Even Languorous Litigation Must Abide Rule 12(B)(6), Chancery Court Holds
In Beach to Bay Real Estate Center LLC et al. v. Beach to Bay Realtors Inc. et al., Civil Action No. 10007-VCG (Del. Ch. July 10, 2017), the Delaware Court of Chancery granted in part the defendants’ motion to dismiss because the plaintiffs’ alleged only conclusory facts in support of their claims for breach of fiduciary duty and constructive trust. The court also dismissed the plaintiffs’ claim for breach of implied contract based on an oral LLC operating agreement, a theory of recovery that was in tension with the sole written document proffered by the plaintiffs and the plaintiffs’ own allegations about the parties’ obligations to the LLC.
The claims in the case arise from the winding-down of Beach to Bay Real Estate Center LLC (the “Center”), a Delaware limited liability company formed as a real estate venture between two realtors, Anthony Kulp and Andy Staton, acting through their respective companies. The plaintiffs were Kulp, his Delaware limited liability company AJ Realty LLC (“AJ”), and the Center. AJ was the managing member and majority interest-holder in the Center. Among other parties, the defendants include Staton and the Delaware corporation owned by him, Beach to Bay Realtors Inc. (“Realtors”). Relators and Staton were both minority members in the Center.
Before their business relationship soured, Kulp and Staton created the Center in February 2006 out of a predecessor entity through the contributions of AJ and Realtors, with Kulps’ AJ entity holding 51% interest and Staton’s Realtors entity holding 49% of the interest in the Center. No LLC operating agreement was entered into at that time; Kulp and Staton proceeded instead on the basis of a series of oral agreements and understandings dating back to June 1, 2005, according to later documentation.
In October 2006, the Kulp, Staton, and Realtors executed an agreement (the “2006 Agreement”) to memorialize their relationship with the Center, specifically concerning unequal capital contributions to the Center’s operations in the period after the initial funding from February 2006 to October 2006. The 2006 Agreement reduced Stanton’s and Realtors’ interest in the Center to 22% because of capital contributions made by Kulp but not matched by Stanton or Realtors. The 2006 Agreement required Stanton to assign 27% of his 49% interest in the Center to Kulp, and authorized Kulp to continue making dilutive contributions, automatically reducing Staton’s ownership interest in proportion to any future unmatched capital contribution by Kulp. The 2006 Agreement also recited that no written operating agreement for the Center had been drafted or signed by the parties.
In 2013, Kulp sought to wind down the Center. Despite the automatic dilution mechanism specified in the 2006 Agreement, the complaint alleges that Staton owed Kulp approximately $105,744 for unmatched capital contributions by Kulp and loans from Kulp to the Center from 2006 to 2013. The complaint also alleges that Kulp and Staton had an additional oral agreement that all loans to the Center would be accounted for paid and upon closing of the business in proportion to each member’s interest. Staton refused to pay the $105,744 allegedly owing to Kulp from unmatched contributions and loans to the Center, the complaint asserts. Afterwards, Kulp discovered that Staton had used the Center resources and client lists to fund a different real estate venture without Kulp, starting as earlier as 2009.
The plaintiffs filed the complaint in August 2014, covering six counts, and the defendants moved to dismiss three of those claims in September 2014: breach of fiduciary duty, breach of implied contract or estoppel, and assertion of constructive trust. The Court pointed out with some flourish that the matter was full briefed by December 2014 and ready for argument nearly three ago. Underscoring the parties’ “desultory” pace, the Court observed that the crucial events at issue in this litigation transpired mostly during George W. Bush administration.
The Court dispatched with the plaintiffs’ three challenged claims quickly under the well-established standard for motions to dismiss pursuant to Court of Chancery Rule 12(b)(6), preserving only the plaintiffs’ alternate promissory estoppel claim.
First, siding with the defendants, the Court held that the plaintiffs failed to plead the existence of a fiduciary duty extending from Realtors or Staton (as minority LLC members of the Center) to Kulp, who exclusively manages and controls the Center. Delaware Courts have interpreted the Delaware LLC Act to imply default fiduciary duties to managers of a LLC unless such duties are clearly disclaimed, but have made no similar inference for members. Yet the compliant relied on minority membership as the “sole allegation that purports to create the fiduciary duty.” The Court ruled that is insufficient as a matter of law. The Court also noted, in dicta, while conceivable that a minority member of an LLC could stand in a fiduciary relationship to the entity or other members (e.g. by having access to confidential information in certain circumstances), the complaint made no such claims. The complaint failed to allege that any special trust was reposed in Staton or adopted by him through a special relationship towards Kulp or the Center.
Second, siding in part with the defendants again, the Court rejected the plaintiffs’ theory of recovery based on implied contract because the plaintiffs’ claim for relief alleges the existence of express and other agreements covering the same subject matter. The plaintiffs asserted the existence of an oral operating agreement and additional oral agreements pertaining to the repayment of loans on the Center’s wind-down. These represented express contracts, the Court observed, not contracts implied from the circumstances. In fact, the complaint contained “the complete absence of facts” regarding the circumstantial intent of the parties to be bound by an unexpressed agreement, making it impossible for the Court to reasonably conceive of an implied contract claim.
In a brief interim, the Court held that the plaintiffs’ alternate claim for relief under a theory of promissory estoppel survived dismissal. The Court ruled that the complaint adequately alleged each element under the doctrine of promissory of estoppel. The complaint alleged that (i) Staton promised to repay any loans to the Center by Kulp upon dissolution, (ii) reasonably inducing continued contributions by Kulp, (iii) in reliance on which Kulp made additional loans to the Center to his detriment, and (iv) which funds are now unrecoverable except by action against Staton. The Court therefore denied the motion to dismiss for the promissory estoppel theory, provided the complaint is read as a whole and all reasonable inferences are drawn in favor of the plaintiffs.
Third and finally, the Court held the plaintiffs waived their claim for a constructive trust. In their briefing, the plaintiffs’ claimed they were pursuing recovery for lost sales commissions and the allegedly purloined client lists—not the loss of the $105,744 in contribution amounts originally alleged in the complaint. The Court ruled that remedies for these injuries were untenable under trust theory and unavailable in equity. The proper place to recover for conversion is a claim at law. The Court noted that a plea for damages of this sort subsists under the unchallenged trade secrets claim that remained to be litigated, and dismissed the trust theory accordingly.
In substance, the Court ruled that—no matter how long litigation is delayed by the parties in search of settlement—the factual allegations in a complaint must be well-plead to survive a motion to dismiss under Rule 12(b)(6).