IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
CLIFFORD PAPER, INC., ) ) Plaintiff, ) ) v. ) C.A. No. 2020-0448-JRS ) WPP INVESTORS, LLC; EDGAR [L.] ) SMITH, JR., RICHARD A. BAPTISTE, ) ) Defendants. )
MEMORANDUM OPINION
Date Submitted: March 2, 2021 Date Decided: June 1, 2021
Samuel T. Hirzel, II, Esquire and Elizabeth A. DeFelice, Esquire of Heyman Enerio Gattuso & Hirzel LLP, Wilmington, Delaware and Matthew M. Oliver, Esquire of Lowenstein Sandler LLP, Roseland, New Jersey, Attorneys for Plaintiff Clifford Paper, Inc.
Oderah C. Nwaeze, Esquire, of Faegre Drinker Biddle & Reath LLP (formerly of Duane Morris LLP), Wilmington, Delaware, Attorney for Defendants WPP Investors, LLC and Edgar L. Smith, Jr.
SLIGHTS, Vice Chancellor In 2004, Plaintiff, Clifford Paper, Inc. (“CPI”), along with Defendants, WPP
Investors, LLC (“Investors”) and its owners, Edgard L. Smith and Richard A.
Baptiste (collectively, “Defendants”), formed World Pac Paper, LLC (“WPP” or the
“Company”) to distribute paper and packaging products and provide printing,
shipping and warehousing consignment services to commercial and retail clients.
CPI and Investors owned 45% and 55% of WPP, respectively. Under the
Company’s Operating Agreement, Smith and Baptiste, along with CPI’s President,
John Clifford, were designated to oversee WPP’s operations as its managers.
Though this arrangement ran smoothly for a time, relations between the
parties soured after CPI and Clifford opposed Smith’s proposal to create a lucrative
position in WPP for his wife with responsibilities duplicating services already
performed for WPP by CPI. Undeterred, Smith and Baptiste unilaterally promoted
Smith’s wife to the position notwithstanding Clifford’s contractual right to vote on
the decision. According to Plaintiff’s Amended Verified Complaint
(the “Complaint”), that act marked the start of a concerted (and wrongful) effort by
Smith and Baptiste to divert profits away from WPP to Investors and railroad CPI
into divesting its interest in the Company. Smith and Investors have moved to
dismiss the Complaint under Chancery Rules 12(b)(6) and 23.1.
1 At the threshold, CPI insists it has brought direct (as opposed to derivative)
claims because it has challenged wrongful acts that have denied it the right under the
Operating Agreement to vote on key decisions affecting the Company. In most
instances, the denial of the franchise will cause direct harm to the owner, but not
always. When classifying a claim as direct or derivative, Delaware courts focus not
on the nature of the wrong but the nature of the alleged harm flowing from the wrong.
Here, the harm, if any, flowing from the alleged wrongful conduct directly affected
WPP, not CPI. CPI’s claims, therefore, are derivative, not direct. Because CPI was
not a member of WPP when it brought these claims and did not, in any event, make
a demand on the WPP board to pursue the claims, or attempt to plead demand futility,
Smith and Investors’ motion to dismiss must be granted in full. My reasoning
follows.
I. BACKGROUND
I have drawn the facts from the well-pled allegations in the Complaint and
documents properly incorporated by reference or integral to that pleading.1
1 See generally Am. Verified Compl. (D.I. 18) (“Compl.”); see also Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 860 A.2d 312, 320 (Del. 2004) (noting that on a motion to dismiss, the Court may consider documents that are “incorporated by reference” or “integral” to the complaint).
2 For purposes of this motion, I accept as true the Complaint’s well-pled factual
allegations and draw all reasonable inferences in Plaintiff’s favor. 2
A. Parties
Plaintiff, CPI, is a Delaware corporation. 3 At all times relevant to this action,
and prior to his passing in November 2018, non-party, Clifford, served as CPI’s
President and one of WPP’s three “Managers” as defined in WPP’s Operating
Agreement. 4 CPI was at all relevant times the minority (45%) owner of WPP.5
Defendant, Investors, is an Ohio limited liability company.6 It was at all
relevant times the majority (55%) owner of CPI. 7
Defendant, Smith, served as Chairman, Chief Executive Officer and, at all
relevant times, one of three Managers of WPP. 8 Smith owns an 80% equity interest
in Investors.9
2 Savor, Inc. v. FMR Corp., 812 A.2d 894, 896–97 (Del. 2002). 3 Compl. ¶ 15. 4 Compl. ¶¶ 15, 22; D.I. 1, Ex. A (“Operating Agreement”) at 18. 5 Compl. ¶ 16. 6 Compl. ¶¶ 17–19. 7 Compl. ¶ 17. 8 Compl. ¶ 18. 9 Id.
3 Defendant, Baptiste, served as President, Chief Operating Officer and one of
three Managers of WPP. 10 Baptiste owns a 20% equity interest in Investors. 11
Non-party, WPP, is a Delaware LLC formed by CPI and Investors on June 11,
2004, under the terms of the Operating Agreement.12 Section 7.1 allocates WPP’s
Profits and Losses to Investors and CPI in proportion to their respective ownership
interests.13
B. Investors and CPI Form WPP
In June 2004, WPP was formed by CPI and Investors as a distributor of paper
and packaging products and provider of printing, shipping and warehousing
consignment services to commercial and retail clients. 14 CPI and Investors remained
