CMS Investment Holdings, LLC v. Castle et al., C.A. No. 9468–VCP (Del. Ch. June 23, 2015) (Parsons, VC)

In this decision, the Delaware Court of Chancery largely declined to dismiss claims for breach of a limited liability company agreement, breach of the implied covenant of good faith and fair dealing, unjust enrichment, breach of fiduciary duty, aiding and abetting, civil conspiracy, and fraudulent transfer in connection with the allegedly forced insolvency of a limited liability company. In so ruling, the Court rejected, among other things, defendants’ arguments that all of plaintiff’s claims were derivative, rather than direct, in nature.

Plaintiff CMS Investment Holdings, LLC (“Plaintiff”) invested in and owned 99% of the Class A units of RP Holdings Group, LLC, a Delaware limited liability company (“RPH”), whose business was providing non-legal administrative services in connection with mortgage foreclosures. That business was created by the principal defendants: Lawrence E. Castle (“Mr. Castle”), Caren J. Castle (“Mrs. Castle”, and together with Mr. Castle, the “Castles”), Leo C. Stawiarski, Jr. (“Stawiarski”), Jennifer Wilson–Harvey (“Wilson–Harvey”), and Robert M. Wilson (“Wilson”, and together with Wilson-Harvey, the “Wilsons”), individuals who practiced law in Colorado and Arkansas. Those individuals sold the business to RPH in exchange for membership units and continued to run the business as employees, officers, and managers. Plaintiff paid cash to acquire other membership units. According to Plaintiff, the defendants, along with several of their affiliated entities, failed to facilitate RPH’s collection of fees owed to it, instead retaining the fees for themselves or paying them in improper distributions, and then purposely ushered RPH into insolvency and receivership, at which time defendants bought RPH’s main assets at bargain prices through entities they allegedly owned. Plaintiff’s complaint charged the individual defendants, along with several affiliated entities, with breach of the RPH LLC agreement (the “RPH LLC Agreement”), breach of the implied covenant of good faith and fair dealing, unjust enrichment, breach of fiduciary duty, aiding and abetting, civil conspiracy, and fraudulent transfer. The defendants each moved to dismiss. The Court largely denied the motions, but did grant dismissal of some of the claims as to certain defendants.

In assessing Plaintiff’s claims on the motion to dismiss, the Court first rejected the defendants’ assertion that the claims were all derivative and Plaintiff therefore lacked standing to pursue them directly. Applying the analysis outlined by the Delaware Supreme Court in Tooley v. Donaldson, Lufkin & Jenrette, Inc. to determine whether claims are direct or exclusively derivative in nature, the Court noted that Plaintiff had direct claims for breach of contract and related causes of action. According to the complaint, parties to the RPH LLC Agreement, including some defendants, promised that Plaintiff, as a Class A unitholder, would have priority for certain distributions, and that Plaintiff did not receive the distributions to which it was entitled. Thus, the predominant harm fell on the Class A unitholders, giving rise to direct claims. In continuing with the Tooley analysis for purposes of the remaining claims for alleged breaches of fiduciary duties, aiding and abetting, and civil conspiracy, the Court noted that the complaint alleged that the individual defendants purposefully engineered the dissolution of RPH to disloyally purchase its only valuable assets out of receivership, thereby squeezing out the Class A unitholders for less than fair value. As such, Class A unitholders individually would be the principal recipients of any benefit of a recovery and, on that basis, could pursue the claims directly.

The Court also rejected the contention of defendant Associates Management Services, LLC (“AMS”), an entity affiliated with Wilson–Harvey that purchased assets in the 2012 receivership action, that actions taken in the receivership action precluded Plaintiff from bringing claims against AMS because of res judicata. AMS’s argument proceeded from the necessary premise that the claims in this action were the same claims as those sold by the receiver. The claims brought in this action, however, were direct claims that accrued to Plaintiff—not RPH—and no defendant attempted to argue how Plaintiff’s direct claims could have become part of the RPH receivership estate and thereafter been sold away.

The Court next rejected arguments that Plaintiff’s claims should be barred as untimely. The alleged wrongdoing occurred within three years prior to the filing of the complaint, and, to the extent any alleged wrongdoing took place before that time, Plaintiff could be entitled to the benefit of tolling. For purposes of the motion to dismiss, Plaintiff had adequately alleged that certain defendants consistently lied to Plaintiff’s representatives regarding—and thus fraudulently concealed—facts necessary to put Plaintiff on notice of its claims.

