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Christopher Miller v. HCP & Company
Citation: Not availableDocket: CA 2017-0291-SG
Court: Court of Chancery of Delaware; January 31, 2018; Delaware; State Appellate Court
Original Court Document: View Document
In the case before the Delaware Court of Chancery, Plaintiffs Christopher Miller and the C. L. Miller Revocable Trust seek relief based on the implied covenant of good faith and fair dealing within an LLC operating agreement concerning Trumpet Search. The HCP Entities, as major stakeholders, held significant membership units and were involved in the creation of new "Class E" units, which granted them preferential financial returns upon a sale of Trumpet. Specifically, the HCP Entities purchased 80% of these Class E units for nearly $2 million and held almost 90% of the existing Class D units, which together entitled them to the majority of the initial $30 million from any sale proceeds. The operating agreement stipulated that the HCP Entities, holding a majority, could appoint four of the seven managers on the Trumpet Board and that all members had to consent to any sale approved by the Board. It also allowed the Board full discretion over the sale process while waiving fiduciary duties among members. Plaintiffs argue that this arrangement incentivized the HCP-dominated Board to negotiate a sale price up to $30 million but not beyond, as they would not benefit from additional proceeds. Shortly after the operating agreement was adopted, the HCP-led Board facilitated a sale to MTS Health Partners, initially at $31 million. The Board did not conduct a thorough sales process, limiting the time for other members, including Plaintiff Miller, to find alternative buyers. Eventually, the sale price was negotiated up to $43 million, raising concerns from the Plaintiffs about the fairness and good faith of the Board's actions in light of their interests. The Trumpet Board approved the sale of the company for $43 million. Plaintiffs contend that an open auction would have yielded a higher price but acknowledge that all members waived fiduciary duties under the Operating Agreement (OA). They argue for an implied covenant requiring an open-market sale or auction to maximize value for all members, citing the incentive structure set by the OA. However, the court notes that the members explicitly chose to waive fiduciary duties and granted the Board sole discretion over the sale method, with the only condition being that the buyer must be an unaffiliated third party. This suggests the parties considered the sale conditions and intentionally structured the OA to accommodate their interests, leaving no gaps for implied terms. The Plaintiffs' regret over the provisions does not justify altering the agreement's intent. The OA was likely designed to attract capital by allowing favorable exit terms for investors, and imposing an auction requirement could jeopardize these terms. Ultimately, the absence of a gap for an "auction sale" term led to the granting of the Defendants' Motion to Dismiss. In terms of parties involved, Plaintiff Christopher Miller, co-founder of Trumpet Search, LLC, acted in both his individual capacity and as a trustee of the Miller Trust. The Defendants include various entities affiliated with HCP Company, a private equity firm, which held significant membership interests in Trumpet prior to its sale. Defendant Carlos Signoret, along with Victor Maruri, cofounded HCP and both served as “HCP-controlled” members of Trumpet’s Board of Managers, alongside fellow defendant Jason Shafer, who is an HCP employee and president of HCP Pachyderm and HCP Investments. Mark Russell also works for HCP and is an HCP-controlled member of the Trumpet Board. Trumpet, founded in 2008 by Miller and Franklin “Lani” Fritts, specializes in clinical services for autism and developmental disabilities, positioning itself as a leading provider in this sector due to favorable economic and political conditions. In late 2014, HCP Investments and HCP Pachyderm acquired a majority of Trumpet’s Class D interests, becoming the largest members and appointing a majority of the Board. HCP’s website identifies Trumpet as a portfolio company targeted for high potential value. On May 5, 2016, Trumpet’s members executed the Second Amended and Restated Operating Agreement (OA), which established a new class of membership interests primarily for HCP Investments. The OA outlines a distribution waterfall for capital returns in sales or similar events: 1. Class E members receive a 200% return on their contributions. 2. Class D members receive a 200% return on their contributions. 3. Participating Class A and B members receive a 100% return. 4. Nonparticipating Class A and B members receive a 100% return. 5. Nonparticipating Class C members receive a 100% return. 6. Certain members receive distributions totaling $1,092,500. 7. All Trumpet members receive a total of $6,907,500. 8. Participating Management Members receive an additional $1,092,500. 