the only two Members of WPP, with Smith serving as WPP’s Chief Executive
Officer and Chairman and Baptiste serving as the Company’s President and Chief
10 Compl. ¶ 19. 11 Id. 12 Compl. ¶¶ 1, 16, 21. 13 Operating Agreement § 7.1. 14 Compl. ¶¶ 1, 16.
4 Operating Officer. 15 At all relevant times, WPP had three Managers: Smith, Baptiste
and Clifford.16
Section 8 of the Operating Agreement sets out the rights, responsibilities and
procedures related to the Company’s governance.17 Section 8.1 provides that,
“[e]xcept as otherwise provided in this Agreement, all actions by the Managers on
behalf of the Company shall require the consent of [the] majority of the Managers.”18
Section 8.3 sets out the procedure for Manager decisions relating to “Related Party
Transactions,” providing in relevant part:
If any Manager shall have an ownership, financial, or familial relationship with any party . . . and said party desires or intends to enter into a material contract or agreement with the Company, then such Manager with a relationship described above shall not be permitted to participate in a vote regarding the Company’s participation in said contract or agreement; provided however that John Clifford shall be permitted to so participate with respect to the Company’s relationships with [CPI] and its affiliates.19
15 Compl. ¶¶ 12, 15, 18–19, 21; see also Operating Agreement at 20. 16 Operating Agreement at 20 (identifying Smith, Baptiste and Glen Butler as the three Managers designated by Investors and Clifford as the Manager designated by CPI); see also Compl. ¶ 22 (alleging that, while Butler was named as a Manager in Section 8.1(b) of the Operating Agreement, he resigned in 2006). 17 See generally Operating Agreement § 8.1. 18 Id. 19 Id. § 8.3.
5 The Operating Agreement does not disclaim any fiduciary duties owed by the
Managers, but Section 8.4 of the Operating Agreement exculpates Managers from
any liability “to the Members or the Company for any mistake of fact or judgment
or for the doing . . . or failure to do any act . . . in conducting the Company’s business,
operations and affairs, which may cause or result in any loss or damage to the
Company or the Members.”20 Managers are not exculpated under the Operating
Agreement, however, for “fraud, gross negligence, willful misconduct or a wrongful
taking.”21 Finally, Section 8.10 states that, “[e]xcept as expressly provided in the
Agreement,” no Manager or Member has authority “to undertake or assume[] any
obligation, debt, duty or responsibility on behalf of [] any Member or the Company,
or to bind the Company in any way, to pledge its credit or to render it liable peculiarly
for any purpose.”22
While the Operating Agreement generally allows Members and Managers to
engage in other business ventures, Section 14 delimits the specific instances where
such outside corporate opportunities are prohibited. Relevant here, Section 14(a) of
the Operating Agreement provides that no Member or “Manager shall directly, or
indirectly through any affiliate or related party . . . solicit sales for, divert or take
20 Id. § 8.4; Compl. ¶ 23. 21 Operating Agreement § 8.4. 22 Id. § 8.10.
6 away any customers from the Company.”23 Specific exceptions are made for CPI
and John Clifford, and for Defendants only as to a separate packaging company
(World Packaging Company LLC) owned by Defendants. 24
C. The Relationship Between Investors and CPI Deteriorates
On June 11, 2004, WPP entered into an Administrative Services & Raw
Material Supply Agreement with CPI (the “Services Agreement”). 25 Under this
agreement, CPI managed all of WPP’s accounts receivable, invoicing, financing and
materials sourcing and coordination, among other administrative tasks.26 The
Services Agreement contained a New Jersey choice of law and forum selection
clause.27 CPI performed its obligations under the Operating Agreement and Services
Agreement without objection or controversy for over thirteen years.28
In September 2016, Smith expressed to Clifford his desire to create a salaried
position at WPP for his wife, Toni M. Robinson-Smith M.D. 29 Though Robinson-
23 Id. § 14(a). 24 Id. § 14(c). 25 Compl. ¶¶ 4, 24–25. 26 Compl. ¶ 24. 27 Compl. Ex. B (“Services Agreement”) § 8(e). 28 Compl. ¶¶ 24–25. 29 Compl. ¶ 26.
7 Smith had served previously at WPP in a minor sales role, Smith proposed that the
Company promote her to Vice President of Administration, a new position with an
annual salary of $185,000.30 Clifford objected on the grounds that her excessive
salary was beyond the means of the Company and her responsibilities would be
duplicative of those contracted out to CPI under the Services Agreement.31
Notwithstanding Clifford’s stated objections, Smith and Baptiste moved unilaterally
to create the role and hire Robinson-Smith to fill it, offering her the full $185,000
salary originally contemplated by Smith (and rejected by CPI). 32
On March 10, 2017, Defendants delivered a letter (the “Termination Letter”)
to CPI’s office giving Plaintiff 90 days’ notice of Smith and Baptiste’s intent on
behalf of WPP to terminate the Services Agreement.33 That same month, Defendants
contacted a key mutual supplier to both WPP and CPI to negotiate an expansion of
the business relationship on behalf of WPP.34 Defendants told the supplier that WPP
30 Compl. ¶¶ 26–27. 31 Compl. ¶ 28. 32 See Compl. ¶¶ 28–29. 33 Compl. ¶ 34. 34 Compl. ¶ 37.
8 would delay pursuing the new business opportunity with the supplier until after
WPP’s Services Agreement with CPI had fully terminated.35
On April 3, 2017, Defendants sent CPI a letter encouraging it to withdraw as
a Member of WPP. 36 Smith then proposed to a CPI representative on behalf of
Investors that WPP should replace the financing CPI had arranged for the Company
with financing from MBE Capital Partners (“MBE”), despite the fact that MBE’s
financing rate was several times higher than the rate CPI had secured for WPP over
the past 13 years.37 CPI responded by pointing Smith to Section 8.10 of the
Operating Agreement, which CPI read to prevent Smith from unilaterally
undertaking “any obligation, debt, duty, or responsibility” on behalf of WPP or from
“pledg[ing] [WPP’s] credit or render[ing] it liable . . . for any purpose” without the
unanimous consent of WPP’s Managers, including Clifford.38 Defendants
apparently disagreed with that reading, and soon after unilaterally entered into a
