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Robert M. CONDON and CKC Partners, LLC, Appellants v. Alpesh KADAKIA; Ruchir Kadakia; Jeff Hodgson; Manticore Fuels LLC; and Gladieux Energy LLC, Appellees
For a member to sue derivatively on behalf of a Delaware LLC, the member must either make a demand that the LLC pursue litigation or meet a heightened pleading standard showing with particularity that such a demand would have been futile. Properly pleading demand futility is a difficult burden, which is not satisfied by conclusory statements or mere notice pleading.
In today's case, an individual seeks to sue derivatively on a Delaware LLC's behalf (and purportedly on his own behalf), alleging that his business associate and others wrongfully usurped corporate opportunities. According to appellant Robert Condon, appellees’ actions violated a royalty agreement between several parties and enriched the business associate at the LLC's expense. Condon alleged that his business associate's actions breached the LLC agreement and the business associate's fiduciary duties. Condon did not make a pre-litigation demand on the LLC, but instead pleaded that demand would have been futile.
Appellees filed special exceptions, asserting in relevant part that all of Condon's claims were derivative in nature and that he failed to sufficiently plead demand futility as required by Delaware law. The trial court granted the appellees’ special exceptions and dismissed Condon's claims without prejudice.
Condon appeals, arguing that he properly pleaded demand futility for his derivative claims and that his direct claims were subject only to Texas's fair notice pleading standards, which he met. After thorough review of the record, we hold that Condon's claims are all derivative in nature and that he failed to overcome the heightened pleading burden required to show demand futility under Delaware law. Accordingly, we overrule Condon's issues and affirm the trial court's order dismissing his claims.
CKC Partners, LLC is a Delaware limited liability company that Condon and appellee Alpesh Kadakia formed to invest in startup opportunities. CKC has two voting members—Condon and Alpesh,1 who also serve as CKC's only managers. CKC is governed by a company agreement (the “CKC Agreement”).2
Condon is the plaintiff below, and we summarize the following facts from his live pleading. CKC, appellee Manticore Fuels LLC, and appellee Gladieux Energy LLC, are parties to a contract (the “Royalty Agreement”) under which Manticore distributed diesel fuel supplied by Gladieux to meet the fueling needs for drilling and completion of oil wells in the Permian Basin. Manticore is a Texas company, and Alpesh served as its president. Gladieux is an Indiana company allegedly owned and operated by Alpesh and appellees Ruchir Kadakia (Alpesh's brother) and Jeff Hodgson.3
Condon “sponsored” the start-up of the Manticore business and then brought the Manticore opportunity to CKC. Condon provided $500,000 to CKC, which was then invested in Manticore. In September 2018, Alpesh contributed additional funds to CKC to support Manticore, but the petition does not state the amount provided by Alpesh. Manticore quickly began generating a “gross profit margin of over 20%.” Condon and the other defendants signed Memorandums of Understanding to document their “partnership,” agreeing that “each would own Manticore Fuels.” Later, however, “Gladieux and the Defendants began a pattern of renegotiating or reneging on their obligations” to Manticore. Gladieux told Condon that he could not own Manticore if they wanted to use financing through Gladieux's credit facility, which was a stipulated in-kind contribution that Gladieux was required to make in exchange for Condon's equity interest in the partnership. Alpesh, Ruchir, and Hodgson represented that using Gladieux's credit facility was the only feasible way to make Manticore profitable and doing so required Gladieux to own 100% of Manticore. Under pressure and facing the others’ threatened withdrawal from the venture, Condon and CKC “relinquished equity ownership in Manticore” to Gladieux.
These events led to CKC, Manticore, and Gladieux executing the Royalty Agreement in July 2018.4 Section 5 of the Royalty Agreement established three Manticore payment obligations:
• § 5(a): “Performance and Success” fees for the six-month period July 1 - December 31, 2018, if Manticore increased its sales to a specific customer, ProPetro.
• § 5(b): Monthly commission/royalty payments based on a third-party published indexed price of diesel fuel (the “rack rate”).
• § 5(c): Reimbursement to CKC of $190,000 for all investment management services, paid on or before July 20, 2018.
Section 7 established a single Gladieux payment obligation:
• § 7(a): A “Change of Control” payment of “20% of the consideration paid for the Equity Interest” of Manticore or net assets received, less 20% of any broker fees and customary transaction expenses, if any.
