Chancery Finds LLC Managers Liable for Self-Dealing Scheme Depleting Nearly All Investment Capital

Morris James LLP

Stone & Paper Investors, LLC v. Blanch, C.A. No. 2018-0394-PAF (Del. Ch. July 30, 2021)

This post-trial opinion involves a particularly egregious set of facts. Two LLC managers were accused of breaching their contractual and fiduciary duties and of fraudulently inducing the plaintiff, Stone & Paper, to invest $3.5 million in the company, Clovis Holdings, in connection with a series of self-dealing transactions wherein the managers paid themselves large sums of money in the form of salary and purported “loans” without receiving the required approvals for interested transactions. 

The operating agreement provided that the company’s resources—which included both the Stone & Paper investment and the time and effort of the managers—would be devoted to acquiring the stone paper business of ViaStone.  The agreement also contained limitations on interested transactions involving the managers.  While the Court found that initially, the managers attempted to negotiate the purchase of ViaStone on behalf of the company, one year after the formation of the company, unbeknownst to the plaintiff, the managers abandoned those efforts.  Instead, the managers worked to pay themselves close to the entirety of the plaintiff’s investment through a combination of disclosed and undisclosed payments in the form of salary and purported “loans” to entities that (at least in one instance) had undisclosed affiliations with the managers, ultimately leaving the company with a few thousand dollars in its account. 

The Court of Chancery found that plaintiff’s claim for fraudulent inducement failed as there was evidence that the managers were, at least in the beginning, actively working to negotiate the acquisition of ViaStone.  The Court also found that salary payments to one of the managers—but not the other—had been properly disclosed and approved by the plaintiff.  But the Court found in favor of the plaintiff on the core contractual and fiduciary claims.  The Court held that the managers’ self-dealing conduct constituted a breach of the operating agreement and a breach of the managers’ duty of loyalty and that their deceitful attempts to have the payments to themselves categorized as “loans” constituted fraudulent concealment of their misconduct.  Plaintiff was awarded over $2 million in damages in connection with the successful prosecution of its claims.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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