Scarabee Holdings, LLC v. 4301 Operations, LLC

• Court: Court of Chancery of Delaware
• Decided: January 22, 2025
• Docket: C.A. No. 2022-1207-MTZ
• Status: Published

Opinion

COURT OF CHANCERY OF THE STATE OF DELAWARE MORGAN T. ZURN LEONARD L. WILLIAMS JUSTICE CENTER VICE CHANCELLOR 500 N. KING STREET, SUITE 11400 WILMINGTON, DELAWARE 19801-3734

January 22, 2025

Andrew H. Sauder, Esquire Sean J. Bellew, Esquire Dailey LLP Bellew LLC 1201 North Orange Street, Suite 7300 2961 Centerville Road, Suite 302 Wilmington, DE 19801 Wilmington, DE 19808

RE: Scarabee Holdings, LLC v. 4301 Operations, LLC, et al., Civil Action No. 2022-1207-MTZ

Dear Counsel:

This has been a high-touch case. Defendants 4301 Operations, LLC, and

Brian Conners (“Defendants”) strung plaintiff Scarabee Holdings, LLC

(“Plaintiff”) along in discovery, and Plaintiff sought help from this Court; I was

patient, perhaps to a fault, and I gave Defendants the benefit of the doubt on

multiple occasions. My tune changed when Defendants’ former Delaware counsel

took the difficult and commendable step of notifying the Court that their clients

had repeatedly lied in sworn and represented filings about fundamental facts

supporting their defense. Defendants also falsified evidence in furtherance of their

lies. The falsity of those statements was borne out in a deposition. Defendants’

misconduct presents the rare occasion when a default judgment is the only

appropriate sanction. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 2 of 15

I. Background

Plaintiff filed this action seeking a “Class B Preferred Return” payable

annually under 4301 Operations’ LLC agreement “to the extent that the Board

determines there are sufficient operating funds.”1 In discovery, Defendants told

Plaintiff that 4301 Operations’ board (the “Board”) had never evaluated whether to

pay the Class B Preferred Return, and indeed had never met. 2

Plaintiff then filed an amended complaint adding a claim that Conners, as

4301 Operations’ sole director, had failed to carry out his board obligations

regarding the Class B Preferred Return.3 Defendants scrambled. In their answer

and subsequent discovery, they stated that “[o]n each December 31, 2019,

December 31, 2020, December 31, 2021, December 31, 2022, and December 31,

2023, the Board, acting through Conners, as its sole Director, determined that there

were insufficient operating funds to pay the Class B Preferred Return to

1 Docket item (“D.I.”) 108 Ex. 1 § 8.4(b). 2 D.I. 108 Ex. 2 at Interrog. Resp. Nos. 3, 14; D.I. 28 ¶ 27 (“On information and belief, the Company’s Board has . . . never even considered whether there were sufficient operating funds to pay the Class B Preferred Return.”). 3 D.I. 44. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 3 of 15

Scarabee.”4 Defendants represented twelve times in their answer that Conners

made that determination in those years. 5

Defendants went further. They stated in their answer to the amended

complaint that on May 5, 2024, between when the amended complaint was filed

and when their answer was due, the board met and “ratified and confirmed”

Conners’ determinations. 6 Defendants produced to Plaintiff purported meeting

minutes, which again represented that “[t]he Board, acting through its sole

Director, determined that there were insufficient funds to pay the Class B Preferred

Return to the Class B Unit Holder” in 2019 through 2023. 7 The minutes also

represented that the board met in person on May 5; that defendant Theodore

Broudy had been appointed to the 4301 Operations Board; that Conners had read a

lengthy prepared statement describing 4301 Operations’ financial situation each

year a preferred return was owed; that Conners provided an historical overview of