The Royalty Agreement also prohibited Manticore and Gladieux from engaging in actions or transactions that would directly compete with the services Manticore was providing. Specifically, Gladieux and Manticore agreed that
they shall not circumvent, avoid or bypass CKC, directly or indirectly, to avoid payment of Commission and Fees as defined in Section 5 herein. [Gladieux and Manticore] further agree that they will not take any action, or enter into transaction, that would result in the formation of a business that would directly compete with the comprehensive Frack Fleet Fueling Business, as referred to as the last mile services, of Manticore Fuels, LLC; provided, however, that it is acknowledged that Gladieux Energy is a private equity firm that may acquire new businesses in the future and it will not be a violation of this Section 1 if any such acquired business conducts operations that would otherwise constitute a part of the Frack Fleet Fueling Business if such activities do not constitute more than 20% of the acquired business’[s] gross revenue. For the avoidance of doubt, it is understood by all Parties that the Gladieux Companies have been, are currently involved in and intend to continue to trade, market and distribute fuel throughout the United States, including the Permian basin located in West Texas, which is not and shall not be considered a violation of this Section 1.
Manticore paid royalties to CKC in 2018, but the amount of royalties declined in 2019. According to Condon, the defendants began “circumventing” the Royalty Agreement by engaging in acts that reduced the amount payable by Manticore to CKC under the agreement. Condon alleged that Alpesh, Manticore's president, did not cause Manticore and Gladieux to maintain separate accounting records, which enabled Alpesh to hide certain charges and margins by Gladieux. Further, Manticore is alleged to have altered its pricing structure to unbundle fuel from other services. Fuel, the only item on which royalties are based, was “deeply discounted and sold separate and apart from the other services.” Condon asserted that the defendants were having Manticore sell fuel at a low price in order to create a higher margin on all other “last mile services” for themselves. In 2020, the royalty payments stopped altogether.
Also, under the Royalty Agreement, Manticore engaged CKC to provide “executive, managerial and leadership” services. Although Manticore is alleged to have paid CKC $15,000 per month from July to December of 2018 for these services, those payments stopped in January 2019 after Alpesh began taking a $500,000 annual salary from Manticore.5 Additionally, CKC had three employees working on Manticore's projects, for which Manticore was paying CKC,6 but Alpesh told Condon that CKC no longer needed them, and Condon agreed that they could be fired. Manticore then hired the employees directly, allegedly taking away profits for CKC.
Condon asserted that another development contributed to Manticore's failure to pay amounts owed under the Royalty Agreement, thus harming CKC's business interests. Alpesh in 2019 secretly created a new entity, Permian Global, Inc. d/b/a Core Automated Fueling Solutions (“CORE”), which competed directly with Manticore and effectively siphoned away all of Manticore's business and services. CORE's ownership is not alleged in the pleadings, but Condon asserted that Alpesh was its only director. According to Condon,
instead of promoting Manticore Fuels’ fueling services to existing and potential customers, Alpesh is promoting and selling CORE's automated fueling equipment and services to the same customers. The direct result of Alpesh's actions are that he has transferred the lucrative last mile services that Manticore Fuels was providing to Alpesh's entity, CORE. Alpesh's actions have devalued the value of Manticore Fuels by reducing Manticore Fuels’ margins, but enriched Alpesh's CORE entity by the same or greater amounts. Alpesh neither fully informed, nor sought consent from Condon in accordance with the CKC Company Agreement for these actions that harm CKC Partners’ financial interests under the Royalty Agreement.
In August 2019, Alpesh told Condon that Manticore was worth at least $15 million. However, shortly thereafter, the defendants began telling Condon that Manticore could not “continue to operate as a wholly-owned subsidiary of Gladieux.” Hodgson emailed CKC in November telling CKC that it needed to invest $1.2 million to own twenty percent of Manticore, but he gave CKC only three days to make this “significant decision.” Alpesh called a special meeting of CKC's members, where this investment was discussed.
