, Plaintiffs allege that Westreich owed MNY a fiduciary duty of loyalty and candor as manager of MNY, and that he breached his fiduciary duty by resigning as manager and refusing to fund the capital calls, as part of a strategy to dilute MNY's interests in the property as against those of Max 260. The second cause of action, against Max 260, seeks a declaration that MNY's distribution rights in the property should not be diluted with respect to those of Max 260.
Defendants moved to dismiss pursuant to C.P.L.R. §§ 3211(a)(1), (3), and (7), on the grounds that the MNY Agreement and the Delaware LLC Act, Del. Code Ann. tit. 6, § 18-1101(d) bar Plaintiffs' claim and that Plaintiffs lack standing to bring a direct action against Max 260 on behalf of MNY.
For purposes of this motion, I will presume the allegations of the Complaint to be true and accord them "every favorable inference," except insofar as they "consist of bare legal conclusions" or are "inherently incredible or flatly contradicted by documentary evidence." Beattie v. Brown Wood, 243 AD2d 395, 395 (1st Dep't 1997).
The parties appear to agree that this dispute is governed substantively by Delaware law.
A. Whether Westreich breached a fiduciary duty in resigning as Manager of MNY and failing to meet Max 260's capital call
Defendants have moved to dismiss the Complaint's first cause of action against Westreich. The Complaint alleges that: (1) Westreich issued on behalf of Max 260 a capital call (or demand for a loan) to MNY on July 15, 2005; (2) he resigned as manager of MNY four days later; (3) Hochfelder, the remaining manager, was insolvent, and Westreich knew it; (4) Westreich issued another capital call to MNY on behalf of Max 260 in December 2005; (5) MNY did not give Max 260 a loan in response to either capital call; and (6) Westreich, acting as manager of Max 260, paid MNY's share of both capital calls to Max 260, which resulted in a substantial dilution of MNY's distribution rights. Defendants frame the issues in this way: (a) Westreich had a right to resign whenever he wanted, under the MNY Agreement; (b) once he resigned, he had no obligation to answer capital calls on MNY's behalf or any fiduciary duty to MNY; and consequently Plaintiffs have not stated a cause of action against Westreich for breach of fiduciary duty. For the reasons that follow, I do not think that Defendants have correctly stated the issues.
Delaware courts have found that a manager of a limited liability corporation owes a fiduciary duty of loyalty to the LLC, its investors and his fellow managers under the common law. See VGS, Inc. v. Castiel, 2000 WL 1277372, *4 (Del.Ch.Ct. Aug. 31, 2000), aff'd, 781 A.2d 696 (Del. 2001) (LLC managers breached their duty of loyalty by secretly orchestrating a squeeze-down merger of the LLC). The facts of this case also provide ample reasons to infer that Westreich had a fiduciary duty to MNY as manager. Under the MNY Agreement, the non-manager members have no power to participate in the management of the MNY business, (MNY Agt. § 3.2), including no power to select replacement managers, ( id. § 3.1.1). The authority to control the affairs of MNY is "vest[ed] solely" in the managers. (MNY Agt. § 3.1.1).
Nevertheless, the Delaware LLC Act provides that a manager's fiduciary duties may be limited to some extent by the LLC agreement. Del. Code Ann. tit. 6, § 18-1101 provides that a manager's "duties (including fiduciary duties) to a limited liability company or to another member" may be "expanded or restricted or eliminated" in an LLC agreement, provided that the LLC agreement "may not eliminate the implied contractual covenant of good faith and fair dealing," id. § 18-1101, and "may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing," id. § 18-1101(e).
Although Defendants do not appear to claim that Westreich owed no fiduciary duties to MNY, they contend that the actions alleged in the Complaint were expressly authorized by permissive language in the MNY Agreement, which permits a manager to "engage in any other business" and to "compete directly or indirectly with the business of [MNY]." (MNY Agt. § 3.5.) In support of this interpretation of the MNY Agreement, they cite Kahn v. Icahn, 1998 WL 832629, 24 Del. J. Corp. L. 738 (Del.Ch.Ct. 1998), aff'd, 746 A.2d 276 (Del. 2000), in which the plaintiffs, limited partners of a limited partnership (L.P.) that managed real estate investments, alleged that the general partner failed to make completely available to the L.P. a corporate opportunity, which it shared with a different company affiliated with the general partner. The Court found that the plaintiffs' claim for breach of fiduciary duty based on usurpation of a partnership opportunity was barred by a provision of the partnership agreement that expressly permitted such competition. Id. at *3. The operative provision of the partnership agreement in Kahn mirrored the language in the MNY Agreement; it provided that the general partner could "compete, directly or indirectly with the business of the Partnership." Id. at *1.