9. Remaining distributions are made to all members based on ownership interests. HCP Investments acquired 78.5% of the new Class E units for a total investment of $1,963,354, entitling them to a first-position payout of $3,926,708 in the event of a sale. Together, HCP Investments and HCP Pachyderm hold 87.5% of the Class D units, with a total capital contribution of $12,000,000. Two HCP entities were entitled to a second-position payout of $24 million upon a sale. Christopher Miller held 39.1% of the Participating Management Member Common Interest units, while the Miller Trust owned 11,338 Class D units and 50,001 Class A units, totaling capital investments of $19,654 and $50,001, respectively. The Operating Agreement (OA) waives fiduciary duties for both Trumpet members (Section 2.05) and Trumpet’s Board members (Section 3.09). The HCP entities had the authority to appoint a majority of Trumpet's seven-member Board, which they did by appointing Signoret, Shafer, Russell, and Maruri, leaving Miller, Fritts, and Leslie Margolin on the Board. Section 8.06 mandates that if the Board approves a sale of all membership units to an independent third party, all members must consent. If a member objects, the Board can act as that member's attorney-in-fact to sign necessary documents. Section 8.06(a) grants the Board sole discretion on the manner of the sale and requires written notification to members detailing the sale’s terms. The Plaintiffs allege they expected an open-market auction process for any sale, ensuring the highest value for all members, not just those affiliated with HCP. After the HCP entities gained control, they allegedly engineered a sale to MTS Health Partners, L.P. for $31 million, seeking a 200% return on their investment, neglecting the interests of other members. This, according to the Plaintiffs, breached the implied covenant of good faith and fair dealing. They claim the sale process was rushed and lacked a reasonable effort to secure the best price, as evidenced by a Board meeting in December 2016 where objections to the sale process and price were raised. Signoret asserted that the OA waived fiduciary duties, and limited the search for competing offers to just five days, allowing communication with only two interested parties, while Maruri supported HCP's proposals behind the scenes. After a December meeting, Trumpet contacted two investment funds interested in the company, leading to a letter of intent for a sale around $36 million and prompting MTS to raise its offer from approximately $31 million to $41 million. Plaintiffs claim this indicated MTS recognized its offer was below market value and sought a bargain without competing. Despite the potential for better offers, the Defendants chose to pursue MTS's $41 million offer, which would leave Class A and B members with minimal returns and nothing for nonparticipating Class A and B members, Class C members, and Common Interest members. On February 24, 2017, Miller received an unsolicited voicemail from Chris Harris of FFL Partners, expressing interest in purchasing Trumpet's membership interests, valuing them at over $50 million. The next day, Miller received a non-binding letter from FFL, valuing Trumpet between $50 million and $60 million, which he presented to the Board to argue against MTS’s offer. However, HCP Board members were suspicious of FFL's interest, fearing it would delay their anticipated payout. They colluded to downplay FFL’s valuation and expedite the MTS deal, leading to a disclosure of FFL's interest to MTS, which threatened legal action if the deal did not close by the following week. The Plaintiffs allege that MTS's threat was unfounded, as the letter of intent did not prohibit Trumpet from exploring other offers. Additionally, MTS accused Miller of contacting FFL, a claim the Plaintiffs dispute, alleging it resulted from unauthorized communications between Board members and MTS. Tensions escalated until Fritts, Trumpet's CEO, withdrew support for the MTS deal during a March 2, 2017 Board meeting, prompting the Board to consider an open-market approach instead. Subsequently, Fritts and Shafer informed MTS of Trumpet's withdrawal from negotiations, though they were not authorized to reinitiate purchase discussions. HCP Board members re-engaged MTS in sale negotiations after MTS increased its offer by approximately $1.6 million, despite the expiration of MTS’s letter of intent and the absence of competing offers. Allegations suggest that the HCP Board used intimidation tactics to pressure Fritts and Leslie Margolin into approving the sale, including threats of litigation from MTS and increased monitoring of Fritts. During a March 7, 2017, meeting, Shafer acknowledged that a more competitive sales process should have been considered but justified accepting MTS's $43 million offer due to the lack of alternatives. The sale's structure meant minimal returns for participating Class A and B members unless they waived claims against the Board, while non-participating members received nothing. Plaintiffs argue that a proper open-market process could have yielded a significantly higher sale price, allowing all classes of members to receive full payouts. For instance, a sale at $53 million would have fully compensated preferred members, including a potential payout of over $1 million for Miller and the Miller Trust. The Plaintiffs' Complaint, filed on April 14, 2017, includes four counts: breach of the implied covenant of good faith and fair dealing, aiding and abetting such breach, tortious