After the special meeting, Condon and Alpesh agreed to request additional information and time to evaluate the potential $1.2 million investment in Manticore. However, the other parties “had no interest in this request” and gave CKC an ultimatum on November 26, 2019 to either fund the $1.2 million by December 2 and receive a twenty percent interest in the newly formed holding company for Manticore; (2) accept a $200,000 termination fee under the terms of the Royalty Agreement in exchange for a full release; or (3) do nothing and receive nothing. Alpesh did not tell Condon that Alpesh would be part of the newly formed holding company or that he would be receiving a $600,000 annual salary for his work with this company. CKC's response to the investment request is unclear from the pleadings, but Condon contends that in March 2020 the defendants sold Manticore “for nothing” to a holding company the defendants controlled.
Condon filed suit on December 7, 2019, alleging both direct and derivative claims on CKC's behalf. Prior to filing suit, Condon made no demand on Alpesh, CKC's other manager, to authorize CKC to assert the claims. Condon amended his petition in May 2020, after Hodgson, Manticore, and Gladieux filed an answer and plea to the jurisdiction. Appellees (Alpesh individually with his own counsel and Ruchir, Hodgson, Manticore, and Gladieux jointly with their own counsel) challenged Condon's first amended petition by special exceptions, which the court sustained. The trial court gave Condon ten days to amend, and Condon timely filed his second amended petition. In that pleading, Condon asserted the following claims:
(1) a derivative claim on CKC's behalf against Gladieux and Manticore for breach of the Royalty Agreement;
(2) a direct and derivative claim against Alpesh for breach of the CKC Agreement by:
(a) disclosing confidential information,
(b) breaching his duty of loyalty to CKC, and
(c) assigning CKC's “property”—the Manticore business opportunity—without Condon's approval and for a purpose not benefitting CKC;
(3) a direct and derivative claim against Alpesh for breach of the duties of loyalty and care by:
(a) aligning with others in contravention of the interests of CKC,
(b) sharing CKC's confidential information, and
(c) various other actions; and
(4) a derivative claim for “aiding and abetting and knowing participation in breach of fiduciary duty” by Ruchir, Hodgson, and Gladieux.
Appellees filed various challenges to Condon's second amended petition, including special exceptions. Ruchir, Hodgson, Manticore, and Gladieux (collectively, the “Gladieux Defendants”) contended that: (1) Condon failed to make a demand on Alpesh to authorize CKC to assert the claims and failed to properly plead facts demonstrating why a demand was excused as futile under Delaware law, as necessary to maintain the derivative claims against them; and (2) Condon failed to provide fair notice of his breach of contract and aiding and abetting claims. Alpesh contended that: (1) all of Condon's claims were, as a matter of law, derivative and not direct; (2) Condon failed to adequately plead demand futility with particularity under Delaware law; and (3) Condon failed to provide fair notice of his breach of contract and breach of fiduciary duty claims. The trial court sustained appellees’ special exceptions “in all respects” and dismissed Condon's claims without prejudice.
Condon now appeals the trial court's actions in granting special exceptions and dismissing the case.
CKC is a Delaware LLC, and the CKC Agreement is governed by Delaware law.7 Under Texas law, subject to exceptions inapplicable here, “[i]n a derivative proceeding brought in the right of a foreign limited liability company, the matters covered by [Subchapter J, Derivative Proceedings] are governed by the laws of the jurisdiction of the foreign limited liability company․” Tex. Bus. Orgs. Code § 101.462; cf. also Moody v. Nat'l W. Life Ins. Co., 634 S.W.3d 256, 273 (Tex. App.—Houston [1st Dist.] 2021, no pet.) (citing analogous provision applicable to foreign for-profit corporations, Bus. Orgs. Code § 21.562). The parties agree that Delaware's substantive law on derivative lawsuits controls our analysis related to Condon's claims filed derivatively on CKC's behalf. In particular, because CKC is a Delaware limited liability company, Delaware law governs the issue of the sufficiency of Condon's pleadings regarding the demand requirements if Condon's claims are derivative. See In re Helix Energy Sols. Grp., Inc., 440 S.W.3d 167, 174 (Tex. App.—Houston [14th Dist.] 2013, orig. proceeding) (citing analogous provision applicable to foreign for-profit corporations, Bus. Orgs. Code § 21.562); In re Crown Castle Int'l Corp., 247 S.W.3d 349, 354 (Tex. App.—Houston [14th Dist.] 2008, orig. proceeding).