4 D.I. 52 ¶ 82; see also id. ¶¶ 21, 24, 34, 46–48, 59, 63, 70–72. 5 Id. ¶¶ 21, 24, 34, 46–48, 59, 63, 70–72, 82. 6 E.g., id. ¶ 24. 7 D.I. 108, Ex. 10 at -1495–99. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 4 of 15

his salary from 2009 to 2023; and that the board had ratified Conners’ annual

preferred return determinations and Conners’ salary.8

Defendants kept their story going. In their July 5 responses and objections

to Plaintiff’s fourth set of interrogatories, Defendants continued to represent that

“Conners evaluated and/or determined that there were insufficient operating funds

to pay the Class B Preferred Return to Plaintiff on each December 31, 2019,

December 31, 2020, December 31, 2021, December 31, 2022, and December 31,

2023.” 9

Defendants’ representations of annual determinations and a May 5 board

ratification were untrue. On July 31, Broudy was deposed, and his candid

testimony gave the game away. He and Conners are very close personal friends,

and Conners asked him to join the board as a favor after this litigation began. 10 To

Broudy’s credit, that favor did not include lying for Conners: Broudy testified

there had been no May 5 board meeting, that Conners had never read the prepared

statement in the minutes to him, and that Conners had never discussed with him

8 See generally id. Defendants’ counsel also made representations about Conners’s supposed determinations in court. See e.g., D.I. 99 at 27 (“Your Honor, the same rationale that were in the board minutes was the rationale that Mr. Conners used back in December 31st of 2019, 2021.”). 9 D.I. 108 Ex. 6 at Interrog. Resp. No. 8; see also id. at Interrog. Resp. Nos. 2–8, 10. 10 D.I. 108 Ex. 7 at 38. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 5 of 15

other topics the minutes said had been discussed. 11 Broudy testified that even

though he did not understand what the Class B Preferred Return was, he still

signed the minutes’ resolution purporting to ratify Conners’s determinations.12

Worse yet, discovery revealed the May 5 meeting minutes were prepared by

Defendants’ litigation counsel, word for word, two days before the meeting

purportedly occurred.13

At this point, Defendants’ former Delaware counsel responded

commendably. On August 12, they wrote the Court to disclose that Defendants’

statements that Conners had annually evaluated the Class B Preferred Return were

false. 14 The letter noted that false statement appeared in Defendants’ pleadings and

written discovery. 15 The misrepresentation appeared in Defendants’ answer to the

amended complaint, May 17 and July 5 supplemental interrogatory responses, July

5 request for production responses, two oppositions to discovery motions, and the

May 5 meeting minutes.16 Defendants’ former Delaware counsel also moved to

withdraw, which I granted; on August 15, I gave Defendants thirty days to retain

11 Id. at 18–19, 25–26, 53–56, 70–71, 104, 117, 176. 12 Id. at 74–75, 107. 13 D.I. 108 Ex. 8. 14 D.I. 86. 15 Id. at 2. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 6 of 15

new counsel. 17 Defendants requested an extension to find new counsel, which I

denied.18

Plaintiff responded with a second amended complaint, adding Broudy as a

defendant.19 Defendants missed the Court’s deadline for retaining new counsel

and failed to timely respond to the complaint. 20 Defendants then sat silent for

months until Plaintiff filed this motion for default judgment.

Some additional context is necessary. On the path to our present situation, I

twice addressed Defendants’ discovery shortcomings with intermediate sanctions,

giving them the benefit of the doubt. Conners had engaged in self-collection, first

alone and then with minimal input from his counsel, and used unilaterally chosen

search terms.21 Defendants’ collections from other custodians were delayed by

meritless objections.22

Defendants raised the May 5 ratification defense for the first time near the

close of discovery. Plaintiff cried foul, moving to preclude that defense as

16 Id.; D.I. 108 Ex. 5. 17 D.I. 92. 18 D.I. 94; D.I. 96. 19 D.I. 101. 20 D.I. 92. 21 See D.I. 84. 22 See id. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 7 of 15