interference with contract, and civil conspiracy. Following the dismissal of HCP and HCP Pachyderm, the remaining Defendants sought to dismiss the Complaint. The Court’s analysis of the motion to dismiss emphasizes the necessity to accept well-pleaded factual allegations as true and to draw reasonable inferences favorably for the Plaintiffs, while rejecting unsupported conclusory claims. The central issue revolves around the alleged breach of the implied covenant of good faith and fair dealing through the Board's failure to pursue an optimal sales process for Trumpet's members. Plaintiffs claim that Defendants executed a below-market sale to MTS, enabling a quick exit and a 200% return on investment while disadvantaging other Trumpet members. However, these claims do not establish a breach of the implied covenant of good faith and fair dealing. According to the Delaware Limited Liability Company Act, LLC agreements can waive fiduciary duties but cannot eliminate the implied covenant. This covenant is inherent in contracts under Delaware law, and the operating agreement (OA) confirms that managers are bound by it. To succeed in a breach of the implied covenant claim, a plaintiff must demonstrate a specific implied obligation, a breach by the defendant, and resultant damages. The application of the implied covenant is cautious and rarely successful, requiring proof that one party acted arbitrarily or unreasonably, undermining the other party's reasonable expectations at the time of contracting. Any implied terms must address gaps in the contract that were unanticipated by both parties. The court will not alter a contract simply because a party now regrets its terms; good faith here relates to adherence to the contract's scope and purpose rather than moral considerations. Evaluating an implied covenant claim starts with determining if the contract has a relevant gap. If the contract addresses the issue, those terms govern, and implied obligations cannot override the explicit agreement. If there is a gap, the court assesses whether the parties would have included a specific prohibition if they had considered the issue during negotiations. Implied obligations are not derived from concepts of justice but rather from the parties' original intentions when forming the contract. The implied covenant thus applies only when the contract suggests an obligation but does not explicitly address it. Delaware courts are generally reluctant to apply the implied covenant of good faith and fair dealing when a limited partnership (LP) or limited liability company (LLC) agreement expressly eliminates fiduciary duties, as this indicates an intention for losses to remain with their original bearers rather than be redistributed through fiduciary reviews. In this case, Trumpet's Operating Agreement (OA) waives fiduciary duties among its members and managers and does not mandate an open-market process for selling the company once a decision to sell is made. Plaintiffs argue that such a requirement should be inferred from the implied covenant. The Defendants counter that the OA explicitly addresses sales procedures, referencing Section 8.06(a), which grants the Board sole discretion over the manner of selling Trumpet’s membership units to independent third parties, permitting various sale structures without needing to pursue an open-market process. Consequently, they assert that there is no gap for the implied covenant to address. In response, Plaintiffs argue that Section 8.06(a) only pertains to the structure of the sale and does not cover marketing methods, suggesting a gap that necessitates an auction-sale requirement. Additionally, they contend that even if the Board's discretion includes marketing methods, it must be exercised reasonably and in good faith. The court supports the Defendants’ view, emphasizing that the OA clearly grants the Board discretion over the marketing and sale process, provided the sale is to an unaffiliated third party. The court finds Plaintiffs' interpretation of Section 8.06(a) unreasonable, affirming that the Board has broad authority in determining how to market the company, encompassing decisions about the sale's structure. The provision grants the Board broad discretion in determining the marketing and structuring of company sales, provided these transactions do not involve insiders. While discretion must be exercised reasonably and in good faith, if the contract's language clearly defines the scope of discretion, there is no gap for the court to interpret. The court has previously established that the implied covenant cannot override explicit contractual terms. In this case, the Operating Agreement (OA) specifies the Board's sole discretion in managing the sales process, limited to unaffiliated third parties. This explicit limitation indicates that the members of the Board anticipated the implications of their discretion, thus precluding the application of the implied covenant. The plaintiffs do not contest that the sale to MTS qualifies as an "Approved Sale," which falls within the Board's discretion. The court assumes, for the purpose of ruling on the Motion to Dismiss, that the transaction with MTS meets this definition. Additionally, plaintiffs argue against the implied covenant in the context of