financing agreement with MBE and directed customers to remit payments due to
WPP into an MBE-controlled bank account. 39
35 Id. 36 Compl. ¶ 36. 37 Compl. ¶ 38. 38 Compl. ¶ 39. 39 Compl. ¶¶ 39, 40, 57–58.
9 By letter dated June 26, 2017, Smith and Baptiste informed WPP customers
that Investors was WPP’s new “administrative services and financial agent.” 40 It is
alleged that Defendants thereafter directed multiple longtime WPP customers to
send payments for orders placed with WPP directly to Investors instead of the
Company.41 The termination of the Services Agreement and appointment of
Investors as the administrative services provider is alleged to have harmed Plaintiff
“by diverting funds so that Plaintiff, which was then still a Member of WPP entitled
to share in its profits, could not so share.”42
D. CPI Initiates Litigation in New Jersey
On May 1, 2017, CPI initiated an action against WPP, Investors, Smith and
Baptiste in New Jersey state court asserting various claims arising from WPP’s
alleged breach of the Operating Agreement and the Services Agreement
(the “New Jersey Action”).43 The claims relating to the Operating Agreement were
dismissed without prejudice in accordance with that agreement’s exclusive
Delaware forum selection clause; the claims relating to the Services Agreement are
40 Compl. ¶ 40. 41 Compl. ¶¶ 42–43. 42 Compl. ¶ 44. 43 Compl. ¶ 11.
10 still being litigated in New Jersey. 44 In the course of the New Jersey litigation, CPI
discovered Defendants had falsified versions of the Operating Agreement and
Services Agreement for submission both to the Ohio Minority Business Enterprise
authorities in 2005 and the court in the New Jersey Action in 2017. 45 Smith has
since claimed that he had verbal permission to affix Clifford’s signature from the
original agreements to the altered versions of those documents, which Clifford has
denied.46
CPI also alleges that it learned during the course of discovery in the New
Jersey Action that “Defendants falsely represented to Plaintiff and WPP’s vendors
that WPP had access to a $35 million line of credit through MBE, which it did not
have.”47 It is further alleged that “Defendants continued placing orders with vendors
through WPP based on the false assurance of access to a non-existent line of credit,
and diverted certain associated receivables to Investors, so that Plaintiff could not
share in profits, in violation of Section 14(a) of the Operating Agreement.”48
44 Id. 45 Compl. ¶ 45. 46 Id. 47 Compl. ¶ 46. 48 Id.
11 E. CPI Withdraws as a Member of WPP
On February 21, 2018, CPI and Investors entered into a Consent and
Acknowledgement to Withdrawal Agreement (the “Withdrawal Agreement”) to
memorialize CPI’s election to withdraw as a member of WPP. 49 Under the
Withdrawal Agreement, CPI “relinquished . . . all ownership interests in [WPP], all
claims to the return of its Capital Contribution, . . . all claims to the distribution of
cash generated by [WPP], and all claims to any economic interests in [WPP] as a
lender to or owner of the Company.”50 The withdrawal was expressly “subject in all
respects to the reservation of all rights and remedies of the parties in respect of any
and all claims, actions or proceedings by and between Investors . . . and CPI, which
in each case are pending as of the date hereof in any court or before any judicial
body of competent authority.”51
49 Compl. Ex. D (“Withdrawal Agreement”). 50 Id. 51 Id. The parties specifically identified the New Jersey Action and agreed that neither party has “waive[d] or postpone[d]” its rights with respect to that litigation. Id.
12 F. Procedural History
Plaintiff filed its first Verified Complaint on July 9, 2020,52 which it amended
on September 21, 2020.53 The operative Complaint asserts five Counts.54 Count I
is a claim against Investors, Smith and Baptiste for breach of Section 8.1 of the
Operating Agreement by excluding Clifford from voting on WPP’s hiring of
Robinson-Smith as Vice President of Administration. 55 Count II is a claim against
Smith for breach of Section 8.3 of the Operating Agreement (governing related party
transactions) by participating in WPP’s decision to create a new position for his wife,
whom he appointed unilaterally.56 Count III is a claim against Investors, Smith and
Baptiste for breach of Section 8.10 of the Operating Agreement by preventing CPI’s
representative Manager, Clifford, from voting on WPP’s entry into a financing
agreement with MBE. 57 Count IV is a claim against Investors, Smith and Baptiste
for breach of Section 14(a) of the Operating Agreement by diverting payments from
the Company to Investors following termination of the Services Agreement in the
52 D.I. 1. 53 D.I. 18. 54 Compl. ¶¶ 50–67. 55 Compl. ¶¶ 50–52. 56 Compl. ¶¶ 53–55. 57 Compl. ¶¶ 56–58.
13 summer of 2017. 58 Count V is a claim against Investors, Smith and Baptiste for
breach of the fiduciary duty of loyalty when they: (1) postponed the expansion of a
lucrative business arrangement with a key mutual supplier to both WPP and CPI
until after WPP’s Services Agreement with CPI terminated; (2) unilaterally diverted
sales from longtime WPP customers to Investors; and (3) unilaterally appointed
Investors as WPP’s administrative services agent, replacing CPI without affording
its representative Manager, Clifford, a vote on the decision. 59
Defendants filed their motion to dismiss the operative Complaint on
October 23, 2020.60 After full briefing, oral argument and a supplemental
submission, the matter was deemed submitted for decision on March 2, 2021.61
II. ANALYSIS
Defendants’ showcase argument for dismissal is that CPI lacks standing to
pursue its claims, all of which must be characterized as derivative. Standing “refers
58 Compl. ¶¶ 59–61. 59 Compl. ¶¶ 62–67. 60 D.I. 21 (Defs. WPP Invs., LLC’s and Edgar L. Smith, Jr.’s Opening Br. in Supp. of their Mot. to Dismiss Pl.’s Am. Verified Compl.) (“Defs.’ Opening Br.”). 61 See D.I. 23 (Pl.’s Answering Br. in Opp’n to Defs.’ Mot. to Dismiss) (“Pl.’s Answering Br.”); D.I. 25 (Defs. WPP Invs., LLC’s and Edgar L. Smith, Jr.’s Reply Br. in Further Supp. of their Mot. to Dismiss Pl.’s Am. Verified Compl.) (“Defs.’ Reply Br.”); D.I. 31 (Oral Arg. on Defs. WPP Invs., LLC’s and Edgar L. Smith, Jr.’s Mot. to Dismiss) (“Oral Arg. Tr.”); D.I. 31 (letter regarding authority mentioned for the first time at oral argument).
