A&J Capital, Inc. v. Law Office of Krug, C.A. No. 2018-0240-JRS (Del. Ch. Jan. 29, 2019) (Slights, V.C.)
In this memorandum opinion, the Delaware Court of Chancery granted a request by plaintiff, A&J Capital, Inc. (“A&J”), for a declaration pursuant to 6 Del. C. §§ 18-110 and 18-111 that A&J had been improperly removed without cause as a manager of LA Metropolis Condo I, LLC, a Delaware limited liability company (the “Company”).
The Company was formed to raise investment capital under the EB-5 Immigrant Investor Visa Program, which provides a means by which investors in US businesses can become lawful permanent residents. Investors purchased a “Class B Unit” in the Company in order to become eligible to participate in the EB-5 program. Henry Global Consulting Group (“Henry Global”), a company that solicits investments for EB-5 projects, along with A&J, its strategic partner, secured the Company’s investment in a construction loan with Greenland LA Metropolis Development I, LLC (“Greenland”). A&J was engaged as the “Class B Manager,” charged with managing the day-to-day operations of the Company in exchange for a management fee. Under a series of agreements between the investors and the various entities involved, the Class B Manager of the Company could only be removed by the Class B Members of the Company for cause, which the agreements define as “gross negligence, intentional misconduct, fraud or deceit.” Defendant Law Offices of Krug (“Krug”) initiated distribution of a ballot to the Class B Members soliciting a vote for the removal of A&J as Class B Manager, and the election of Krug as the new Class B Manager. The ballot did not identify the basis for removal, nor was any such basis included in the solicitation. Purporting to have received sufficient ballots voting in favor of removal, Krug notified A&J of its removal as Class B Manager.
Krug asserted two sets of actions taken by A&J as supporting the removal of A&J for cause. First, A&J negotiated for a prepayment fee in connection with a proposed plan to repay the Greenland loan, and structured the vote on the prepayment plan so that any abstention counted as a vote in favor of the proposal. Second, A&J made payments to Henry Global in exchange for Henry Global’s role in the business, which included raising capital, acting as a liaison between investors and the Company, and assisting investors with their immigration applications.
The Court began its analysis by noting that after-the-fact grounds for removal could not be used as justification for removal. It then defined the standards for gross negligence, intentional misconduct, and fraud or deceit, noting the difficulty of proving any one of them. Regarding the substance of the purported grounds for removal, the Court found Krug’s claims of wrongdoing relating to the prepayment plan mere “litigation hyperbole.” The Court found that there had been full disclosure of the prepayment fee and the reasons why it was sought, and that there was no evidence of an intent to deceive. The fact that prepayment had been Greenland’s idea, and that the Class B Members voted to reject the proposal, further undermined the allegations of deceitful or harmful conduct. Similarly, the Court rejected Krug’s arguments that counting silence as a vote in favor indicated an intent to deceive, and that conditioning approval of the prepayment plan on approval of the prepayment fee was a breach of the duty to act in the best interest of the Company. Again, there had been full disclosure, and the Class B Members had been free to reject the plan and solicit approval for their own initiatives, which could have included separating the prepayment plan approval from the prepayment fee approval.
The Court also rejected Krug’s arguments that the payments to Henry Global were improper. The Court found it contractually permissible for payments to Henry Global to be made from the interest income generated by the Class B Members’ investment. Second, the Court held that the fee paid to Henry Global was not excessive given the many services it performed, and that, even if Henry Global was already receiving compensation for some of these services under separate contracts, there was no evidence that A&J knew about these other contracts. Finally, the Court found no evidence supporting Krug’s allegations that A&J had intentionally concealed the payments to Henry Global. A&J had ordered an independent accounting firm to review the Company’s financial statements, including payments to Henry Global, and had provided the results of that review to Henry Global for distribution to the Class B Members. While Henry Global had excluded from distribution to the Class B Members a page of the statement regarding its payment, there was no evidence of A&J’s involvement in the exclusion of the page.
Therefore, having found no evidence of gross negligence, intentional misconduct, fraud or deceit, the Court held that removal was improper, and that A&J should be immediately reinstated to its position as the Class B Manager.