LVI Group Investments LLC v. NCM Group Holdings LLC

• Court: Court of Chancery of Delaware
• Decided: March 29, 2017
• Docket: CA 12067-VCG
• Status: Published

Opinion

COURT OF CHANCERY OF THE SAM GLASSCOCK III STATE OF DELAWARE COURT OF CHANCERY COURTHOUSE VICE CHANCELLOR 34 THE CIRCLE GEORGETOWN, DELAWARE 19947

Date Submitted: December 2, 2016 Date Decided: March 29, 2017

John L. Reed, Esquire Richard D. Heins, Esquire Ethan H. Townsend, Esquire Peter H. Kyle, Esquire DLA Piper LLP Ashby & Geddes 1201 North Market Street, Suite 2100 500 Delaware Avenue Wilmington, DE 19801 Wilmington, DE 19801

Rudolf Koch, Esquire John A. Sensing, Esquire J. Scott Pritchard, Esquire Potter Anderson & Corroon LLP Matthew D. Perri, Esquire 1313 North Market Street Richards, Layton & Finger, P.A. Wilmington, DE 19801 One Rodney Square 920 North King Street Wilmington, DE 19801

Bradley R. Aronstam, Esquire Nicholas D. Mozal, Esquire 100 S. West Street, Suite 400 Wilmington, DE 19801

Re: LVI Group Investments, LLC v. NCM Group Holdings, LLC and Subhas Khara, Civil Action No. 12067-VCG

Dear Counsel:

This rather complex litigation can usefully be conceived in simplified form as

follows. Two large demolition firms—Delaware LLCs—merged their businesses

into a single entity, NorthStar Group Holdings, itself a Delaware LLC of which the

firms became the members (the “Merger”). The percentage ownership of the member LLCs in NorthStar was based on a formula pegged to each LLC’s financial

statements prior to the Merger. These financial statements, in turn, were subject to

certain representations and warranties from each LLC. The parties to the Merger

agreed to indemnify one another for breaches of the merger agreement (the

“Contribution Agreement”), including for inaccuracies in the representations and

warranties, but such indemnification is capped at $15 million. The Contribution

Agreement provides for unlimited recovery for fraud, however. Both parties,

respectively via complaint and counterclaim, have alleged the other has committed

fraud regarding its financial representations.

Before me are the Counterclaim Defendants’ (collectively, the “Counter-

Defendants”) Motions to Dismiss. The allegations of fraud against the Counter-

Defendants—including one of the member LLCs, LVI Group Investments (“LVI”),

and individuals associated with that entity—are pled in minimal fashion. At the

motion to dismiss phase, however, the pleadings need only make ultimate recovery

reasonably conceivable. It is true, as the Counter-Defendants point out, that

elements of fraud must be pled with particularity, in order that a defendant may

reasonably understand and defend the allegations against it. Here, however, I find

the required elements pled: the Counterclaim Plaintiff—the other member LLC,

NCM Holdings (“NCM”)—alleges that LVI and its agents made certain financial

representations; that the representations were made to NCM in negotiating and

2 consummating the NorthStar merger, including with respect to NCM’s percentage

ownership; that these representations have proved false or inaccurate; that the

Counter-Defendants knew the representations were false when made; and that NCM

reasonably relied thereon to its detriment, while LVI profited from the false

representations. This is sufficient particularity in a pleading of fraud to withstand

dismissal. It is true, as the Counter-Defendants point out, that a required element—

these parties’ knowledge and intent regarding the falsity of the representations—is

pled in a general averment. Knowledge, however, is not an element of fraud that

must be pled with particularity. Accordingly, I find that the fraud allegations survive

this motion to dismiss.

The Counter-Defendants also seek to dismiss claims, brought by NCM both

directly and derivatively on behalf of NorthStar, against current and former officers

of NorthStar, who, NCM alleges, acted in support of the fraudulent activities

described above. Those allegations fail to state cognizable claims. My rationale

follows.

3 I. BACKGROUND1

A. The Parties

Counterclaim Plaintiff NCM is a Delaware limited liability company and a

member of NorthStar, of which NCM owns 37.5%. 2 Counterclaim Defendant LVI

is a Delaware limited liability company and also a member of NorthStar, of which it

owns 62.5%.3 Prior to the Merger, NCM and LVI were competitors that were each

engaged in the “business of demolition and remediation of large-scale projects.”4

Nominal Defendant NorthStar is a Delaware limited liability company formed

by the Merger. 5 NorthStar’s Board of Directors (the “Board”) is comprised of eleven

individuals. 6 Counter-Defendant Scott State is an owner of LVI and was “one of the

persons who caused LVI to merge with NCM.”7 Leading up to the Merger, State

was a managing member of LVI and LVI’s President and CEO. 8 State was also

President and CEO and a member of the boards of several LVI subsidiaries. 9 Prior

to the Merger, State “participated materially in the management of LVI” and, after