14 to the right of a party to invoke the jurisdiction of a court to enforce a claim or redress
a grievance.”62 “Standing is properly a threshold question that the Court may not
avoid,”63 and “a legal question that is well suited to resolution on a motion to
dismiss.”64 “Where, as here, the question of standing is so related to the merits,”
and asks “not whether the Court can grant the requested relief to any plaintiff, but
rather whether the Court can grant the requested relief to [this] plaintiff[], the
appropriate framework [for deciding a motion to dismiss purported derivative
claims] is under [Chancery] Rule 12(b)(6).” 65
Chancery Rule 12(b)(6) requires dismissal of a complaint if the plaintiff
cannot recover under “any reasonably conceivable set of circumstances susceptible
of proof” based on the complaint’s pled facts. 66 While the court need not accept
conclusory allegations or “every strained interpretation of the allegations proposed
62 Morris v. Spectra Energy P’rs (DE) GP, LP, 246 A.3d 121, 128 (Del. 2021) (quoting Stuart Kingston, Inc. v. Robinson, 596 A.2d 1378, 1382 (Del. 1991)); see also El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1256 (Del. 2016) (“El Paso Pipeline II”) (observing that without standing, “the court lacks the power to adjudicate the matter”). 63 Morris, 246 A.3d at 129. 64 In re AbbVie Inc. S’holder Deriv. Litig., 2015 WL 4464505, at *3 (Del. Ch. July 21, 2015). 65 Id. (emphasis in original) (citation omitted). 66 Beck v. Brady, 860 A.2d 809, 809 (Del. 2004) (TABLE) (quoting Kofron v. Amoco Chems. Corp., 441 A.2d 226, 227 (Del.1982)).
15 by plaintiff,”67 it “must accept as true all well-pled allegations in the complaint and
draw all reasonable inferences from those facts in plaintiff’s favor.”68 As the Court
considers the viability of Plaintiff’s claims under Rule 12(b)(6), it must remain
mindful that “[t]he party invoking the jurisdiction of a court bears the burden of
establishing the elements of standing.”69
Under Delaware’s Limited Liability Company Act, a claim will be deemed
derivative when it is brought by a member “in the right of a limited liability company
to recover a judgment in its favor.”70 The member’s right to bring the action is
conditioned upon a determination that “managers or members with authority . . .
have refused to bring the action or if an effort to cause those managers or members
to bring the action is not likely to succeed.” 71 “The derivative suit is a corporate
concept grafted onto the limited liability company form.”72 As such, “case law
governing corporate derivative suits is equally applicable to suits on behalf of
67 In re Gen. Motors (Hughes) S’holder Litig., 897 A.2d 162, 168 (Del. 2006) (quoting Malpiede v. Townson, 780 A.2d 1075, 1083 (Del. 2003)). 68 In re Rouse Props., Inc., 2018 WL 1226015, at *10 (Del. Ch. Mar. 9, 2018) (citations omitted). 69 Dover Hist. Soc’y v. City of Dover Planning Comm’n, 838 A.2d 1103, 1110 (Del. 2003).
70 6 Del. C. § 18-1001. 71 Id. 72 Elf Atochem N. Am., Inc. v. Jaffari, 727 A.2d 286, 293 (Del. 1999).
16 an LLC.”73 Thus, it is appropriate to look to our law of corporations when assessing
whether CPI has brought direct or derivative claims and whether it has standing to
prosecute the claims it has brought.
At the threshold, Defendants argue CPI has brought derivative claims but
lacks standing to prosecute them both because it is no longer a member of WPP and
because it has failed to satisfy the procedural imperatives under our law for asserting
claims on behalf of a Delaware LLC.74 More specifically, Defendants argue that
CPI’s claims, while packaged as direct claims, are actually claims belonging to WPP
that CPI no longer has standing to bring derivatively, having withdrawn as a member
of WPP more than three years ago and having released all claims to any interest it
held in the Company. 75 Under 6 Del. C. § 18-1002, “[i]n a derivative action, the
plaintiff must be a member or an assignee of a limited liability company interest at
73 VGS, Inc. v. Castiel, 2003 WL 723285, at *11 (Del. Ch. Feb. 28, 2003). 74 The Withdrawal Agreement reserved CPI’s right to continue to prosecute claims it raised in the New Jersey Action, but also reserved Investor’s right to raise any and all defenses to those claims. See Withdrawal Agreement. Thus, even if it is assumed that CPI’s claims here mirror the claims that were brought and then dismissed in the New Jersey Action, such that they could be asserted again in Delaware under the Withdrawal Agreement, that same agreement preserved Investor’s right to raise applicable defenses to the claims, including that CPI lacks standing to prosecute derivative claims. 75 Compl. ¶¶ 12–15; Withdrawal Agreement.
17 the time of bringing the action.” 76 This requirement reflects the well-understood
canon of our corporations law that “[t]he right to sue derivatively is a property right
associated with share ownership.”77 Thus, to the extent CPI’s claims are derivative,
they fail as a matter of law for CPI’s lack of standing to assert them.