the general partner's removal, but the court finds that the specific discretion concerning this issue was not clearly defined in the contract. The parties can establish either unfettered discretion or impose limits based on reasonableness, which would clarify their intentions in the contract. The Plaintiffs assert that the implied covenant of good faith applies strongly to contracts granting sole discretion, but the cited cases do not control this situation. An unqualified grant of sole discretion can lead to abuse, potentially depriving the other party of their contractual benefits. However, in this case, the parties addressed the risks of self-dealing by explicitly stating that the Board cannot sell the company to insiders. Therefore, the Complaint does not adequately demonstrate a gap in the Operating Agreement (OA), leading to the dismissal of the Plaintiffs' implied covenant claim. Even if a gap were present regarding the sale of Trumpet, the claim would still fail as the Plaintiffs have not shown that they had reasonable expectations that were not met. The inquiry focuses on whether the parties would have agreed to prohibit the contested action if they had negotiated about it. The Plaintiffs have not identified any clause in the OA indicating that the parties would have restricted the sale process, and the contract's terms suggest that they anticipated a private sale rather than an open-market one. Specifically, Section 8.06(a) indicates that the Board must notify Members in writing about sales to independent third parties, reinforcing the notion that private negotiations were contemplated. The implied covenant in this case is derived from the contract's language rather than any disclaimed fiduciary duties. The contract includes a provision requiring the Board to notify Trumpet’s members upon approving a sale, suggesting that the parties did not intend to limit the sale process to an open-market approach. The absence of a requirement to inform members about an ongoing sales process indicates that privately negotiated sales were not excluded from consideration. The Plaintiffs' request to enforce an auction sale requirement would fundamentally change the agreement rather than uphold it. The Defendants' actions during the sales process were neither arbitrary nor unreasonable, and the Complaint does not allege fraud or improper motives beyond self-interest related to their financial returns. The self-interest of the Defendants, as reflected in the distribution waterfall provision, was anticipated by the parties, and while the sales process favored the Defendants, this was not unexpected. The Defendants had incentives to maximize sale price to ensure their returns, but the Plaintiffs have not substantiated claims that would warrant invoking the implied covenant as a legal remedy. The Operating Agreement (OA) eliminates all fiduciary duties for Trumpet’s members and managers. It specifically restricts the Board's ability to approve sales to insiders, indicating a concern about conflicts of interest in the sales process. This context led to the Plaintiffs' expectation that the Defendants would act in their own interests when pursuing a sale, undermining the Plaintiffs' claim related to the implied covenant of good faith and fair dealing. The Delaware Supreme Court has clarified that this implied duty does not serve as a remedy for economic imbalances that could have been foreseen. Plaintiffs argue that they could not have anticipated the HCP Entities and their Board members would aim for a below-market sale with limited time for competing offers. However, the OA does not obligate the Board to conduct a full auction process, which would shift the risk of missing a better offer. The HCP Entities did not use their majority to finalize the initial $31 million offer from MTS, and the sales process extended over several months, ultimately increasing MTS’s offer to approximately $43 million. Non-HCP Board members raised concerns, and the HCP members responded by allowing efforts to seek better offers. The deal took about three months to finalize, with no competing offers at the time of agreement. Plaintiffs’ contention that the HCP Board should have jeopardized the MTS offer to negotiate better terms is countered by the OA's waiver of fiduciary duties, which they attempt to bypass by invoking the implied covenant. The court rejects the Plaintiffs' attempt to invoke the implied covenant of good faith and fair dealing as a means to reintroduce fiduciary review, stating that doing so would undermine the limited scope of the implied duty. The Plaintiffs could have included specific protections against self-interested conduct in their contract, such as requiring the Board to pursue a sales process aimed at maximizing value or establishing minimum sales prices, but chose not to. The court emphasizes that parties have the right to enter into both advantageous and disadvantageous contracts, and it will not provide the Plaintiffs relief for their contractual regrets. As the Plaintiffs failed to substantiate their claim for breach of the implied covenant, their associated claims for aiding and abetting breach, tortious interference, and civil conspiracy are also dismissed. Consequently, the Defendants' Motion to Dismiss is granted.