1 The facts, drawn from NCM’s Amended Verified Counterclaim Complaint (the “Counterclaim” or “CC”) and from documents incorporated by reference therein, are presumed true for purposes of evaluating Counter-Defendants’ Motion to Dismiss. 2 CC. ¶ 5. 3 Id. at ¶ 6. 4 Id. at ¶ 12. 5 Id. at ¶¶ 9, 19. 6 Id. at ¶ 123. 7 Id. at ¶ 7. 8 Id. 9 Id. 4 the Merger, State “continues to participate materially in the management of

NorthStar.”10

Counter-Defendant Paul Cutrone is an owner of LVI and “was one of the

persons who caused LVI to merge with NCM.”11 Leading up to the Merger, Cutrone

was the Vice-President and CFO of LVI and several of its subsidiaries, as well as a

member of the subsidiaries’ boards. 12 Cutrone “participated materially in the

management of LVI before the Merger and NorthStar after the Merger.” 13 LVI,

Cutrone, and State collectively comprise the Counter-Defendants.

B. The Merger

LVI approached NCM in September 2013 about a strategic merger between

the two companies.14 Initially, NCM was not interested in the proposed merger due

to recently restructuring its debt and equity. 15 LVI continued its pursuit, however,

and NCM eventually relented and agreed to discuss a merger. 16 LVI and NCM

executed a non-disclosure agreement and negotiated throughout the end of 2013 and

into the beginning of 2014. 17 Eventually, LVI and NCM agreed on a 62.5/37.5 split,

10 Id. 11 Id. at ¶ 8. 12 Id. 13 Id. 14 Id. at ¶ 13. 15 Id. 16 Id. at ¶¶ 14–15. 17 Id. at ¶ 15. 5 “with LVI receiving 62.5% of the new company and NCM receiving 37.5%

thereof.”18

On or about April 23, 2014, LVI and NCM “contributed and merged their

subsidiaries” into a newly formed entity, NorthStar, pursuant to their merger

agreement, the Contribution Agreement.19 “State and Cutrone became CEO and

CFO of NorthStar, respectively,” although NorthStar now no longer employs

Cutrone.20 “Pursuant to the Contribution Agreement, LVI submitted consolidated

financial statements of the subsidiaries it was contributing to NCM” (the “LVI

Financial Statements”).21 LVI represented and warranted in the Contribution

Agreement that the LVI Financial Statements

fairly present, in all material respects, the consolidated financial position of the LVI Subsidiaries as of their respective dates, and the consolidated results of operations and cash flows of the LVI Subsidiaries for the respective periods covered thereby, in conformity with GAAP consistently applied throughout the period covered thereby . . . .22

LVI also agreed to indemnify “and hold harmless [NorthStar] and each of its

Subsidiaries from and against all Losses arising out of, relating to or resulting” from

any inaccuracy in LVI’s representations and warranties with respect to the LVI

18 Id. 19 Id. at ¶ 19. 20 Id. at ¶ 20; Countercl. Pl’s Answering Br. 42 n.4. 21 CC. ¶ 21. 22 Id. at ¶ 22; Id. at Ex. A (the “Contribution Agreement”) § 3.4(b). 6 Financial Statements.23 The Contribution Agreement also included a notice and

claim procedure “pursuant to which NCM could bring a claim to enforce LVI’s

indemnity obligation to NorthStar” and provided that “the parties’ exclusive

remedies in connection with the Merger were” indemnification claims, which the

Contribution Agreement capped at $15 million, and fraud claims, which were not

capped.24

C. Post-Merger Facts Leading to this Litigation

Soon after the Merger, NorthStar began recognizing losses on the LVI legacy

jobs.25 NCM served a claim notice on LVI on April 21, 2015 alleging that the LVI

Financial Statements were materially misstated because of improper accounting for

ongoing jobs.26 The Contribution Agreement required the parties “to cooperate and

assist in all reasonable respects regarding the investigation and resolution” of a

party’s claim. 27 Accordingly, the parties engaged in an investigation of NCM’s

claim notice and this litigation commenced thereafter.28

D. Procedural History

LVI, not NCM, filed the first complaint in connection with the Merger on

March 3, 2016 alleging fraud, fraudulent inducement, and unjust enrichment and

23 See CC. ¶ 23; Contribution Agreement § 5.2(b). 24 See CC. ¶ 24; Contribution Agreement § 5.4(e). 25 CC. ¶ 68. 26 Id. at ¶ 25. 27 Id. at ¶ 26. 28 Id. 7 pleading claims for indemnification and a declaratory judgment against NCM with

respect to certain representations and warranties NCM made in the Contribution

Agreement (the “LVI Complaint”). More specifically, LVI alleges that NCM

intentionally overstated earnings and manipulated NCM’s accounting in violation of