Having dispensed with defendants’ threshold arguments on standing and timeliness, the Court addressed each of Plaintiff’s claims in turn. First, the Court held that Plaintiff stated claims for breach of contract against some of the defendants. The Court held that defendants LEC Holdings, LLC (“LEC”), an entity affiliated with the Castles, as a member of RPH and signatory of the RPH LLC Agreement, and Mr. Castle, as a member of RPH’s Board of Managers, were bound by the terms of the RPH LLC Agreement, and that the complaint adequately pled that they each breached certain provisions of the RPH LLC Agreement. For example, Mr. Castle allegedly orchestrated distributions being made in violation of the RPH LLC Agreement, and LEC would have violated the RPH LLC Agreement if it knowingly accepted improper distributions or colluded with Mr. Castle. For similar reasons, the Court also held that the contract claims were well-pled against Stawiarski, defendant LCS Colorado Holdings, LLC (“LCS”), and the Wilsons. However, the Court dismissed this claim as to certain other defendants. The Court held that Mrs. Castle was not liable for breach of the RPH LLC Agreement because nothing in the record supported a reasonable inference that she intended to be bound by the terms of the RPH LLC Agreement, and Delaware does not recognize a cause of action for aiding and abetting a breach of contract. The Court also held that it was not reasonably conceivable that AMS would be liable for any breach of the RPH LLC Agreement because AMS was not a member of RPH, and Plaintiff made no effort to explain why AMS would be bound by the RPH LLC Agreement.

Plaintiff also charged the Castles, LEC, Stawiarski, LCS, and the Wilsons with breach of the implied covenant of good faith and fair dealing. Because the complaint alleged that all of these defendants except Mrs. Castle breached a specific term implicit in the RPH LLC Agreement, the Court denied the motions of each of these defendants except Mrs. Castle. Because Mrs. Castle was not a party to the RPH LLC Agreement, she could not be liable. As to the defendants who were parties to the RPH LLC Agreement, however, the Court found that the complaint supported a reasonable inference that the underlying purpose of the RPH LLC Agreement was to create a structure that would enable the parties to separate the administrative services businesses from defendants’ law firm businesses, and defendants’ failure to maintain separation conceivably frustrated the RPH LLC Agreement’s basic purpose.

The Court next declined to dismiss Plaintiff’s claim for unjust enrichment. While this claim arguably was duplicative of Plaintiff’s claims for breach of contract and the implied covenant of good faith and fair dealing, the Court permitted this claim to proceed in tandem with Plaintiff’s claim for breach of fiduciary duty under the Court rules permitting alternative pleading.

The Court next held that Plaintiff had stated claims for breach of fiduciary duty against the Castles, Stawiarski, and the Wilsons. The Court concluded that the RPH LLC Agreement did not diminish the default standards of care and loyalty under Delaware law and that Mr. Castle and Stawiarski, as members of RPH’s Board of Managers, Wilson–Harvey, as CEO of RPH, Mrs. Castle, as a high level officer of RPH and CEO of a region of operation, and Wilson, as an officer responsible for a region of operations, owed fiduciary duties to RPH and its members. Allegedly, the Castles and Wilsons facilitated RPH’s insolvency, secretly negotiated with creditors, and purchased RPH assets on favorable terms in receivership. Conceivably, Stawiarski was aware of the plan to facilitate RPH’s insolvency, and he did nothing other than resign from RPH’s Board of Managers. However, the Court dismissed this claim as to LEC and LCS because they were not managing members of RPH and did not exercise control over RPH.

Plaintiff also brought claims against all defendants for aiding and abetting the alleged breaches of fiduciary duty. The Court held that this claim was well-pled as to certain defendants. Because wrongful conduct on the part of a defendant fiduciary simply would give rise to direct liability for a breach of the duties he owes, rather than secondary liability on the theory of aiding and abetting, Plaintiff’s aiding and abetting claims against Mr. Castle, Stawiarski, and Wilson–Harvey were dismissed. However, the Court declined to dismiss this claim as it related to Mrs. Castle and Wilson because, if Plaintiff’s fiduciary duty claims failed as to them, they still could be liable for aiding and abetting. Furthermore, the Court found it reasonably conceivable that the defendant entities associated with the individual defendants could be liable for aiding and abetting the breaches of fiduciary duty allegedly committed by the Castles, Stawiarski, and the Wilsons if they participated in the alleged scheme to push RPH into insolvency. Thus, the Court denied the motions to dismiss this aspect of Plaintiff’s aiding and abetting claims.

Finally, the Court allowed both Plaintiff’s civil conspiracy claim and its fraudulent transfer claim to proceed.  With regard to the first, the Court reasoned that Plaintiff had sufficiently pled the existence of an “unlawful act” based on Plaintiff’s other claims, and it was reasonably inferable that defendants formed a “confederation,” conducted unlawful acts in furtherance of the conspiracy, and caused actual damages. With regard to the fraudulent transfer claim, the Court held that it could not conclude that it was inconceivable Plaintiff would be able to recover on this claim because Plaintiff had contended that underpayment of fees to RPH and the receivership sales were made purposefully to hinder Plaintiff’s interest.

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