The parties disagree, however, whether Condon has asserted direct claims in addition to derivative claims. Thus, before we address Condon's first issue regarding demand futility, we must determine whether any of his claims are direct rather than derivative in nature, and thus presumably would be subject only to Texas's fair notice pleading standard. Alpesh asserts that this question is governed by Delaware law as well. See Shirvanian v. DeFrates, 161 S.W.3d 102, 110 (Tex. App.—Houston [14th Dist.] 2004, pet. denied) (applying Delaware law to threshold question whether claims by shareholders of publicly traded corporation were derivative); MatlinPatterson Glob. Opportunities Partners L.P. v. Deutsche Bank Sec., Inc., No. 09-13-00070-CV, 2014 WL 2050237, at *4 (Tex. App.—Beaumont May 15, 2014, pet. denied) (mem. op.); Tex. Bus. Orgs. Code § 1.102 (law of the state where entity is formed governs the internal affairs of the entity). Condon does not dispute this proposition, and we apply Delaware law to determine whether Condon's claims are direct or derivative.
A. Condon's claims are derivative, not direct.
1. Applicable law
Under Delaware law, when a claimant seeks recovery for an injury to a limited liability company, that claim belongs to the company and can be brought by a member only as a derivative claim. See Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004); VGS, Inc. v. Castiel, C.A. No. 17995, 2003 WL 723285, at *11 (Del. Ch. Feb. 28, 2003) (mem. op.) (explaining that “case law governing corporate derivative suits is equally applicable to suits on behalf of an LLC”). To determine whether a claim must be asserted derivatively under Delaware law, courts consider (1) whether the company or the members suffered the harm, and (2) whether the company or the members would receive the benefit of any recovery. Shirvanian, 161 S.W.3d at 110 (citing Tooley, 845 A.2d at 1035). If the limited liability company alone, rather than the individual member, suffered the alleged harm, the company alone is entitled to recover, and the claim in question is derivative. See Feldman v. Cutaia, 951 A.2d 727, 732 (Del. 2008). But if the member suffered harm independent of any injury to the company that would entitle him to an individual recovery, the cause of action is direct. Id.
Condon's petition makes clear that his claims against Ruchir, Hodgson, Manticore, and Gladieux are derivative. Against Alpesh, however, Condon purports to bring both direct and derivative claims. In Condon's second and third issues, he contends that he provided fair notice of his direct claims against Alpesh, as well as fair notice of his claims against the Gladieux Defendants. As we discuss below, regardless of how Condon characterizes his claims against appellees in his brief, we conclude they are derivative, not direct, and are thus subject to Delaware's stringent demand-futility pleading requirements.
2. Claims against Alpesh for breach of the CKC Agreement
Condon alleged that Alpesh breached the CKC Agreement in three ways: (1) disclosing CKC's confidential information in violation of article 7; (2) failing to disclose his competitive ventures with CKC, in violation of article 6.03(b); and (3) possessing CKC's property and assigning rights in that property in violation of article 6.02(e). All these claims are derivative because they derive from contractual duties that Alpesh allegedly owed (if at all) to CKC, not to Condon. Therefore, these claims belong to CKC. Under the Tooley test discussed above, the purported harm from Alpesh's alleged breaches of the CKC Agreement would fall on CKC because it is CKC's confidential information, CKC's property, and Alpesh's duty of loyalty allegedly owed to CKC that are at issue. See Shirvanian, 161 S.W.3d at 110 (citing Tooley, 845 A.2d at 1035). Any remedy for these breaches would accrue to CKC, and Condon cannot demonstrate that any duty breached was owed to him or that he can prevail on any of these claims without showing an injury to CKC. See id.; see also Feldman, 951 A.2d at 732; Clifford Paper, Inc. v. WPP Investors, LLC, C.A. No. 2020-0448-JRS, 2021 WL 2211694, at *8 (Del. Ch. June 1, 2021) (mem. op.) (“Where, as here, one of two members brings a claim that the other member has depleted company assets, that claim is and remains derivative.”).
Condon urges that his claims are direct, rather than derivative, because he would be entitled to indemnification under the CKC Agreement. The agreement's indemnification provision states:
To the fullest extent permitted by law, each Member shall indemnify the Company, each Manager and each other Member and hold them harmless from and against all losses, costs, liabilities, damages, and expenses (including, without limitation, cost of suit and attorney's fees) they may incur on account of any breach by that Member of this Agreement.