GAAP in such a way that an auditor or purchaser would be unlikely to detect. 29

NCM, in turn, filed its Original Verified Counterclaim on April 4, 2016 and

subsequently filed its Amended Verified Counterclaim on August 9, 2016, pleading

five counts that are similar to the LVI Complaint. Count I is a claim for fraud against

the Counter-Defendants and NorthStar alleging that the Counter-Defendants

knowingly made or caused to be made false representations of material facts in the

LVI Financial Statements and knowingly misrepresented that the LVI Financial

Statements were prepared in accordance with GAAP.30 Count I alleges further that

the Counter-Defendants concealed substantial losses they knew would occur “that

were not reflected in the LVI Financial Statements.”31 Count II is a claim for

fraudulent inducement against the Counter-Defendants and NorthStar alleging,

similar to Count I, that the Counter-Defendants “made or caused to be made false

representations of material facts in the LVI Financial Statements” and that the

Counter-Defendants misrepresented that the LVI Financial Statements were

29 LVI Complaint ¶ 13. 30 See CC. ¶¶ 71–83. 31 See id. ¶¶ 71–83. 8 prepared in accordance with GAAP. Count II also alleges that the Counter-

Defendants “orally and in writing further misrepresent[ed] to NCM that LVI’s Jobs

were properly reported in the LVI Financial Statements” and concealed substantial

losses the Counter-Defendants knew would occur. 32 Count III is a claim for

indemnification against LVI alleging that LVI’s representations and warranties with

respect to the LVI Financial Statements were not accurate and arguing that LVI must

indemnify NCM pursuant to the Contribution Agreement. 33 Count IV alleges that

Cutrone and State breached their fiduciary duties of care and loyalty to NorthStar

and its members, including NCM, by, among other things, knowingly failing to

follow GAAP, manipulating NorthStar’s financial statements, manipulating costs

and revenues of LVI jobs, and inducing LVI to file its claim against NCM. 34 Count

V is a derivative claim for breach of fiduciary duty brought by NCM on behalf of

NorthStar against Cutrone and State asserting that Cutrone and State’s intentional

failure to comply with GAAP and manipulation of NorthStar’s financial reporting

harmed NorthStar. 35

NCM seeks damages, in an amount to be proven at trial, of not less than $223

million for Counter-Defendants’ alleged fraud, and equitable reformation of the

32 Id. at ¶¶ 85–97. 33 Id. at ¶¶ 98–106. 34 Id. at ¶¶ 107–113. 35 Id. at ¶¶ 117–120. 9 Contribution Agreement to lower LVI’s allocated equity in NorthStar. 36 NCM also

asks for the maximum amount of indemnification under the Contribution

Agreement, $15 million. It seeks a finding that Cutrone and State, as officers of

NorthStar, breached their fiduciary duties of care and loyalty to NCM and to

NorthStar, an order removing State as an officer of NorthStar, and an order

compelling both Cutrone and State to forfeit any compensation received from

NorthStar while they were in breach of their fiduciary duties to NorthStar. 37

On August 23, 2016, the Counter-Defendants moved to dismiss the various

counts against them. State and Cutrone moved to dismiss Counts I, II, IV, and V

under Court of Chancery Rules 8(a), 9(b), 12(b)(6), and 23.1. Cutrone also moved

to dismiss all counts against him under Court of Chancery Rule 12(b)(2) for lack of

personal jurisdiction. NorthStar moved to dismiss Count V under Rule 23.1. LVI

moved to dismiss certain counts against it in part, focusing particularly on NCM’s

allegations of fraud pertaining to additional jobs that were not alleged in NCM’s

Original Verified Counterclaim. I heard oral argument on the Counter-Defendants’

motions on December 2, 2016. My Letter Opinion follows.

36 Id. at Request for Relief. 37 Id. 10 II. ANALYSIS

The various Counter-Defendants have moved to dismiss certain counts of the

Counterclaim pursuant to Rule 12(b)(6) for failure to state a claim. When evaluating

a motion to dismiss under 12(b)(6), the Court accepts well-pleaded factual

allegations as true, drawing all reasonable inferences in favor of the non-moving

party.38 The Court must deny the motion unless “the [non-moving party] could not

recover under any reasonably conceivable set of circumstances susceptible of

proof.”39 NCM asserts both fraud and fiduciary duty claims against the Counter-

Defendants. I address each in turn below. 40

A. The Fraud Claims

Counts I and II assert claims for fraud against Counter-Defendants LVI, State,

and Cutrone. The Counter-Defendants moved to dismiss these claims under Rule

9(b), arguing that NCM has failed to plead fraud with the required level of

particularity. To claim fraud, a plaintiff must plead, “(i) a false representation, (ii)

the defendant's knowledge of or belief in its falsity or the defendant's reckless

indifference to its truth, (iii) the defendant's intention to induce action based on the

representation, (iv) reasonable reliance by the plaintiff on the representation, and (v)