Kahn is inapplicable here, because the Complaint does not allege that Westreich has breached a fiduciary duty by engaging in competition with MNY, whether by usurping a corporate opportunity or otherwise. Rather, it alleges that Westreich acted with disloyalty to MNY by "refusing to fund payment of the capital calls as manager of MNY in an attempt to dilute the interests of MNY . . . and increase the distribution rights of Max 260 in the property for Westreich's own benefit." (Compl. ¶¶ 43-44.) This conduct cannot be considered "compet[ition] . . . with the business of [MNY]."
The Complaint further alleges that Westreich "renounced" his duties as a manager under the MNY Agreement. (Compl. ¶¶ 44-45.) These obligations included a duty to "use ordinary care and reasonable diligence in carrying out the affairs of the Company," (MNY Agt. § 3.1.2), and a duty to "carry on, manage and conduct the Company business and devote so much of his time thereto as shall be reasonably necessary," (MNY Agt. § 3.1.3). One part of MNY's business, for which Westreich was responsible, was to "loan such additional funds" to MNY, "[i]n the event the Managers determine that the Company requires additional funds." (MNY Agt. § 2.2.5.) It would be unreasonable to interpret one provision of the MNY Agreement to authorize Westreich to ignore his obligations under these other provisions of the MNY Agreement. Therefore, I will not interpret § 3.5 to eliminate Westreich's fiduciary duties to MNY as a manager, insofar as his duties are specified in the MNY Agreement.
I reject Defendants' contention that the Complaint failed to plead that the manager made a determination that MNY "require[d] additional funds," because the issuance of a capital call to MNY would seem to make such a determination unnecessary or redundant. Moreover, one could infer from the Complaint's allegation that Westreich loaned those funds to Max 260, with the intention and effect of diluting MNY's distribution rights, that Westreich had made a determination that "MNY require[d] additional funds" to avoid a dilution of its distribution rights.
For example by analogy, a California appellate court has held that limited partners subject to a limited partnership agreement may not contract away their "fiduciary duties in matters fundamentally related to the partnership business," such as the fiduciary duty not to purchase partnership debt and foreclose out one's partner. BT-I v. Equitable Life Assurance Soc'y, 75 Cal.App.4th 1406, 1411-12, 89 Cal.Rptr.2d 811 (Cal.App.Ct. 4th Dist. 1999), as mod. on denial of reh'g (1999), review den. (Cal. 2000). The California court reasoned: "[T]he fact that the [Revised Uniform Limited Partnership Act] allows the parties to structure many aspects of their relationship is not a license to freely engage in self-dealing." BT-I, 75 Cal.App.4th at 1414.
For these reasons, I conclude that section 3.5 does not eliminate Westreich's fiduciary duties to MNY. Because there is a question of fact as to whether Westreich engaged in self-dealing and satisfied his contractual obligations as manager of MNY, I conclude that the Complaint has stated a claim for breach of fiduciary duty.
Furthermore, even if the MNY Agreement went so far as to eliminate a manager's fiduciary duties, it "may not eliminate the implied contractual covenant of good faith and fair dealing," (Del. Code Ann. tit. 6, § 18-1101), and "may not limit or eliminate liability for any act or omission that constitutes a bad faith violation of the implied contractual covenant of good faith and fair dealing," id. § 18-1101(e). A party may breach the implied covenant of good faith and fair dealing without violating an express term of the contract. The implied covenant is designed to protect the spirit of an agreement when, without violating an express term of the agreement, one side uses oppressive or underhanded tactics to deny the other side the fruits of the parties' bargain.' PAMI-LEMB I Inc. v. EMB-NHC, L.L.C., 857 A.2d 998, 1016 (Del.Ch.Ct. 2004) (quoting Chamison v. HealthTrust, Inc., 735 A.2d 912, 920 (Del.Ch.Ct. 1999), aff'd, 748 A.2d 407 (Del. 2000)). If the facts alleged in the Complaint were proven if Westreich left an obligation unfulfilled at the time of his resignation as manager, with the intention of taking actions after his resignation that would dilute MNY's distribution rights a finder of fact could conclude that Westreich had violated the implied covenant of good faith and fair dealing.