Regardless of this provision, however, and as this court explained in Shirvanian, the relevant question in determining whether a claim is direct or derivative is whether the claimed direct injury is independent of any alleged injury to the company. See 161 S.W.3d at 110. When a plaintiff cannot show that the duty breached was owed to him and he cannot prevail without showing a corresponding injury to the company, then his claim is derivative. See id.; see also Clifford Paper, 2021 WL 2211694, at *10-11 (breach of company agreement claims were derivative because any recovery from the harm flowing from the breach accrues to the LLC). Condon's breach of contract claims are derivative, not direct, regardless of the indemnification provision.
3. Claims against Alpesh for breach of fiduciary duties
Condon does not expressly allege whether his breach of fiduciary duty claim is direct or derivative in his petition, but he presents this claim as both direct and derivative in his appellate briefing. But applying Tooley, this claim is also derivative.
Condon alleged that Alpesh “completely disregarded the harm that his actions would cause to CKC” and that Alpesh's misdeeds “devalued CKC Partners’ interest and royalties under the Royalty Agreement” and were taken “at the expense of CKC Partners.” He alleged that Manticore no longer paid CKC $15,000 per month, which cost CKS profits and left CKC's interest in Manticore worthless.
Like the breach of contract claims, all the alleged duties were owed to CKC and any damages flowing from these alleged actions belong to CKC. See Shirvanian, 161 S.W.3d at 110. Thus, these claims are derivative rather than direct. See id.; see also Feldman, 951 A.2d at 732; Tooley, 845 A.2d at 1033; Clifford Paper, 2021 WL 2211694, at *11 (holding that breach of fiduciary duty claims were derivative because the “harm suffered by Defendants’ disloyal postponement of a lucrative business expansion and diversion of business” from LLC to member runs first to LLC).
* * *
Because we have determined that Condon's claims are derivative, rather than direct, we overrule his second and third issues as moot and turn to his first issue concerning whether his pleading met the demand-futility test.8
B. Condon did not sufficiently plead demand futility.
1. The pre-suit demand requirement and its exception
By their nature, derivative actions encroach on the managerial discretion of directors (or managers) by seeking to deprive them of control over a company's litigation asset. See United Food & Commercial Workers Union & Participating Food Indus. Emp'rs Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1034, 1048 (Del. 2021). For a member to divest the managers’ authority and bring a derivative action on behalf of the company, the member must (1) make a demand on the company's decision-making body or (2) show that demand would be futile. See id.; see also 6 Del. C. § 18-1001 (“A member or an assignee of a limited liability company interest may bring an action in the Court of Chancery in the right of a limited liability company to recover a judgment in its favor if managers or members with authority to do so have refused to bring the action or if an effort to cause those managers or members to bring the action is not likely to succeed.”). This requirement is substantive. See Zuckerberg, 262 A.3d at 1048; see also Kamen v. Kemper Fin. Servs. Inc., 500 U.S. 90, 96, 111 S.Ct. 1711, 114 L.Ed.2d 152 (1991) (“In our view, the function of the demand doctrine in delimiting the respective powers of the individual shareholder and of directors to control corporate litigation clearly is a matter of ‘substance,’ not ‘procedure.’ ”).
The pre-suit demand requirement typically imposes little burden and it serves important functions, including promoting intra-corporate dispute resolution. For example:
it gives the directors—even interested, non-independent directors—an opportunity to consider, or reconsider, the issue in dispute. It may be their first knowledge that a decision or transaction they made or approved is being questioned, and they may choose to seek the advice of a special litigation committee of independent directors, which has become a common practice, or they may decide, as a business matter, to accede to the demand rather than risk embarrassing litigation. The futility exception essentially eliminates any chance at meaningful pre-litigation alternative dispute resolution. It also virtually assures extensive and expensive judicial wrangling over a peripheral issue that may result in preliminary determinations regarding director culpability that, after trial on the merits, turn out to be unsupportable. If a demand is made and refused, that decision, and the basis for it, can be reviewed by a court under the business judgment rule standard.
Werbowsky v. Collomb, 362 Md. 581, 766 A.2d 123, 144 (Ct. App. 2001) (footnotes omitted).
