LVI Group Invs., LLC v. NCM Group Holdings, LLC, C.A. No. 12067-VCG (Del. Ch. Mar. 29, 2017) (Glasscock, V.C.)
In this letter opinion, the Court of Chancery found that counterclaim plaintiff, NCM Group Holdings, LLC (“NCM”), adequately pled fraud with particularity under Chancery Rule 9(b) but failed to state direct and derivative claims against current and former officers of NorthStar Group Holdings (“NorthStar”), a Delaware LLC.
On or about April 23, 2014, NCM and counterclaim defendant LVI Group Investments (“LVI”)—both Delaware LLC competitors in the demolition and remediation business—merged their businesses (the “Merger”) to form NorthStar. As part of the Merger, the parties agreed to indemnify each other for breaches of the merger agreement (the “Contribution Agreement”), including for inaccuracies in each party’s representations and warranties regarding their respective financial statements each party submitted in connection with the Merger.
On March 3, 2016, LVI filed a complaint (the “LVI Complaint”) asserting, among other claims, fraud and fraudulent inducement against NCM with respect to certain representations and warranties NCM made in the Contribution Agreement and alleged that “NCM intentionally overstated earnings and manipulated NCM’s accounting in violation of GAAP.” In response to the LVI Complaint, NCM filed counterclaims. Among them were claims for fraud (Count I) and fraudulent inducement (Count II, and together with Count I, the “Fraud Claims”) against LVI, Scott State, who was affiliated with LVI and was CEO of NorthStar (“State”), Paul Cutrone who also was affiliated with LVI and was former CFO of NorthStar (“Cutrone,” and together with State and LVI, the “Counterclaim-Defendants”), and NorthStar centered around certain alleged misrepresentations and concealments of losses in the financial statements LVI submitted in connection with the Merger (the “LVI Financial Statements”). In addition, NCM brought direct claims (Count IV) and derivative claims on behalf of NorthStar (Count V) against State and Cutrone for allegedly manipulating NorthStar’s financial statements and knowingly failing to comply with GAAP.
The Counterclaim-Defendants moved to dismiss Counts I and II under Rule 9(b) arguing that NCM failed to plead fraud with particularity. State and Cutrone moved to dismiss Counts IV and V pursuant to Rule 12(b)(6), and also joined with NorthStar in moving to dismiss Count V pursuant to Rule 23.1 for failure to make a demand on the NorthStar Board.
The Court denied the Counterclaim-Defendants’ motion to dismiss the Fraud Claims. It found that NCM pled fraud with particularity as required by Rule 9(b). Among other reasons supporting that finding, the Court noted that NCM presented examples of LVI’s “pattern and practice” of certain accounting improprieties related to several specific jobs. The Court then turned to the adequacy of the allegations for fraud and found that NCM alleged sufficient facts from which the Court could “infer a misrepresentation in the Contribution Agreement.” The Court noted that because the Fraud Claims were based on a written contractual representation, it was “relatively easy” for NCM to allege the necessary facts such that “all that remains to decide this matter is whether NCM has adequately pled knowledge on the part of [the Counterclaim-Defendants].” With respect to that issue, the Court found the facts NCM alleged, including that the Counter-Defendants “‘knew that at least some of the Jobs were misstated on the LVI Financial Statements,’ and knew before the Merger that ‘there would be millions of dollars in [undisclosed] losses,” were sufficient to infer such knowledge.
Next, the Court turned its analysis to NCM’s direct (Count IV) and derivative (Count V) fiduciary duty claims against State and Cutrone. For Count IV, the Court found that NCM failed to state a direct claim because NCM’s allegations were derivative in nature in that they involved “both injury—and potential relief—to NorthStar.” That finding was “convincingly demonstrated” by the fact that the relief NCM sought—removal of State as CEO of NorthStar—would “run to NorthStar directly, and only indirectly to any of NorthStar’s members.” With respect to Count V, the Court found that NCM failed to show demand futility under Rule 23.1. Specifically, the Court found that NCM’s reference to “one broad group of seven board members and claims that they have an interest in LVI and stand to personally benefit from the actions of Cutrone and State” was inadequate for purposes of Rule 23.1. NCM’s “cursory allegations” fell short of the “fact-intensive, director-by-director analysis required to plead demand futility.”