Furthermore, Defendants contend that Westreich did not breach a fiduciary duty by resigning, because he relied on section 3.1.1 of the MNY Agreement, which unconditionally permits a manager to resign. Del. Code Ann. tit. 6, § 18-1101(d) provides that "[u]nless otherwise provided in a limited liability company agreement, a member or manager . . . shall not be liable to . . . another member or manager . . . for breach of fiduciary duty for the member's or manager's . . . good faith reliance on the provisions of the limited liability company agreement."
I reject this contention as well for several reasons. First, I cannot find as a matter of law that Westreich acted in "good faith," as § 18-1101(d) requires, before a factual record has been developed. See Anglo Amer. Sec. Fund, L.P. v. S.R. Global Int'l Fund, L.P., 829 A.2d 143, 157 (Del.Ch.Ct. 2003) (determination of whether provisions of agreement exculpating defendant from liability caused by "honest mistakes in judgment" was premature on a motion to dismiss, where circumstances suggested "some degree of bad faith").
In any case, according to the Complaint, Westreich did not rely on provisions of the MNY Agreement affirmatively permitting Westreich to resign under these conditions, but rather on the absence of any provisions limiting his right to resign. No provision of the MNY Agreement affirmatively indicates that a manager may resign rather than answer an outstanding capital call, especially one that he himself issued (albeit not in his capacity as MNY Manager) and to which he was obligated to respond.
Moreover, the Complaint alleges that Westreich failed to fulfill his obligations under affirmative provisions of the MNY Agreement. Westreich, as manager of MNY, was obligated to "use ordinary care and reasonable diligence in carrying out the affairs of the Company," (MNY Agt. § 3.1.2), and to "carry on, manage and conduct the Company business and devote so much of his time thereto as shall be reasonably necessary," (MNY Agt. § 3.1.3). "In the event the Managers determine that the Company requires additional funds," Westreich was also obligated to "loan such additional funds to the Company." (MNY Agt. § 2.2.5.) Therefore, because there is a question of fact as to whether Westreich fulfilled his contractual obligations as manager of MNY, there exists a question as to whether Westreich relied in good faith on the provisions of the MNY Agreement.
Defendants contend that this case is analogous to Lazard Debt Recovery GP, LLC. v. Weinstock, 864 A.2d 955 (Del.Ch.Ct. 2004), which involved the sudden departure of the defendants, two key employees, from an investment fund, one of the plaintiffs. The investment fund was formed by an investment bank (not a plaintiff) at which the two employees served as managing director and director. Two other corporate entities were involved in the management of the fund. One entity, the "investment manager," also a plaintiff, was responsible for investing the fund's capital. This entity was controlled by a second entity, the fund's "general partner." When the defendants announced their intention to depart and join a competing firm, they warned officials from the general partner that it should transfer the fund to its competitor in order to protect its clients' interests. Instead, the fund folded and sued for, inter alia, breach of fiduciary duty, alleging that the defendants had plotted to resign without warning in order to coerce the general partner into transferring the fund to the competing venture.
The Court of Chancery found that the employees did not breach any fiduciary duty to the fund or its investors, because they were subject to no duty that limited their right to resign. Furthermore, the Court found that the plaintiffs were responsible for their own failure to "plan adequately for the possible departure of key employees who it knew could depart," by "using a commonly employed technique known as contracting," such as by negotiating an employment contract that required the defendants to give three months' notice or incorporated a non-competition clause. Lazard, 864 A.2d at 968-69. The Court reasoned that granting the employer "those protections now . . . would be to grant employers an important right against employees that they did not bargain for and did not pay for," because in negotiating such an employment contract, the defendants would have demanded some "reciprocal" compensation from their employer. Lazard, 864 A.2d at 969.
Delaware law treats allegations of breach of fiduciary duty on a case-specific basis. Lazard is distinguishable from the present case for two reasons. First, there was no allegation in Lazard that the defendants had resigned to avoid an obligation to their employer or that they had failed in a duty of their employment at the investment fund. On the contrary, the defendants continued to help market the fund "enthusiastically" to new investors while they were employed there. Id. at 961. And even though the fund folded as a result of their resignations, no "investor of the Fund actually lost existing value as a result of the termination of the Fund."