38 Cent. Mortg. Co. v. Morgan Stanley Mortg. Capital Holdings LLC, 27 A.3d 531, 536 (Del. 2011). 39 Id. 40 Cutrone also argues that this Court lacks personal jurisdiction over him in this case. I analyze the issues below generally and address personal jurisdiction at the end of this Letter Opinion. 11 causally related damages.”41 Court of Chancery Rule 9(b) requires a plaintiff to

plead fraud with particularity. 42 The particularity requirement “means that a plaintiff

must allege the circumstances of the fraud with detail sufficient to apprise the

defendant of the basis for the claim.” 43 “The relevant circumstances are the time,

place, and contents of the false representations; the facts misrepresented; the identity

of the person(s) making the misrepresentation; and what that person(s) gained from

making the misrepresentation.” 44 However, Delaware courts have held that lack of

specificity as to date, place, and time are not fatal, provided that the pleadings put

defendants on sufficient notice of the actual misconduct with which they are

charged.45

When, as here, a plaintiff’s claim for fraud is based on a written contractual

representation, it is “relatively easy [for a plaintiff] to plead a particularized claim

of fraud.”46 In such a situation, the plaintiff “can readily identify who made what

representations where and when [and] what the defendant gained, which was to

induce the plaintiff to enter into the contract.”47 At that point, the plaintiff “need

41 Prairie Capital III, L.P. v. Double E Holding Corp., 132 A.3d 35, 49 (Del. Ch. 2015) (citations omitted). 42 Ct. Ch. R. 9. 43 Prairie Capital III, L.P., 132 A.3d at 62 (citations omitted). 44 Id. 45 See Yavar Rzayev, LLC v. Roffman, 2015 WL 5167930, at *4 (Del. Super. Ct. Aug. 31, 2015). 46 Prairie Capital III, L.P., 132 A.3d at 62. I note that NCM concedes that it “does not assert fraud claims based on the oral and written representations of State and Cutrone that occurred pre- Merger.” Countercl. Pl’s Answering Br. 36–37. 47 Id. 12 only allege facts sufficient to support a reasonable inference that the representations

were knowingly false.”48 Importantly, a defendant’s state of mind, such as its

knowledge and intent, “may be averred generally,” or, in other words, a plaintiff

“need only point to factual allegations making it reasonably conceivable that the

defendants charged with fraud knew the statement was false.”49 More specifically,

where a plaintiff is pleading a claim of fraud “that has at its core the charge that the

defendant knew something, there must, at least, be sufficient well-pleaded facts from

which it can reasonably be inferred that this ‘something’ was knowable and that the

defendant was in a position to know it.” 50 NCM has met such a standard here.

NCM alleges in Counts I and II that LVI, with the

direct participation of State and Cutrone, intentionally manipulated revenues, costs

and profit margins to hide losses and knowingly misrepresented that the LVI

Financial Statements were prepared in accordance with GAAP (the “Fraud

Claims”).51 NCM then presents six specific jobs as examples of LVI’s “pattern and

practice of failing to recognize revenue and losses in accordance with GAAP” (the

“Investigated Jobs”).52 Having allegedly established a pattern and practice, NCM

alleges further fraud with respect to other additional jobs, including seventeen

48 Id. 49 Id. (internal quotations omitted) (emphasis added). 50 Metro Commc'n Corp. BVI v. Advanced Mobilecomm Techs. Inc., 854 A.2d 121, 147 (Del. Ch. 2004). 51 See CC. ¶¶ 2, 71, 85. 52 See id. at ¶¶ 45–67; Countercl. Pl’s Answering Br. 26. 13 specific jobs, based on discovering “evidence of the same improprieties in their

accounting treatment as NCM found in the Investigated Jobs” (the “Additional

Jobs”).53

As an initial matter, the Counter-Defendants do not dispute, and I assume for

purposes of addressing these motions, that the fraud claims here can adequately be

brought against State and Cutrone 54 personally as well as against LVI. I turn, then,

to the adequacy of the complaint against the Counter-Defendants. Based on the

allegations of the Counterclaim, I find that NCM has adequately alleged facts that,

if true, demonstrate fraudulent representation by the Counter-Defendants.