In a typical case, this court distinguishes between direct and derivative claims
by application of the well-settled test set out in Tooley v. Donaldson, Lufkin &
Jenrette, Inc., 78 where the Court distilled the direct versus derivative analysis down
to two inquiries: “(1) who suffered the alleged harm (the [LLC] or the suing
[member], individually); and (2) who would receive the benefit of any recovery or
other remedy (the [LLC] or the [members], individually)?” 79 CPI, however,
maintains that this is not a typical case. According to CPI, because WPP was a two-
member LLC, Tooley’s two-part test cannot apply because it ignores the reality that
harm to the LLC caused by one member flows directly to the other member.
76 6 Del. C. § 18-1002 (emphasis added); see also CML V, LLC v. Bax, 6 A.3d 238 (Del. Ch. 2010), aff’d, 28 A.3d 1037 (Del. 2011) (upholding a plain reading of Section 18-1002’s membership requirement.) 77 Urdan v. WR Cap. P’rs, LLC, 2019 WL 3891720, at *8 (Del. Ch. Aug. 19, 2019), aff’d, 244 A.3d 688 (Del. 2020). 78 845 A.2d 1031 (Del. 2004). 79 Id. at 1039; see also Hindlin v. Gottwald, 2020 WL 4206570, at *6 (Del. Ch. July 22, 2020) (applying Tooley in the LLC context).
18 I address this argument first. Because I disagree with CPI that this case is atypical,
I go on to apply Tooley to the claims asserted here.
A. Tooley Applies in the Context of a Two-Member LLC
As noted, CPI asserts that where, as here, claims arise from a dispute between
members of a two-member LLC and only one member is harmed, “the relationships
among the parties [become] so simple and circumstances so clear-cut that the
distinction between direct and derivative claims becomes irrelevant . . . .” 80 Of
course, 6 Del. C. § 18-1001 does not distinguish two-member LLCs from other
LLCs when addressing derivative actions—a distinction our General Assembly
easily could have codified had it been so inclined.81 And CPI’s cited authority
relates only to claims arising from dissolved limited partnerships, whereas WPP
remains a going concern.82 Indeed, in CPI’s favorite case, In re Cencom Cable
Income Partners, L.P., the court declined to apply Tooley only after observing that,
80 Pl.’s Answering Br. at 16 (quoting In re Cencom Cable Income P’rs, L.P., 2000 WL 130629, at *6 n.14 (Del. Ch. Jan. 27, 2000) (disregarding the direct versus derivative distinction for claims brought by one former limited partner against the other former limited partner for wrongdoing associated with the final transaction of a dissolved limited partnership)). 81 See 6 Del. C. § 18-1001. 82 The only case CPI cites not in the dissolved entity context is Stevanov v. O’Conner, but the court there deferred (but did not reject) application of Tooley because it required “a more thorough development of the record [to] clarify the law or its application.” 2009 WL 1059640, at *6 (Del. Ch. Apr. 21, 2009) (internal quotations and citation omitted).
19 “[w]ith the partnership in dissolution the ‘partnership’ entity is simply an artifice
representing the relationship between two legally juxtaposed parties and is no longer
relevant as a distinct legal creature for the purpose of resolving the final claims
between those parties.” 83 Our courts have since made clear that Cencom is “limited
to its own unique set of facts,” 84 and that the presence of “a partnership that had been
liquidated or dissolved” was a “material[]” distinction in determining the extent to
which Tooley should apply. 85
That distinction was brought to the fore in Dietrichson v. Knott, where then-
Vice Chancellor Montgomery-Reeves applied Tooley’s test to breach of fiduciary
duty claims asserted by one 50% member of an LLC against the other 50%
member. 86 CPI did not address Dietrichson either in briefing or at oral argument,
and no wonder: as a case applying Tooley in the context of a two-member LLC, its
example directly contradicts CPI’s proffered state of Delaware law. Indeed, the
court in Dietrichson dismissed the plaintiff’s fiduciary duty and waste claims after
83 Cencom, 2000 WL 130629, at *6. 84 Agostino v. Hicks, 845 A.2d 1110, 1125 (Del. Ch. 2004). 85 Metro. Life Ins. Co. v. Tremont Gp. Hldgs., Inc., 2012 WL 6632681, at *10 (Del. Ch. Dec. 20, 2012) (“I see no basis for expanding Cencom to entities . . . [that are] relevant as [] distinct legal creature[s] for the purpose of resolving the final claims between [the disputing] parties.” (internal quotation and citation omitted)). 86 2017 WL 1400552, at *1, *4–5 (Del. Ch. Apr. 19, 2017) (dismissing derivative claims on a motion to dismiss).
20 concluding they were derivative in nature and finding the plaintiff did not make a
demand on the board or attempt to plead demand futility.87 The same analysis is
required here.
B. Tooley’s Application Requires Dismissal of Plaintiff’s Complaint
As noted, the test set forth in Tooley assesses the nature of a claim by reference
to two questions: “(1) who suffered the alleged harm (the [LLC] or the suing
[member], individually); and (2) who would receive the benefit of any recovery or
other remedy (the [LLC] or the [members], individually)?”88 The first prong of
Tooley directs the Court’s analysis to the nature of the alleged harm; the “claimed
direct injury must be independent of any alleged injury to the corporation. The
stockholder must demonstrate that the duty breached was owed to the stockholder
and that he or she can prevail without showing an injury to the corporation.”89 Under
the second prong of Tooley, “[w]here all of a corporation’s stockholders are harmed
and would recover pro rata in proportion with their ownership of the corporation’s
stock solely because they are stockholders, then the claim is derivative in nature.” 90
87 Id. at *4–5. 88 Tooley, 845 A.2d at 1039; Hindlin, 2020 WL 4206570, at *7 (applying Tooley in the LLC context). 89 Tooley, 845 A.2d at 1039. 90 El Paso Pipeline II, 152 A.3d at 1261 (quoting Feldman v. Cutaia, 951 A.2d 727, 733 (Del. 2008)).
