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Forsythe v. ESC Fund Management Co., C.A. No. 1091-VC (Del. Ch. Aug. 11, 2010 (Vice Chancellor Laster)

August 11, 2010

The Court of Chancery granted in part and denied in part defendants’ post-close-of-discovery motion for summary judgment with respect to claims brought by two investors against the CIBC Employee Private Equity Fund (U.S.) I, L.P. (the “Fund”), an investment fund created by Canadian Imperial Bank of Commerce (“CIBC”) to permit CIBC’s top employees to invest side-by-side with CIBC. The plaintiffs claimed that the Fund was harmed by the investment process followed by its Advisory Board and by a lack of oversight by its General Partner.

According to the terms of the Fund’s limited partnership agreement and ancillary investment agreements, the Fund could only invest side-byside with CIBC in investments selected for CIBC by the CIBC Investment Committee and only in those investments that met the Fund’s eligibility criteria. The Fund’s portfolio was divided into three  categories: (i) Trimaran Investments; (ii) Fund-of-Funds Investments; and (iii) Merchant Banking Investments. The Court granted the motion for summary judgment on all claims related to the Trimaran portfolio because it was clear from the offering documents and the Fund’s limited partnership agreement that Trimaran’s managers – not the Fund’s managers – were responsible for making all investment decisions for Trimaran; the Fund’s managers were not required to make any discretionary determinations with respect to Trimaran. In contrast, the Fund’s managers were charged with making certain discretionary decisions with respect to the Fund-of-Funds and Merchant Banking portfolios. The Court denied defendants’ motion for summary judgment with respect to the Fund-of-Funds and Merchant Banking portfolios because it found material issues of fact as to whether the Fund’s General Partner and the members of the Advisory Board carried out their duties with respect to the Fund.

The Fund’s limited partnership agreement limited the liability of the General Partner, Special Limited Partner, and the Investment Advisor such that plaintiffs could recover damages only if they could establish bad faith, willful misconduct, gross negligence, or a material breach of the limited partnership agreement or other related investment agreements. The Court held that the plaintiffs may be able to establish a material breach of the limited partnership agreement and the related investment agreements because, although such agreements provided that investments could bemade only side-by-side with CIBC, such agreements also (i) required the Fund’s managers to make determinations with respect to exiting the Fund-of-Funds and Merchant Banking investments, (ii) placed limits on the Fund’s investments in those portfolios, and (iii) specified eligibility criteria. The Court found questions of material fact as to whether the Fund’s managers made such determinations and considered the limits and eligibility criteria.  The record suggested that the Fund’s managers did not manage the Fund’s investments as they were obligated to do, but instead, merely relied on investment decisions made by the CIBC Investment Committee. The Court further held that this suggested reliance could demonstrate that the defendants acted in bad faith or with gross negligence because the Advisory Board was informed repeatedly in writing regarding its obligations to make discretionary decisions from the perspective of the Fund.

The Court noted that the limited partnership agreement imposed on the General Partner an active obligation to oversee the Fund. However, for the first two years of the Fund’s existence, during which time it performed disastrously, the record showed that the General Partner was “AWOL” because its board of directors acted by consent once to address organizational issues but did not otherwise meet or act. The Court found that all investment decisions with respect to the Fund-of-Funds and Merchant Banking portfolios were delegated to CIBC affiliates staffed by senior CIBC  executives who received their primary compensation from CIBC. Although the Court held that the General Partner and its board of directors were independent of CIBC, the Court stated, “Ordinarily, independent director approval could validate the actions of conflicted day-to-day decision-makers … [but] the General Partner’s disappearance from the scene and its studious impersonation of a rubber stamp eliminate my ability to rely on the [independence of the General Partner and its board of directors] as a cleansing device.” 

The Court stated that, if the plaintiffs were to prevail at trial, a judgment rescinding the challenged transactions and restoring the Fund’s capital plus interest, or rescissory damages if rescission proved too cumbersome, would be within the range of possible remedies.  The Court also denied summary judgment with respect to plaintiffs’ claims that CIBC aided and abetted the alleged breaches because the Court held that the knowledge of every member of the Advisory Board could be attributed to CIBC since every member who made investment decisions for the Fund was a CIBC executive.

The full opinion is available here