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K&K Screw Products, L.L.C. v. Emerick Capital Investments, Inc., C.A. No. 5633-VCP (Del. Ch. Aug. 9, 2011) (Parsons, V.C.)

August 9, 2011

In this opinion, the Court of Chancery granted the plaintiff’s motion for summary judgment on its request for declaratory relief, holding that the plaintiff did not breach contractual or noncontractual duties, or commit fraud, when the plaintiff entered into a restructuring transaction that adversely affected the priority of the defendant’s note.

In 1999, the defendant, Emerick Capital Investments, Inc. (“ECI”), sold all of its assets (the “1999 Transaction”) to the plaintiff, K&K Screw Products, L.L.C. (“K&K”). K&K was formed to acquire ECI’s assets. Jack Emerick (“Emerick”), the sole shareholder of ECI, acquired 20% of the common equity of K&K. Continental Illinois Venture Corporation (“CIVC”) and its coinvestors acquired the remaining interests of K&K. As part of the consideration for the 1999 Transaction, ECI received a promissory note (the “Seller’s Note”). K&K’s members financed a portion of the purchase price for the 1999 Transaction by obtaining loans (the “Senior Loans”) from a group of lenders (the “Senior Lenders”). Under the terms of a subordination agreement (the “Subordination Agreement”) between ECI and the Senior Lenders, ECI agreed to subordinate the Seller’s Note to the Senior Loans. Both the Subordination Agreement and the Seller’s Note were governed by Illinois law.

By September 2000, K&K was in default under the Senior Loans. K&K’s board of managers (the “Board”), including Emerick, negotiated with the Senior Lenders to forbear action on K&K’s defaults. In 2001, the Board approved a transaction to increase K&K’s capital (the “2001 Transaction”), whereby CIVC Partners LP (“CIVC LP”), a CIVC affiliate, agreed to provide a loan (the “CIVC Loan”) and a guaranty. The CIVC Loan was subordinate to the Senior Loans, but senior to the Seller’s Note. As part of the 2001 Transaction, CIVC LP would be entitled to a $5 million lump sum payment when the CIVC Loan was repaid in full (the “CIVC Bonus”).

On April 28, 2010, after Emerick learned that K&K planned to repay the Senior Loans, but that K&K did not have enough funds to pay the CIVC Loan, the CIVC Bonus, and the Seller’s Note, Emerick, in his personal capacity, instituted mediation against K&K’s members who were signatories to K&K’s operating agreement (the “Operating Agreement”). Emerick alleged those members breached the Operating Agreement by causing K&K to enter into the 2001 Transaction without Emerick’s consent. That dispute was subsequently submitted to arbitration (the “Arbitration”).

On July 14, 2010, K&K filed a complaint in the Court of Chancery (the “Action”), seeking a declaratory judgment that, among other things, ECI had no legally valid or viable claim based on the 2001 Transaction and its impact on the Seller’s Note and the Subordination Agreement. On November 2, 2010, K&K moved for summary judgment. In response, ECI filed a motion to dismiss the complaint for lack of subject matter jurisdiction, requested to stay the Action in favor of the Arbitration, and requested leave to take discovery to respond to K&K’s motion for summary judgment.

First, the Court addressed ECI’s claim that the Court lacked subject matter jurisdiction because there was no justiciable case or controversy between the parties. The Court found that ECI had a real and adverse interest to K&K in the Action because the declarations K&K sought could potentially limit ECI’s rights to bring suit regarding certain issues arising from the 2001 Transaction. The fact that ECI had no present intention to bring the claims raised in the complaint was immaterial. K&K satisfied considerations of ripeness because all material facts giving rise to ECI’s potential claims related to the 2001 Transaction had already occurred and were static, and K&K was suffering current harm due to the prospect of future suits by ECI based on the 2001 Transaction. Finding no other grounds upon which ECI challenged the Court’s subject matter jurisdiction, the Court denied ECI’s motion to dismiss.

Second, the Court addressed ECI’s request to stay the Action in favor the Arbitration. Though acknowledging that the Action and the Arbitration both dealt with matters concerning the 2001 transaction, the Court found material differences between the Arbitration and the Action. The two proceedings involved different parties, different contracts, and different disputes. In addition, the Court found that resolution of the Arbitration was unlikely to preclude further litigation in the Action and proceeding with the Arbitration and the Action would not be duplicative or waste judicial resources. Therefore, the Court denied ECI’s request to stay the Action in favor of the Arbitration.

Third, the Court addressed K&K’s motion for summary judgment on its request for declaratory relief. K&K sought declarations that ECI could not bring certain claims related to the 2001 Transaction regarding (i) breaches of contract, (ii) breaches of fiduciary duty, (iii) breach of the implied covenant of good faith and fair dealing under Illinois law, and (iv) various forms of fraud. ECI did not address the merits of K&K’s arguments for those declarations. Instead, ECI couched its responses in terms of its justiciability argument. The terms of both the Seller’s Note and the Subordination Agreement did not prevent K&K from incurring additional debt or impairing the priority of the Seller’s Note. Therefore, the Court held that K&K did not breach the Seller’s Note or the Subordination Agreement by entering into the 2001 Transaction. In addition, applying the analogous statutes of limitations under both Illinois law and Delaware law, and finding no basis to extend such periods, the Court held that ECI was time-barred from raising any breach of fiduciary duty and fraud actions. See 10 Del. C. § 8106 (providing a three year limitations period for fiduciary duty and fraud actions); 6 Del. C. § 1309 (providing a four year limitations period for certain fraudulent transfer actions). The Court further held that Illinois law did not recognize an independent cause of action for breach of the implied covenant of good faith and fair dealing as to the Seller’s Note or the Subordination Agreement based on K&K’s participation in the 2001 Transaction.

Last, the Court addressed ECI’s request for leave to take discovery. Though the Action commenced July 14, 2010, and K&K filed its motion for summary judgment on November 2, 2010, ECI did not attempt to take any discovery in the Action. The Court never stayed discovery and neither party ever asked the Court to stay discovery. Moreover, much of the information and evidence that ECI would need to rebut several of K&K’s arguments should have been within ECI’s own control, or appeared to be available to ECI through nonlitigation means. Therefore, the Court denied ECI’s request for leave to take discovery and granted K&K’s motion for summary judgment.

The full opinion is available here