The LVI Financial Statements stated certain amounts of profits and losses for

particular jobs. After the Merger, profits and losses on those jobs proved lesser and

greater, respectively. As a result, the assets contributed by LVI to NorthStar

appeared misleadingly more valuable, affecting the allocation of equity in NorthStar

between LVI and NCM. At this stage, these allegations are enough for me to infer

a misrepresentation in the Contribution Agreement. Therefore, because NCM’s

fraud claims here are based on a written contractual representation, all that remains

53 See CC. ¶ 45; Countercl. Pl’s Response to LVI’s Motion to Dismiss 2 (Dkt. No. 156). 54 Cutrone’s defense as to personal jurisdiction is addressed separately. 14 to decide this matter is whether NCM has adequately pled knowledge on the part of

State, Cutrone, and LVI.55

To my mind, and in light of the low pleading standard at the motion to dismiss

stage, NCM has alleged sufficient facts from which I can generally infer knowledge

on behalf of the Counter-Defendants. The Counter-Defendants had access to the

financial data and chose how to report it. They stood to gain financially from an

overstatement of value in their financial statements. Further, NCM alleges that the

Counter-Defendants “knew that at least some of the Jobs were misstated on the LVI

Financial Statements,” and knew before the Merger that “there would be millions of

dollars in [undisclosed] losses” on some jobs.56 NCM also alleges that “[i]nternal

correspondence among LVI’s management team, including Cutrone and State, show

that management knew that losses were imminent, but opted not to take them when

they should have been taken . . . to avoid negatively affecting the LVI Financial

Statements” before the Merger.57 These facts are sufficient for me to infer that the

truth regarding the LVI financial averments was indeed “knowable” by the Counter-

Defendants here and that they were in a position to know it. Accordingly, while

NCM may have a difficult climb in proof of its claims at summary judgment or trial,

55 See Prairie Capital III, L.P., 132 A.3d at 62 (explaining that for fraud based on written contractual representations it is easy to “identify who made what representations where and when [and] what the defendant gained”). 56 CC. ¶ 37. 57 Id. at ¶ 42. This correspondence is neither quoted in nor attached to the Counterclaim Complaint, an omission I find curious but, under the minimal pleading standard here, not fatal. 15 NCM has adequately alleged knowledge on the part of the Counter-Defendants.58

NCM, I find, has sufficiently apprised these parties of the claim against them to

satisfy the requirements of Rule 9(b). Thus, NCM’s claims for fraud and fraudulent

inducement in Counts I and II against State, Cutrone, and LVI survive the Motion to

Dismiss.59

B. The Fiduciary Duty Claims

NCM alleges that State, and formerly Cutrone as well, used their positions as

officers at NorthStar to effectively conceal the fraud described in Counts I and II.

NCM seeks to bring fiduciary duty claims either directly or derivatively for these

actions. These claims, at first glance, appear viable, but on closer examination fail

to state a claim as pled.

In Count IV, NCM asserts a direct claim against State and Cutrone, as officers

of NorthStar, for violating their fiduciary duties to NCM, as a member of

NorthStar.60 NCM also asserts a derivative claim in Count V on behalf of NorthStar

against State and Cutrone for violating their alleged fiduciary duties to NorthStar.

58 See Prairie Capital III, L.P., 132 A.3d at 55–62 (finding allegations of the defendants’ knowledge sufficient because knowledge may be averred generally). See also Oshidar v. Asura Dev. Grp., Inc., et al., 2017 WL 1103014, at *7 (Del. Super. Ct. Mar. 24, 2017) (finding the alleged facts “to be minimal, but sufficient, to state claim for fraud”); Aviation W. Charters, LLC v. Freer, 2015 WL 5138285, at *7 (Del. Super. Ct. July 2, 2015) (finding sufficient allegation of knowledge where the complaint simply alleged that the defendant knew, among other things, about overstated accounts receivable). 59 Having found in NCM’s favor in this regard, I need not examine the Investigated Jobs. With regard to the scope of the fraud, particularly the Additional Jobs, I find that these issues are more properly addressed in further motions practice rather than at the motion to dismiss stage. 60 I assume for purposes of this Letter Opinion that default fiduciary duties apply here. 16 State and Cutrone moved to dismiss both of these Counts pursuant to Rule 12(b)(6)

and, along with NorthStar, to dismiss Count V pursuant to Rule 23.1 for failure to

make a demand on the NorthStar Board.

1. NCM fails to state a direct claim with respect to Count IV

As our Supreme Court recently clarified,

“whether a claim is [direct or derivative] must turn solely on the following questions: (1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)? In addition, to prove that a claim is direct, a plaintiff 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.”61

In Count IV, NCM alleges that State and Cutrone, as CEO and CFO of

NorthStar, respectively, owed fiduciary duties “to NorthStar and its members,

including NCM.”62 According to NCM, State and Cutrone breached these duties by:

a) Knowingly failing to follow GAAP for the purpose of manipulating NorthStar’s revenues, assets and profits on NorthStar’s financial statements to the detriment of NCM and to encourage and support LVI to assert claims against NCM; b) Manipulating costs and revenues to artificially preserve profit margins on LVI legacy jobs; c) Shifting costs between unrelated jobs to manipulate profits and losses on jobs in order to have LVI legacy jobs appear more profitable and NCM legacy jobs appear less profitable;