untimely and inconsistent with Defendants’ representations the board had never

evaluated the Class B Return, or to compel further discovery and extend the

discovery deadline.23 Defendants opposed the motion to preclude, contending they

had simply offered poor descriptions of what had happened, and offered Plaintiff

additional discovery into the board’s evaluations.24 I gave Defendants the benefit

of the doubt that they were bumbling along in good faith. On June 5, I postponed

the September trial so Plaintiff could take discovery into Conners’s annual

evaluations, whether the Company had sufficient operating funds, and the May 5

board meeting, minutes, and purported ratification. 25 But Defendants never had

any intention of collecting more documents: they knew when they offered more

discovery (and a delay of trial) that no documents underlying Conners’s

determinations or the ratification decision existed.26 Defendants produced less

than ten documents, mostly emails concerning the May 5 meeting.27

23 D.I. 57 at 10–15. 24 D.I. 64. 25 D.I. 68. 26 D.I. 99 at 21 (“THE COURT: No additional searches for documents were done after June 5th? ATTORNEY PEARL: No, no, because there wasn’t going to be, because we had already given them everything as part of our normal -- our discovery.”); see D.I. 84. 27 D.I. 75 at Mot. 4, 7–10. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 8 of 15

On July 18, when it was clear no additional document discovery was

forthcoming, Plaintiff moved for sanctions. It again asked the Court to preclude

any board ratification defense.28 On July 29, I once again gave Defendants the

benefit of the doubt that these problems stemmed from “incompetence as opposed

to bad faith,” raising their burden of proof on that defense.29 I noted more severe

sanctions could be warranted based on the landscape at trial.30

Broudy’s July 31 deposition made clear that Defendants had been lying

about the May 5 meeting and falsified the minutes they produced. Defendants’

Delaware counsel then admitted Defendants also lied about the annual

determinations. Plaintiff now seeks a default judgment against Conners, 4301

Operations, and Broudy for their failure to timely respond to the second amended

complaint; against 4301 Operations for failure to retain new counsel by the Court’s

deadline; and against Conners and 4301 Operations under Court of Chancery Rules

11 and 37.

On January 3, I entered an order granting the motion for default judgment

against Conners and 4301 Operations; I stated an explanatory letter would

28 D.I. 75. 29 D.I. 84. 30 Id. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 9 of 15

follow.31 This is that letter.

II. Analysis

Defendants violated both Rule 11 and Rule 37. “Rule 11 applies to all

papers that an attorney files in connection with a matter pending before the

Court.”32 Rule 11 provides that “[b]y presenting to the Court a pleading, written

motion, or other paper . . . an attorney or unrepresented party certifies that to the

best of the person’s knowledge, information, and belief,” the pleading is not being

“presented for any improper purpose” and that “the factual contentions have

evidentiary support.”33 “Although it seems clear that the intentional filing of

factually inaccurate pleadings violates the spirit of Rule 11, there is case law

suggesting that non-material misrepresentations to the court may not be

sanctionable under Rule 11.” 34

Defendants submitted multiple filings governed by Rule 11 containing

blatant and material lies. The filings stated the Class B Preferred Return was not

owed because Conners had annually evaluated the Class B Preferred Return and

31 D.I. 118. 32 Xen Invs., LLC v. Xentex Techs., Inc., 2003 WL 25575770, at *2 (Del. Ch. Dec. 8, 2003). 33 Ct. Ch. R. 11(b). 34 Beck v. Atl. Coast PLC, 868 A.2d 840, 854 (Del. Ch. 2005). Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 10 of 15

concluded 4301 Operations lacked the funds to pay it. That was the crux of

Defendants’ defense. It was plainly material, and false. “To mislead the court and

[Scarabee] about so fundamental a question . . . through plainly false pleadings is a

clear violation of Rule 11.”35

And Defendants violated Rule 37. Under Rule 37, “[i]f a party or an officer,

director, or managing agent of a party . . . fails to obey an order to provide or

permit discovery,” this Court “may make such orders in regard to the failure as are

just.”36 On June 5, I entered an order accepting Defendants’ offer of discovery into

Defendants’ ratification defense, and postponing trial. But Defendants did nothing

but continue to lie in their written responses. When they made that offer, they had

no intention of looking for more discovery. 37 Now the full truth has come out:

there was never a ratification, or any determination to ratify.

