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B.A.S.S. Group, LLC, and Joseph H. Webb, III v. Coastal Supply Co., Inc. and John M. Burkett, C.A. No. 3743-VCP (Del. Ch. June 19, 2009)

June 19, 2009

The Delaware Court of Chancery granted a motion for summary judgment and imposed a constructive trust on property that was purchased by a Delaware limited liability company with funds contributed by a member, but which such member had embezzled from its employer. The Court found that it was able to trace the embezzled funds directly to the purchase of the property and that the limited liability company was not a bona fide purchaser for value, since the wrongdoing member’s state of mind could be imputed to the limited liability company.

Plaintiff Joseph H. Webb, III and Defendant John M. Burkett formed B.A.S.S. Group, LLC (“BASS”), a Delaware limited liability company, on October 22, 2007, the purpose of which was to “acquire, own, hold, manage, operate, improve, develop, lease and otherwise deal” with property. During this time, Burkett also worked as controller of Defendant Coastal Supply Co., Inc. (“Coastal”). Coastal is a Delaware corporation that manufactures lawn and garden products. Burkett admitted to embezzling over $2 million from Coastal during his time as its controller. Burkett used over $400,000 of the embezzled funds to buy a property in Harrington, Delaware (the “Property”) on behalf of BASS. In April 2008, Coastal uncovered the embezzlement and terminated Burkett. Shortly after the termination, Burkett and Coastal executed an agreement (the “Restitution Agreement”) outlining Burkett’s transfer of the Property from BASS to Coastal as partial restitution of his embezzlement. Burkett executed a deed (the “Deed”) on behalf of BASS, which transferred the Property to Coastal.

Shortly after the transfer, Plaintiffs BASS and Joseph H. Webb, III (the “Plaintiffs”) filed an action on behalf of BASS to void the property transfer to Coastal and to obtain relief for alleged breaches of fiduciary duties by Burkett. Coastal answered and brought counterclaims against BASS and potentially Webb for unjust enrichment, conversion, civil conspiracy, and aiding and abetting conversion. Based on its counterclaims, Coastal requested “the imposition of a constructive trust over the Property, restitution of $412,972.52 plus interest, a declaration that legal title to the Property remains with Coastal and an accounting for all money used by BASS with respect to the Property.”

On January 23, 2009, Plaintiffs brought a Motion for Summary Judgment on two of its claims: the validity of the Property transfer and breach of fiduciary duty. Plaintiffs asserted that Burkett did not have the authority to transfer the Property, BASS did not receive consideration for the Property transfer and the Deed was defective on its face. Plaintiffs sought the following remedies: (i) voiding the Property transfer to Coastal, (ii) removal of Burkett as a member of BASS, and (iii) forfeiture of Burkett’s contribution to BASS. Coastal argued that the transfer of the Property should not be voided because Burkett had both actual authority under the limited liability company agreement of BASS (the “LLC Agreement”) as well as apparent authority that was relied on by Coastal. The Court found that, pursuant to the provisions of the LLC Agreement, whether Burkett had actual authority depended on whether he acted in “good faith” in transferring the Property from BASS to Coastal (and that those same “state of mind” issues were involved in the fiduciary duty claims), and that this was a factual matter that needed further development. Similarly, even though the Court questioned whether there was sufficient basis for a finding of apparent authority, it determined there were general issues of material fact surrounding whether Coastal could have reasonably believed in Burkett’s authority to act for BASS. Additionally, the Court held that there was a similar factual dispute with respect to the consideration claim. The Court, therefore, denied all of Plaintiffs’ Motion for Summary Judgment.

Also on January 23, 2009, Coastal filed a Motion for Summary Judgment on its counterclaims for unjust enrichment and for conversion. Coastal requested that the Court impose a constructive trust over the embezzled funds and the Property. With respect to the claim for unjust enrichment, the Court granted summary judgment. The Court found Webb’s argument unconvincing that he and BASS were “innocent parties and, thus, should not be penalized for Burkett’s acts.” The Court stated that “the knowledge of an officer, director or manager of a business entity is generally imputed to the entity” and that “restitution is permitted even when the [party] retaining the benefit is not a wrongdoer.” The Court stated that under Delaware law “if the unjustly obtained funds can be traced into specific property, then a constructive trust can be imposed on the property, regardless of the culpability of the party possessing the property, provided that the person or entity that received the funds was not a bona fide purchaser for value.” The Court found that it was able to trace the embezzled funds from Coastal directly to the Property. Additionally, it held that BASS was not a bona fide purchaser for value of the embezzled funds, but rather was equally culpable with Burkett in the situation, since Burkett was acting for and on behalf of BASS in purchasing the Property with the embezzled funds and Burkett’s state of mind could be imputed to BASS. The Court further held that “even if the Property transfer from BASS to Coastal were voidable, principles of unjust enrichment and constructive trust would dictate that the Property either should be transferred to Coastal or held by BASS subject to a constructive trust for the benefit of Coastal at least until such time as Coastal has been made whole.” Therefore, the Court imposed a constructive trust on the Property for the benefit of Coastal. It is worth noting that, in so doing, the Court rejected Plaintiffs’ suggestion that, instead of a constructive trust, the Court simply grant Coastal a charging order over Burkett’s interest in BASS (pursuant to Section 18-703 of the Delaware Limited Liability Company Act). According to the Court, because BASS was unjustly enriched, such a charging order, which would leave Coastal as merely an economic interest holder in BASS (and, consequently, without any voting rights and at the mercy of a controlling member that it had been engaged in litigation with for years), was not an adequate remedy and “objectively unattractive and untenable.”

Finally, the Court found that, for much the same reasons as it had found with the unjust enrichment claim, Coastal was also entitled to summary judgment on its claim for conversion of the embezzled funds given to BASS, which were later used to purchase the Property. The Court found that the remedy would include, “at least, a damage award against BASS of $412,972.52 plus interest at the legal rate from the date those funds were contributed to BASS.” The Court further noted that “the propriety of any additional relief against BASS, Webb, or both will have to be addressed after trial in connection with the remaining claims and counterclaims in this action.”

The full opinion is available here