61 El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, 2016 WL 7380418, at *10 (Del. 2016) (internal quotations omitted) (emphasis in original) (citing Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033, 1039 (Del. 2004)). 62 CC. ¶ 112. 17 d) Carrying [certain debt] on NorthStar’s books that they know [is] not likely to result in cash collections in order to make LVI legacy jobs appear more profitable; e) Orchestrating a fraudulent “look back” analysis designed to manipulate NorthStar’s reported profits and losses and favor LVI over NCM in their current dispute relating to their Merger by devaluing the jobs NCM contributed to the Merger all for the purpose of covering up their own mismanagement and supporting LVI’s claims in this action; and f) Inducing LVI to file its claim against NCM.63

NCM argues that these alleged actions caused “direct injury to NCM by devaluing

the jobs NCM contributed to NorthStar,” causing LVI to sue NCM and damage

NCM’s reputation in the process, and by “providing a pretext” for removing NCM’s

appointee to the co-CEO position of NorthStar.64 NCM asks that I find that State

and Cutrone, as officers of NorthStar, breached their fiduciary duties, but seeks only

limited resulting relief: that I remove State as an officer of NorthStar. After

examining NCM’s claim here, as set out in detail below, I find that NCM cannot

escape the fact that its allegations in Count IV involve both injury—and potential

relief—to NorthStar.

NCM’s allegations in paragraphs 113(a)-(d) of its Counterclaim Complaint,

set out in full above, involve allegations that State and Cutrone manipulated

NorthStar’s financial statements after the Merger. This is a harm to NorthStar and,

if true, would result in a breach of fiduciary duty to NorthStar, not solely NCM.

63 Id. at ¶ 113. 64 Id. at ¶ 114. 18 Moreover, to the extent State and Cutrone orchestrated a “fraudulent ‘look back’

analysis” and devalued “jobs NCM contributed to the [M]erger” that formed

NorthStar, once again, this action would result in injury to NorthStar.

The derivative nature of NCM’s claim here is convincingly demonstrated by

the inescapable fact that all relief would run to NorthStar. Should I find in its favor

on Count IV, NCM seeks as relief that I remove State as an officer of NorthStar. 65

NCM argues that it would “uniquely benefit” from State’s discharge because his

discharge would prevent State from “using his position of power to continue his

discriminatory conduct aimed at NCM.”66 To my mind, however, the benefit of

removing an officer alleged to be a faithless fiduciary runs to NorthStar directly, and

only indirectly to any of NorthStar’s members. I also note that NCM seeks this very

same relief in its derivative claim on behalf of NorthStar in Count V. 67

In briefing, NCM attempts to recast its allegations as amounting to selective

discrimination by State and Cutrone against NCM and to argue that this alleged

conduct was “directed at NCM and caused NCM harm independent of any harm

suffered by the company.” 68 NCM then cites to three cases for the proposition that

65 Id. at ¶ 116. 66 Countercl. Pl’s Answering Br. 40. 67 See CC. ¶ 130(c). 68 Countercl. Pl’s Answering Br. 39. 19 discrimination against stockholders amounts to quintessential direct claims. 69 With

respect to the direct claims in each of those cases, however, the plaintiffs sought

damages for themselves70 and this Court found no harm to the respective companies

at issue.71 I therefore find each case inapposite here. NCM has, of course, brought

a claim for the behavior of State and Cutrone, sounding in fraud, not as fiduciaries

but as contractual counterparties. NCM’s real complaint in Count IV is that State

and Cutrone used their positions, post-Merger, to try to cover up the fraud alleged

against them in Counts I and II. To the extent State and Cutrone did so, relief may

flow to NCM from the fraud Counts, but the Counterclaim does not state an

independent direct breach of fiduciary duty claim against State and Cutrone on

behalf of NCM.

Important to my analysis is that, in Count IV, NCM is not seeking relief in

damages for actions of its fiduciaries at NorthStar on the ground that they financially

injured NCM. The only damages alleged in the Counterclaim Complaint involve

the fraud allegations of Counts I and II, recovery for which is not sought in this

Count IV. Instead, this Count effectively seeks only an order enjoining the directors