Moreover:
[T]he complaint d[id] not allege that there was anything special about February 28, 2002 [the date of the defendants' resignations] that made [their] departure that particular day a breach of fiduciary duty. It is not alleged that some particular investment opportunity was then pending that was lost or that turned bad as a result of their hasty departure. Lazard, 864 A.2d at 966 (emphasis added).
The plaintiffs' complaint was based on the "mere fact that they left their jobs without giving prior notice." Id. The Court reasoned that the defendants' "fiduciary duty" as agents of the fund was "limited by the scope of the agency," which in that case was defined by their "investment responsibilities" and the "discretion entrusted to them by the Fund and its investors." Id. at 966. Because the complaint failed to allege an abuse of that discretion, it did not allege any breach of a fiduciary duty.
In contrast, here the Complaint does allege that Westreich abused his discretion as manager of MNY and timed his resignation in a calculated attempt to avoid his contractual obligations as manager. The Complaint alleges that Westreich resigned on July 19, 2005 just four days after a capital call was issued by (himself as) the manager of Max 260 although section 2.2.5 of the MNY Agreement obligates the managers to "loan such additional funds to the Company," Westreich had the funds to do so, he knew that Hochfelder would be unable to do so, and he knew that the consequence of his actions would be a significant dilution of MNY's distribution rights. Thus, this situation is distinct from that in Lazard.
A further distinction between the instant case and Lazard is that in Lazard the Court reasoned that the plaintiffs could have contracted with the defendants to place limits on their ability to resign without warning and set up a competing venture. In contrast, here Plaintiffs "have no voice or participation in the management of the Company business, and no power to bind the Company or to act on behalf of the Company in any manner whatsoever, except as specifically authorized by this Agreement." (MNY Agt. § 3.2.) Unlike the plaintiffs in Lazard, Plaintiffs here had no power to negotiate limits on Westreich's ability to resign. In addition, Plaintiffs had no power to either replace Westreich or to remove Hochfelder and appoint a new manager in his place. (MNY Agt. § 3.1.1.)
Therefore, Lazard is not dispositive here. Based on the Complaint's allegations and for the reasons stated above, I cannot find that Westreich did not breach a fiduciary duty to Plaintiffs as a matter of law. Therefore, I will deny the motion to dismiss Count I.
B. Whether Plaintiffs, as Members of MNY, may bring this action against Max 260
In the second count of the Complaint, Plaintiffs seek a declaration that Max 260's distribution rights should not be increased at the expense of MNY. (Compl. ¶ 50.) In their opposition papers, Plaintiffs explain their cause of action as follows: the Court should not, "as a matter of equity," permit Westreich to "induce members [i.e. Plaintiffs] to invest [in MNY] under false pretenses, to draft an LLC agreement that prevents the members from bringing suit, and then to abandon the members (by resignation or, as with Hochfelder, indifference)." (Pls. Opp'n Br. at 18-19.) Plaintiffs explain further that this cause of action is based on the allegation that Westreich acted in bad faith by failing to answer the first capital call, resigning as manager of MNY while knowing that Hochfelder was incapable of answering the capital call, making an additional capital call as manager of Max 260, and paying both capital calls through Max 260 with the goal of diluting MNY 260's distribution rights. (Pls. Opp'n Br. at 18.)
Defendants move to dismiss the second count because (a) it does not state a basis for any claim against Max 260, (b) it alleges injury to MNY, which is not a party to this action, rather than to Plaintiffs, and Plaintiffs are barred by the MNY agreement from bringing either a direct or a derivative action on MNY's behalf.
I agree that the second count does not state a basis for a claim against Max 260. Plaintiffs' argument seems to conflate Westreich's actions as manager of MNY and Westreich's actions as manager of Max 260. Moreover, Plaintiffs have not alleged the breach of any duty fiduciary, contractual, or otherwise owed by Max 260 to MNY.
In addition to having failed to allege a cognizable basis for their claim against Max 260, Plaintiffs have not alleged the basis on which they have standing to bring suit on MNY's behalf. See, e.g., Del. Code Ann. tit. 6, § 18-1003.
Thus, the second cause of action must be dismissed without prejudice. Because this is the only cause of action against Max 260, Max 260 is dismissed without prejudice as a defendant in this action. Plaintiffs have leave to replead this cause of action within 30 days of the date that this memorandum and order are filed.