21 When judging a plaintiff’s claim against Tooley’s rubric, the court awards no
style points for artful pleading. Just because a plaintiff stamps the word “direct” on
its plead claim does not make it so. 91 Rather, the court must look past the labels to
discern “the nature of the wrong alleged, taking into account all of the facts alleged
in the complaint, and determine for itself whether a direct claim exists.”92
Plaintiff’s claims can be divided into contract and fiduciary duty claims.
I address each in turn.
Plaintiff’s Contract Claims are Derivative
CPI brings in Counts I–IV claims based on alleged breaches of the Operating
Agreement. The contract claims come in two varieties. First, in Count IV, CPI
alleges Defendants breached Section 14(a) of the Operating Agreement by diverting
payments from WPP to Investors.93 CPI asserts it suffered direct harm because, as
the only member of WPP without equity in Investors, it was “the only party directly
damaged by diversion of funds.”94 Second, in Counts I–III, CPI alleges Defendants
91 Hartsel v. Vanguard Gp., Inc., 2011 WL 2421003, at *16 (Del. Ch. June 15, 2011) (“The manner in which a plaintiff labels its claim and the form of words used in the complaint are not dispositive”). 92 Id.; see also Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 353 (Del. 1988) (“In determining the nature of the wrong alleged, a court must look to ‘the body of the complaint, not to the plaintiff’s designation or stated intention.” (citation omitted)). 93 Compl. ¶ 43. 94 Compl. ¶ 42.
22 breached various provisions of the Operating Agreement by denying its Manager,
Clifford, a right to vote on certain decisions.
Count IV’s diversion-of-payments claim is quintessentially derivative.
Because it is the Company’s funds Defendants are alleged to have diverted, the harm
caused by Defendants’ actions flows directly to the Company, and only derivatively
to its members. In the same way, any recovery of such funds would flow first to the
Company only then to be distributed pro rata to its members.95 “Claims are treated
as derivative when they naturally assert that the corporation’s funds have been
wrongfully depleted.” 96 CPI’s attempt to convert a diversion-of-funds claim from
95 See In re Happy Child World, 2020 WL 5793156, at *11–34 (Del. Ch. Sept. 29, 2020) (calculating damages flowing from derivative claims against a stockholder/fiduciary and “round tripping” those damages to the company’s stockholders pro rata); see also Dietrichson, 2017 WL 1400552, at *4–5 (explaining that plaintiff’s recovery for defendant’s self-interested diversion of funds “would [run to] the Company, not [plaintiff]. [Plaintiff] would only receive his portion of recovery as an indirect benefit and pro rata according to his membership interest under the Operating Agreement.” (internal citations omitted)). I note that CPI may have had a basis to argue for direct recovery of any judgment obtained on the derivative claims if it had standing to pursue those claims. See In re El Paso Pipeline P’rs, LP Deriv. Litig., 132 A.3d 67, 121 (Del. Ch. 2015) (“El Paso Pipeline I”) (discussing equitable grounds to allow stockholders to recover on derivative claims directly, particularly with respect to claims against controlling stockholders), rev’d on other grounds, El Paso Pipeline II, 152 A.3d 1248. The fact that there may be a basis to allow the stockholder to recover directly on a derivative claim, however, does not render the claim any less derivative. 96 Dietrichson, 2017 WL 1400552, at *4 (internal quotations and citations omitted); see also Kramer, 546 A.2d at 353 (holding claims of corporate mismanagement resulting in a depletion of corporate funds are derivative because they represent a wrong to the corporation indirectly experienced by all shareholders); Feldman, 951 A.2d at 735 (Del. 2008) (noting waste claims are derivative in nature).
23 derivative to direct based on its identity as one of two unitholders in WPP fails; for
reasons already explained, an LLC’s two-member status does not preclude
application of Tooley. Where, as here, one of two members brings a claim that the
other member has depleted company assets, that claim is and remains derivative.97
Plaintiff’s voting rights claims require a separate analysis. Counts I and II
relate to Smith hiring his wife over CPI’s objection: Count I alleges breach of
Section 8.1, which entitled Clifford to vote on the hire, while Count II alleges breach
of Section 8.3 for Smith having voted on a related party transaction from which he
was obligated to abstain. Count III alleges breach of Section 8.10 for denying
Clifford an opportunity to vote on WPP’s entry into a financing agreement with
MBE. As to each of these claims, CPI argues that, because its bargained-for voting
rights under the Operating Agreement were denied, the harm flowing from these
breaches was direct.
To be sure, breach of a contractual right to vote may constitute a direct claim
under Tooley.98 But there is a difference between the nature of a breach and the
97 See Dietrichson, 2017 WL 1400552, at *4. 98 See, e.g., Gotham P’rs, L.P. v. Hallwood Realty P’rs, L.P., 1998 WL 832631, at *1, *5 (Del. Ch. Sept. 30, 2013) (holding voting dilution claim constituted direct harm); but see Hindlin, 2020 WL 4206570, at *7 (holding voting dilution claim constituted derivative harm).