69 Id. at 39–40 (citing Deephaven Risk Arb Trading Ltd. v. UnitedGlobalCom, Inc., 2005 WL 1713067 (Del. Ch. Jul. 13, 2005); Acker v. Transurgical, Inc., 2004 WL 1230945 (Del. Ch. Apr. 22, 2004); Gatz v. Ponsoldt, 2004 WL 3029868 (Del. Ch. Nov. 5, 2004)). 70 The exception is Deephaven, which did not involve a damages action but rather a Section 220 action. 71 See Deephaven, 2005 WL 1713067, at *8; Acker, 2004 WL 1230945, at *1; Gatz, 2004 WL 3029868, at *8. 20 of NorthStar to discharge State as CEO, an action that the Board would clearly be

taking on behalf of NorthStar. Accordingly, I find that NCM fails to plead a direct

claim in Count IV.72

2. NCM has failed to show that demand would be futile under Rule 23.1 as to Count V

NCM asserts a derivative claim on behalf of NorthStar, mirroring the direct

fiduciary duty claim addressed above, “alleging that State and Cutrone, as managers

of NorthStar, breached their duty of good faith, trust, loyalty, and due care to the

company by knowingly failing to follow GAAP and engaging in improper

accounting practices that resulted in misstating NorthStar’s financial condition to

NorthStar’s detriment and concealing their own wrongdoing.” 73 NCM seeks an

order directing State’s discharge, and the restitution to NorthStar of compensation

NorthStar has paid to Cutrone and State. The Counter-Defendants argue that NCM

has not met its pleading burden under Rule 23.1 to show demand futility. I agree.

Before proceeding with this analysis, it is worth examining the nature of the

“derivative” action NCM seeks to advance on behalf of NorthStar. NCM argues that

a majority of NorthStar directors are aligned with LVI, excusing demand. This

might be persuasive if NCM were seeking to sue LVI on behalf of NorthStar (and if

72 NCM also alleges a direct harm to NCM for “inducing” LVI to sue NCM in this matter. I confess that I do not understand how this allegation gives rise to a breach-of-fiduciary-duty claim, or what relief would flow therefrom. 73 Countercl. Pl’s Answering Br. 38. 21 there were some underlying rationale for such an action, which is absent from the

Counterclaim Complaint). Here, however, NCM seeks to act, on behalf of

NorthStar, to punish State and Catrone for the fraud against NCM.

If a stockholder believes an officer is breaching fiduciary duties, and should

be removed, she may bring that to the attention of the board of directors via a

demand. It is a fundamental tenant under Delaware law that “directors, rather than

shareholders, manage the business and affairs of the corporation.” 74 Accordingly,

Delaware Court of Chancery Rule 23.1 contains a demand requirement that plaintiffs

must satisfy to pursue a derivative claim. An “individual stockholder intending to

bring a suit derivatively on behalf of his corporation [must] first make a demand that

the board of directors pursue the cause of action, or demonstrate that the board, as

then constituted, would be incapable of acting in the corporate interest, thus excusing

demand.”75 Rule 23.1 requires that a plaintiff seeking to proceed derivatively must

“allege with particularity the efforts, if any, made by the plaintiff to obtain the action

the plaintiff desires from the directors or comparable authority and the reasons for

the plaintiff's failure to obtain the action or for not making the effort.”76 Where, as

here, a “plaintiff forgoes demand and seeks to proceed with derivative litigation

74 Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984) overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000). 75 Park Emps.' & Ret. Bd. Emps.’ Annuity & Benefit Fund of Chicago v. Smith, 2016 WL 3223395, at *1 (Del. Ch. May 31, 2016). 76 Ct. Ch. R. 23.1 (emphasis added). 22 nonetheless, the action will be dismissed unless the plaintiff can demonstrate that

demand is futile.” 77 Thus, to avoid dismissal under Rule 23.1, NCM “must allege

with particularity . . . the reasons . . . for not making the effort [to make the litigation

demand], and the Court, in turn, must determine based on those allegations whether

the board is able to exercise its business judgment in determining if it is in the

corporate interest to pursue the litigation.” 78

Here, the sole ground alleged to excuse demand is that the directors are not

disinterested in the subject of the demand.79 “A director is considered interested

where he or she will receive a personal financial benefit from a transaction that is

not equally shared by the stockholders [or] where a corporate decision will have a

materially detrimental impact on a director, but not on the corporation and the

stockholders.”80 In other words, “the plaintiff must show that the alleged benefit [or

detriment] was significant enough in the context of the director’s economic

circumstances, as to have made it improbable that the director could perform her

fiduciary duties.”81 Moreover, a “fact-intensive, director-by-director analysis [is]

required to meet the pleading standard for demand futility.” 82

77 In re Duke Energy Corp. Derivative Litig., 2016 WL 4543788, at *11 (Del. Ch. Aug. 31, 2016). 78 Id. at *14 (internal quotations omitted). 79 Pl’s Answering Br. 42 (citing Beneville v. York, 769 A.2d 80, 85–86 (Del. Ch. 2000)). 80 Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993) (citations omitted). 81 Robotti & Co. v. Liddell, 2010 WL 157474, at *12 (Del. Ch. Jan. 14, 2010). 82 Postorivo v. AG Paintball Holdings, Inc., 2008 WL 553205, at *6 (Del. Ch. Feb. 29, 2008). 23 NCM seeks, derivatively, an order removing State as an officer and restitution

from State and Cutrone. According to NCM, four of the eleven Board members are

NCM representatives and the remaining seven board members are all “former LVI

management who, except for one, have ownership interests in LVI.” 83 NCM also

alleges that LVI controls NorthStar, that a “majority of the Board has an interest in