When a putative corporate plaintiff does not make a pre-suit demand, the demand-futility pleading requirement is at issue. Until recently, the Supreme Court of Delaware articulated two tests to determine whether a demand on the board of directors or managers would be futile. Zuckerberg, 262 A.3d at 1048. First, courts have used the Aronson test when the subject of litigation is the directors’ or managers’ alleged wrongful action or wrongful decision. Id. Under Aronson, the failure to make a demand may be excused when the plaintiff alleges particularized facts that create a reasonable doubt that either (1) the directors are disinterested and independent or (2) the challenged conduct was the result of a valid exercise of business judgment. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), overruled on other grounds, Brehm v. Eisner, 746 A.2d 244 (Del. 2000).
The other test—articulated in Rales v. Blasband—applies when the board or managers that would be considering the demand did not make a business decision that is challenged in the derivative suit. 634 A.2d 927, 933 (Del. 1993). In these situations, it is appropriate “to examine whether the board that would be addressing the demand can impartially consider its merits without being influenced by improper considerations.” Id. Under the Rales test, the court asks whether the particularized factual allegations “create a reasonable doubt that ․ the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” Id.
In 2021, the Supreme Court of Delaware blended the Aronson test with the Rales test and adopted a new “three-part test as the universal test for assessing whether demand should be excused as futile.” Zuckerberg, 262 A.3d at 1058. In all derivative suits, absent pre-suit demand, courts must now ask the following three questions on a director-by-director basis when evaluating allegations of demand futility: (1) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; (2) whether the director faces a substantial likelihood of liability on any claims that would be the subject of the litigation demand; or (3) whether the director lacks independence from someone who either received a material personal benefit from the alleged misconduct or faces a substantial likelihood of liability on any of the claims that are the subject of the litigation demand. See id. at 1059. The test is disjunctive, such that “[i]f the answer to any of the questions is ‘yes’ for at least half of the members of the demand board, then demand is excused as futile.” Id. “It is no longer necessary to determine whether the Aronson test or the Rales test governs a complaint's demand-futility allegations.” Id. “The purpose of the demand-futility analysis is to assess whether the board should be deprived of its decision-making authority because there is reason to doubt that the directors would be able to bring their impartial business judgment to bear on a litigation demand.” Id. The test focuses the inquiry on the decision regarding the litigation demand, rather than the decision being challenged. Id. Importantly, though Zuckerberg refined the tests adopted in Rales and Aronson, those cases and their progeny were not overruled and remain authoritative. Thus, courts may still look to pre-Zuckerberg precedent for guidance. Id.
When alleging that the failure to make a demand on a company's decision-makers should be excused as futile, a plaintiff must meet “stringent requirements of factual particularity that differ substantially from ․ permissive notice pleadings.” Zuckerberg, 262 A.3d at 1048; see also Brehm, 746 A.2d at 254; 6 Del. Code § 18-003 (“In a derivative action, the complaint shall set forth with particularity the effort, if any, of the plaintiff to secure initiation of the action by a manager or member or the reasons for not making the effort.”); Del. Ch. Ct. R. 23.1 (providing that in a derivative action, “[t]he complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort”). Conclusory statements and notice pleadings are insufficient; the plaintiff must plead particularized factual statements that are essential to the claim. Moody, 634 S.W.3d at 274. The Delaware Court of Chancery has called the pleading requirement a “high bar.” In re Tyson Foods, Inc., 919 A.2d 563, 582 (Del. Ch. 2007). And this court has noted that Delaware's heightened pleading requirement for derivative suits is substantive, and “not simply a technical rule of pleading.” In re Crown Castle Int'l Corp., 247 S.W.3d at 355. All agree that this factual particularity pleading requirement applies. In examining whether that pleading burden has been met, we are to review the allegations on a claim-by-claim basis,9 and it is a fact-intensive inquiry. See McElrath v. Kalanick, 224 A.3d 982, 990 (Del. 2020).