24 alleged harm flowing from that breach; to determine whether a claim is direct or
derivative, Tooley instructs that our courts train their focus on the latter.99
In this case, CPI alleges that Robinson-Smith’s hiring was “[i]n furtherance
of [Defendants’] plan to divert scarce WPP resources away from Plaintiff in order
to fund Robinson-Smith’s excessive salary.”100 “The hiring of Robinson-Smith,”
CPI alleges, “provided substantial economic benefit to Smith” (through his spouse),
and Smith’s actions were taken to enrich himself to WPP’s detriment. 101 CPI further
alleges that it opposed Robinson-Smith’s hiring because it “would be duplicative
[of work already contracted to CPI] . . . and that in any event, WPP could not afford
to create the position, given its then-marginal profitability.” 102 Viewed through
99 See, e.g., In re J.P. Morgan Chase & Co. S’holder Litig., 906 A.2d 766, 771–73 (Del. 2006) (classifying as derivative a disclosure claim in the context of a merger because, “[e]ven if it were assumed that improper proxy disclosures induced JPMC’s shareholders to approve the merger (including the $7 billion overpayment), the harm resulting from the overpayment was to JPMC.”). 100 Compl. ¶ 7. I note that, although CPI alleges Smith “suggested that Plaintiff reduce its Administrative Fee [under the Services Agreement] to make available funds to pay Robinson-Smith’s proposed $185,000 annual salary,” it does not allege Smith actually reduced CPI’s fee to fund Robinson-Smith’s salary upon her hiring. See Compl. ¶¶ 28–29. To the extent Defendants wrongfully caused WPP to terminate the Services Agreement to make way for Robinson-Smith, that claim can be litigated as a breach of the Services Agreement in the New Jersey Action. 101 Compl. ¶ 33; see also Compl. ¶ 27. 102 Compl. ¶ 4; see also Compl. ¶¶ 27–28 (“Clifford . . . explained to Smith that creating the position would not be economically viable for WPP due to the excessive salary figure, and that the position’s responsibilities would be duplicative of functions Plaintiff was already performing for WPP under the Services Agreement.”).
25 Tooley’s lens, the harm of wastefully hiring unnecessary personnel accrues to the
Company, with any recovery in the first instance running directly to the entity. That
is a derivative claim.103
Confronted with its own (amended) pleadings, CPI raised for the first time at
oral argument Fletcher International Ltd. v. ION Geophyiscal Corp.104 to support its
argument that it was directly harmed by Defendants’ hiring of Robinson-Smith.105
In Fletcher, then-Chancellor Strine calculated the expectation damages flowing from
a company’s violation of a shareholder-hedge fund’s consent rights with respect to
a bridge loan extended to maintain the company’s solvency until it received a more
103 See Dietrichson, 2017 WL 1400552, at *4–5; see also J.P Morgan, 906 A.2d at 771 (observing that “claims of waste are classically derivative”); Protas v. Cavanaugh, 2012 WL 1580969, *6 (Del. Ch. May 4, 2012) (noting that corporate waste claims are derivative as they rest on harm to the corporation). 104 Fletcher, 2013 WL 6327997 (Del. Ch. Dec. 4, 2013). 105 Oral Arg. Tr. at 48:11–50:4. The only other case CPI cites in support of its theory that the hiring of Robinson-Smith gave rise to a direct claim is Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., where the court construed as direct a plaintiff’s claim that its vote was diluted when the limited partnership’s corporate general partner allegedly engaged in a series of unfair and self-dealing unit transactions aimed to increase its ownership stake in the limited partnership. 1998 WL 832631, at *1, *5. The court reasoned that “the disputed transactions impinged upon the unit holder’s right to terminate the general partner. The injury is specific to the unit holders as a class as opposed to a harm inflicted upon the limited partnership.” Id. at *5. Unlike Gotham, CPI’s claim in this case is that its right to vote was denied and it seeks compensatory damages for the Company’s resulting wasteful expenditure of resources on unnecessary personnel. See Compl., Prayer for Relief ¶ A (seeking compensatory damages for its claims); see also J.P. Morgan, 906 A.2d at 772–73 (classifying as derivative a claim of voting dilution where the plaintiff sought compensatory damages identical to those suffered by the company).
26 substantial cash infusion. 106 The hedge fund’s theory of damages was that it could
have leveraged its consent right over the bridge loan to extract for itself outsized
financial benefits.107
As noted, however, CPI’s pled theory is different. Specifically, CPI
affirmatively pleads that it would “not consent to the creation or funding of
Robinson-Smith’s position”108 because the position “would be duplicative” of work
already being performed for WPP and “WPP could not afford to create the position,
given its then-marginal profitability.” 109 Thus, CPI’s allegations not only belie its
contention that it would have extracted (and so was denied) a direct benefit in
exchange for its vote, but also demonstrate that, to the extent any negotiation
occurred, CPI would have negotiated for the benefit of the Company, not itself. That
fact is underscored by the damages CPI seeks: while the hedge fund in Fletcher
sought expectation damages for loss of its consent rights, CPI seeks compensatory
damages for losses incurred by WPP as a result of Defendants’ breach of the
106 Fletcher, 2013 WL 6327997, at *1–2, *17–25. 107 Id. at *13–16 (“[The hedge fund’s expert’s] entire report was premised on the notion that [the hedge fund] was willing to strap a bomb onto its chest and blow up the entire [] deal, force [the company] into bankruptcy, and decimate its own investment portfolio if it was not paid a ransom in exchange for its consent to a transaction that was already expected to create substantial value for it.”). 108 Compl. ¶ 5. 109 Compl. ¶ 4.
27 Operating Agreement. 110 “[T]he fundamental principle governing entitlement to
compensatory damages . . . is that the damages must be logically and reasonably
related to the harm or injury for which compensation is being awarded.” 111 As pled,
those damages would flow from the hiring of Robinson-Smith, which could only
have occurred in the first instance at the Company’s expense. Because the ultimate
harm of Defendants’ actions accrued to WPP, and any remedy would run first to
WPP, Counts I and II are both derivative.