LVI and stands to personally benefit from Cutrone and State’s fraudulent activity”

and that “[m]any of Cutrone and State’s breaches have benefitted LVI.” 84 Finally,

according to NCM, making demand on the NorthStar Board would be futile because

asking the Board to “sue State and Cutrone would be like asking the majority

members of the NorthStar Board to sue themselves.” 85 This is a non-sequitur; the

relief sought here would not flow from LVI.

NCM’s cursory allegations here fall short of the particularity requirements of

23.1. NCM alleges “nothing close to the fact-intensive, director-by-director analysis

required to plead demand futility.”86 As an initial matter, NCM fails even to mention

any of the directors individually, much less describe how the decision whether or

not to sue State and Cutrone for restitution of their salary from NorthStar (or

otherwise discipline State) would have a detrimental material impact on any one of

83 CC. ¶ 123. 84 Id. at ¶¶ 123–125. 85 Id. at ¶ 124. 86 Postorivo, 2008 WL 553205, at *6. 24 them. Instead, NCM refers to one broad group of seven board members and claims

that they have an interest in LVI and stand to personally benefit from the actions of

Cutrone and State.87 NCM fails to describe the facts of that alleged interest and how

it is material to each director. In fact, rather than a direct ownership interest, NCM

in briefing states that six directors represent owners of LVI and does not offer any

more details about the intricacies of this representation. 88 NCM’s offhand allegation

that all former LVI directors now on the Board were engaged in a “conspiracy”

against NCM is also unpersuasive as to the Board’s ability to bring its business

judgment to bear.

State, of course, is a conflicted director. It is certainly conceivable that

individual directors, through long-standing relationships with State or LVI, may be

incapable of following their business judgment in a way averse to State.89 NCM has

failed to make such a pleading here, however. NCM fails to allege that State

dominates the other directors, nor does NCM point to any longstanding personal or

business relationships between State—or Cutrone, for that matter—and any other

board members sufficient to cause those members to be unable to exercise their

business judgment here. Finally, NCM points out that NorthStar “and its LVI

aligned Board members” have ignored its requests—short of formal demands—to

87 CC. ¶ 125. 88 Countercl. Pl’s Answering Br. 42. 89 See Delaware Cty. Emps. Ret. Fund v. Sanchez, 124 A.3d 1017, 1022 (Del. 2015). 25 remove State or investigate LVI.90 This approaches tautology: “it is the Board’s

inaction in most every case which is the raison d’etre for Rule 23.1.”91

In sum, NCM has alleged, but without particularity, that a majority of

NorthStar directors are conflicted with respect to a demand to sue LVI. Even if so,

NCM has failed to allege that the directors are conflicted with respect to a suit against

State and Cutrone, which is the action they seek to bring derivatively. Under the

stringent requirements of Rule 23.1, therefore, the derivative portion of the

Counterclaim Complaint must be dismissed.

C. Personal Jurisdiction

In light of my findings above, the parties should indicate to me whether further

argument or citation to the record is necessary before I decide whether this Court

has personal jurisdiction over Cutrone in this matter.

III. CONCLUSION

For the reasons stated above, the Counter-Defendants’ Motion to Dismiss is

denied as to Counts I and II of the Counterclaim Complaint. Counts IV and V are

90 See CC. ¶¶ 126, 127. NCM also alleges that NorthStar’s management consists of former LVI management who have ownership interests in LVI and have benefitted from State and Cutrone’s actions. See CC. ¶ 123. NCM fails to explain how management’s interest in LVI is relevant, as any demand futility analysis focuses on whether the board of directors, not management, can exercise its business judgment. See, e.g., Park Emps.' & Ret. Bd. Emps.’ Annuity & Benefit Fund of Chicago, 2016 WL 3223395, at *1. 91 Richardson v. Graves, 1983 WL 21109, at *3 (Del. Ch. June 17, 1983) (emphasis in original). See also id. at *3 (noting that “[t]he failure to sue . . . is not enough to demonstrate an ‘interestedness’ sufficient to sterilize the discretion of the remaining members of the board”). 26 dismissed for failure to state a direct claim and failure to plead demand futility under

Rule 23.1, respectively. Counsel should provide an appropriate form of order

consistent with this Letter Opinion.

Sincerely,

/s/ Sam Glasscock III

Sam Glasscock III