The next question is what to do about these violations. Under Rule 11, the

“sanction imposed . . . must be limited to what suffices to deter repetition of the

conduct or comparable conduct by others similarly situated.”38 And if a party

“fails to obey an order to provide or permit discovery,” Rule 37 says the Court may

35 Id. 36 Ct. Ch. R. 37(b)(2). 37 D.I. 99 at 21. 38 Ct. Ch. R. 11(c)(4). Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 11 of 15

implement sanctions “as are just.”39 Possible sanctions include “dismissing the

action or proceedings or any part thereof, or rendering a judgment by default

against the disobedient party.”40 “Discovery abuse has no place in our courts, and

the protection of litigants, the public, and the bar demands nothing less than that

our trial courts be diligent in promptly and effectively taking corrective action to

‘secure the just, speedy and inexpensive determination of every proceeding’ before

them.” 41

Default judgment is a rare sanction. “[C]ourts are and have been reluctant to

apply it except as a last resort.” 42 In deciding whether to sanction a party through

default judgment, the Delaware Supreme Court has adopted the following

guidelines:

[T]o determine whether the trial court has abused its discretion in dismissing, or refusing to lift a default, we will be guided by the manner in which the trial court balanced the following factors, ... and whether the record supports its findings: (1) the extent of the party’s 39 Ct. Ch. R. 37(b). 40 Ct. Ch. R. 37(b)(2)(C). 41 Holt v. Holt, 472 A.2d 820, 824 (Del. 1984) (quoting Super. Ct. Civ. R. 1.); see also Ct. Ch. R. 1; DG BF, LLC v. Ray, 2021 WL 5436868, at *4 (Del. Ch. Nov. 19, 2021), aff’d, 294 A.3d 63 (Del. 2023) (“Trial courts should be diligent in the imposition of sanctions upon a party who refuses to comply with discovery orders, not just to penalize those whose conduct warrants such sanctions, but to deter those who may be tempted to abuse the legal system by their irresponsible conduct.” (quoting Hoag v. Amex Assurance Co., 953 A.2d 713, 717 (Del. 2008))). 42 Hoag, 953 A.2d at 717. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 12 of 15

personal responsibility; (2) the prejudice to the adversary caused by the failure to meet scheduling orders and respond to discovery; (3) a history of dilatoriness; (4) whether the conduct of the party or the attorney was willful or in bad faith; (5) the effectiveness of sanctions other than dismissal, which entails an analysis of alternative sanctions; and (6) the meritoriousness of the claim or defense. 43

“These factors–and all of them need not be met—are useful in evaluating a

decision to dismiss for failure to prosecute or comply with its rules or orders.”44

“[T]here must be an element of willfulness or conscious disregard of a court order

before entry of judgment is warranted.” 45

A default judgment is appropriate here. Defendants have continually and

affirmatively lied to Plaintiff and the Court about facts material to this case,

violated court orders, and utterly failed in their discovery obligations.46 Conners,

in his personal capacity and as a 4301 Operations director, is responsible. He

knew he had not made the yearly determinations concerning the Class B Preferred

Return. He knew there had been no May 5 meeting ratifying those nonexistent

43 Minna v. Energy Coal S.p.A., 984 A.2d 1210, 1215 (Del. 2009) (quoting Hoag, 953 A.2d at 718). 44 Hoag, 953 A.2d at 718. 45 Connection, Inc. v. Synygy Ltd., 2021 WL 1943350, at *2 (Del. Ch. May 11, 2021) (quoting Gallagher v. Long, 2007 WL 3262150, at *2 (Del. Nov. 6, 2007)). 46 See Korn v. New Castle Cnty., 2004 WL 3048839, at *1 (Del. Ch. Dec. 6, 2004) (“To the extent that defendants deny any requests for admissions, and the substance of those denied admissions is later proven, defendants may be subject to appropriate sanctions Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 13 of 15

determinations. He knew counsel prewrote the May 5 minutes.47 He told the

Court and Plaintiff the determinations and May 5 meeting happened when he knew

they had not.