The same analysis applies to Count III, where CPI alleges that Defendants’
decision to replace WPP’s then-financial services provider, M&T Bank, with MBE
resulted in “a rate several times that which Plaintiff had secured for WPP under the
Services Agreement.” 112 Again, while the alleged breach was the denial of CPI’s
voting rights, the alleged harm was suffered by the Company, which ultimately was
forced to shoulder a higher financing rate. Any recovery would thus run first to
WPP, benefiting its stockholders derivatively.113 “Where all of a corporation’s
stockholders are harmed and would recover pro rata in proportion with their
110 See Compl., Prayer for Relief ¶ A. 111 J.P. Morgan, 906 A.2d at 773. 112 Compl. ¶ 38. 113 Again, to the extent this conduct violated the Services Agreement, or some other separate commitment running from WPP to CPI, CPI may assert that claim in the New Jersey Action.
28 ownership of the corporation’s stock solely because they are stockholders, then the
claim is derivative in nature.” 114
For the foregoing reasons, all of CPI’s contract claims are derivative. That
leaves CPI’s fiduciary duty claim in Count V, which, as explained below, is also
derivative.
Plaintiff’s Fiduciary Duty Claims are Derivative
Count V asserts Defendants breached their fiduciary duty of loyalty in three
respects. First, Defendants allegedly “postpone[d] the [Company’s] expansion” of
a “lucrative business” opportunity with a “key” supplier until after WPP terminated
its Services Agreement with CPI and then appointed Investors as the new
administrative services provider.115 Second, Defendants allegedly “breached their
duty of loyalty when they unilaterally diverted sales from longtime WPP customers
to Investors,” thereby “denying Plaintiff’s right to share in WPP’s profits earned
from those sales.”116 Third, Defendants allegedly violated their duty of loyalty by
“unilaterally appoint[ing] Investors . . . as WPP’s new administrative services agent,
replacing Plaintiff without affording Plaintiff’s representative Manager, John
114 El Paso Pipeline II, 152 A.3d at 1261 (quoting Feldman, 951 A.3d at 733). 115 Compl. ¶¶ 37, 64, 66–67. 116 Compl. ¶ 65.
29 Clifford, a vote on the transaction.” 117 CPI argues these are direct claims because
Defendants prevented CPI from duly exercising its rights under the Operating
Agreement and, in doing so, made material misrepresentations to CPI.118
The harm suffered by Defendants’ disloyal postponement of a lucrative
business expansion and diversion of business from WPP to Investors runs first to
WPP, as profits from both opportunities would accrue to the Company. It follows
that the Company would also receive the benefit of any resulting recovery, with CPI
benefiting from such opportunities derivatively, in proportion to its equity stake in
WPP. Under Tooley, then, these fiduciary duty claims are derivative.
In the same vein, CPI alleges Defendants terminated the Services Agreement
“[i]n furtherance of their plan to divert scarce WPP resources” to themselves,119
resulting ultimately in “WPP’s actual losses to total $1,225,049 . . . .” 120 CPI further
alleges that “[t]he termination of the Services Agreement and appointment of
117 Compl. ¶ 66. 118 Compl. ¶¶ 45–46, 62–67. CPI admits that there is “overlap between the breach of contract claims and the breach of fiduciary duty claims in the Amended Complaint.” Pl.’s Answering Br. at 38. 119 Compl. ¶ 7. 120 Compl. ¶ 8; see also El Paso Pipeline II, 152 A.3d at 1261 (“[T]he alleged overpayment left the Partnership $171 million poorer. Any economic harm to [plaintiff] devolved upon him as an equity holder in the form of the proportionally reduced value of his units— a classically derivative injury.” (internal citations and quotations omitted)).
30 Investors as the administrative services provider . . . damaged Plaintiff by diverting
funds so that Plaintiff, which was then still a Member of WPP entitled to share in its
profits, could not so share.”121 By the Complaint’s own pleading, then, the harm
flowing from Defendants’ self-interested assumption of responsibilities enumerated
in the Services Agreement flowed to WPP directly. Any resultant compensatory
recovery for such harm, therefore, would flow first to the Company and only
derivatively to its members. This is the very definition of a derivative claim under
Tooley.
* * * * *
Under 6 Del. C. § 18-1001, only members (or assignees) may bring derivative
claims on behalf of a Delaware LLC. CPI lacks standing because it is no longer a
member of WPP (nor was it when it initiated this litigation). Moreover, 6 Del. C.
121 Compl. ¶ 44. To be clear, CPI does not allege Defendants violated their fiduciary duties by terminating the Services Agreement. And, while CPI perhaps could have alleged direct harm against Defendants through their tortious interference with the Services Agreement, it has elected to litigate its Service Agreement-related claims against WPP (and Investors) in New Jersey. Compl. ¶ 11. Rather, CPI alleges in Count V that Defendants breached their fiduciary duties by contracting to themselves work for which they were overpaid by WPP. Compl. ¶ 8 (alleging that replacing CPI under the Services Agreement cost WPP “actual losses to total $1,225,049”); Compl. ¶ 41 (alleging Defendants’ breached their fiduciary duties by reference to Section 8.3 of the Operating Agreement, which sets forth WPP’s Related Party Transactions voting policy); Compl. ¶ 44 (alleging Defendants’ replacing the Services Agreement “directly damaged Plaintiff by diverting funds so that Plaintiff, which was then still a Member of WPP entitled to share in its profits, could not so share. This self-serving termination and purposeful, wrongful diversion of funds to Investors breached Smith’s and Baptiste’s fiduciary duties.”).
31 §§ 18-1001 and 18-1003 require that the member make a pre-suit demand or plead
demand futility before filing derivative claims. 122 Because CPI undisputedly did not
make a pre-suit demand or plead demand futility, Smith and Investors’ motion to
dismiss the Complaint must be granted in full.
III. CONCLUSION
For the foregoing reasons, Defendants’ motion to dismiss Counts I–V is
granted.
IT IS SO ORDERED.
122 6 Del. C. §§ 18-1001, 18-1003.