And Plaintiff has been and continues to be prejudiced. Defendants raised a

false defense mere weeks before discovery ended. I heard two discovery motions

as Plaintiff tried to investigate those false statements, and I delayed trial so that

Plaintiff could obtain discovery, which Defendants never intended to provide. As

for Defendants’ history of dilatoriness, they strung Plaintiff along for months with

inadequate discovery collections, false promises, and blatant lies about Conners’s

determinations culminating in the concoction of a May 5 board meeting, fake

minutes, and ratification. This conduct was addressed with intermediate sanctions,

yet the issues compounded. Defendants’ conduct was willful and in bad faith, and

prejudiced Plaintiff by depriving it of a timely trial against a truthful adversary.

Defendants oppose a default by once again painting their behavior as

bumbling rather than bad faith.48 Conners affirmed he “made good faith attempts

to respond to Plaintiff’s discovery requests, including by amending and

under Court of Chancery Rule 37(c).”); id. at *2 (noting “defendants may be subject to sanctions for filing knowingly false responses to the interrogatories”). 47 D.I. 108 Ex. 8. 48 D.I. 116 at Ans. Br. 10 (claiming Defendants had merely been “too loose in the Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 14 of 15

supplementing 4301’s and my own discovery responses when I believed I had

misconstrued the requests or the responses were being misinterpreted.” 49 But

Conners does not explain what he misconstrued, or what could be misinterpreted,

in making false representations that he, himself, had annually evaluated the Class

B Preferred Return. Nor does Conners address Broudy’s candid disavowal of the

May 5 meeting and ratification. I cannot conclude Conners was simply confused.

Defendants also oppose a default by praying for mercy, pointing out that a

default judgment is to be awarded sparingly, that this Court has a preference to

resolve cases on the merits. But no mercy can or should be shown to a litigant who

repeatedly lies in sworn filings about a fact fundamental to the case. Whether

Conners as a director made annual determinations that the Class B Preferred

Return could not be paid is fundamental to Plaintiff’s claims that those annual

payments are owed. Defendants’ affirmative false statements that he made those

determinations and that the board met to ratify them, and production of false board

minutes to that effect, tainted this proceeding and obstructed the orderly

administration of justice.50

language they had used regarding LLC formalities” and “imprecis[e]”). 49 D.I. 116 at Aff. of Brian Conners ¶ 14. 50 See Beck, 868 A.2d at 854; Holt, 472 A.2d at 824. Scarabee Hldgs., LLC v. 4301 Operations, LLC, et al., C.A. No. 2022-1207-MTZ January 22, 2025 Page 15 of 15

And Defendants received mercy for earlier misconduct, but did not reform.

The first time they fell short of their obligations, I ordered more discovery (and

delayed trial)—only for it to come out that Defendants never intended to even look

for more discovery because they had known all along that none existed. Even

then, I stopped short of case-dispositive adverse inferences and entered a lesser

sanction of an escalated burden of proof, on the chance Defendants had still been

doing their best in good faith. But Defendants only continued to act in bad faith.

Defendants argue they are owed a trial on the merits. But Defendants

planned to deprive Plaintiff of the same. Having affirmatively lied in multiple

court filings and ignored Court orders, the rare sanction of default judgment is

appropriate here under Rules 11 and 37.

III. Conclusion

Judgment will be entered against Conners and 4301 Operations. 51

Sincerely,

/s/ Morgan T. Zurn Vice Chancellor

MTZ/ms

cc: All Counsel of Record, via File & ServeXpress

51 Whether a default or summary judgment against Broudy is appropriate remains under advisement.