2. Standard of review
It is undisputed that Condon did not make a pre-suit demand; thus, the question is whether he pleaded particularized facts satisfying the requirements for demand futility. Appellees challenged the sufficiency of Condon's pleading by special exceptions. A trial court has broad discretion in ruling on special exceptions. Baylor Univ. v. Sonnichsen, 221 S.W.3d 632, 635 (Tex. 2007). Determining whether a pleading meets Delaware's demand-futility exception, however, is a question of law. See Brehm, 746 A.2d at 253. If, applying Delaware law, a trial court concludes that the petition fails to allege particularized facts sufficient to show demand futility, then the court does not abuse its discretion in sustaining the special exceptions because the court would have acted consistently with “guiding rules or principles.” Cf. Downer v. Aquamarine Operators, Inc., 701 S.W.2d 238, 241-42 (Tex. 1985) (a trial court abuses its discretion if its action is arbitrary, unreasonable, and without reference to any guiding rules or principles). “When a petition fails to satisfy the requirements for demand futility under the laws of a foreign jurisdiction, the proper remedy under Texas procedural law is to sustain the special exceptions.”10 If a trial court properly sustains special exceptions and the plaintiff refuses or fails to amend, or amends the pleading without correcting the deficiency, the trial court does not err in dismissing the case. See Connolly, 257 S.W.3d at 838.
As explained, under Delaware's derivative suit rules, a plaintiff can bypass the demand requirement if he “can allege with sufficient particularity that the demand is futile and should be excused due to a disabling conflict by a majority of the directors to consider the demand.” McElrath, 224 A.3d at 990. A plaintiff can satisfy this requirement in the context of a two-manager decision-making body by sufficiently pleading the existence of a disqualifying interest or relationship as to only one manager. See Lola Cars Int'l Ltd. v. Krohn Racing, LLC, C.A. Nos. 4479-VCN, 4886-VCN, 2009 WL 4052681, at *8 (Del. Ch. Nov. 12, 2009) (“When dealing with a two-member board of directors, this Court has previously held that a finding of interestedness on the part of one director will excuse demand on the board[.]”); Spellman v. Katz, C.A. No. 1838-VCN, 2009 WL 418302, at *5 n.44 (Del. Ch. Feb. 6, 2009) (mem. op.) (applying demand futility analysis to a two-manager LLC); e4e, Inc. v. Sircar, C.A. No. 20366-NC, 2003 WL 22455847, at *2 n.10 (Del. Ch. Oct. 9, 2003).
Because CKC has only two managers, and Alpesh is one of them, Condon can satisfy the pleading requirements of demand futility only if he has alleged with factual particularity that Alpesh: (1) received a material personal benefit from his alleged misconduct that is the subject of the litigation; (2) faces a substantial likelihood of liability on any of Condon's claims; or (3) lacks independence from someone who received a material personal benefit from the alleged misconduct or who faces a substantial likelihood of liability on any of Condon's claims. See Zuckerberg, 262 A.3d at 1059.
In today's case, Condon agrees that he must meet the demand-futility pleading requirements as to his derivative claims, and, asserting that he has done so, he focuses his demand-futility argument only on the first Zuckerberg prong—that Alpesh received a material personal benefit from the alleged misconduct that is the subject of the litigation. Condon says that Zuckerberg’s first prong is the only one implicated by this case because that prong applies to allegations of manager self-dealing and Alpesh has enriched himself through his self-dealing, against CKC's interests and to its detriment. For this reason, Condon claims Alpesh is interested and cannot be considered an appropriate person to have considered a demand by Condon to sue the defendants.
Appellees agree that Zuckerberg’s first prong applies to allegations of manager self-dealing but disagree that Condon's pleading describes self-dealing by Alpesh. According to appellees, Zuckerberg’s second prong applies because Condon complains of actions taken by Alpesh outside of his role as a CKC manager or member.
We need not resolve this disagreement. Because Condon has explicitly limited his argument to Zuckerberg’s first prong, we accordingly constrain our analysis to whether Condon has alleged with factual particularity that Alpesh received a material personal benefit from his alleged misconduct that is the subject of the litigation. See Liles v. Contreras, 547 S.W.3d 280, 296 (Tex. App.—San Antonio 2018, pet. denied) (“In civil cases, we have no discretion to consider an issue not raised in appellant's brief, even if the court may perceive that the ends of justice seem to require it.”). We need not and do not address whether Condon's allegations meet Zuckerberg’s second or third prongs.
Zuckerberg’s first prong derives from Aronson’s first prong and focuses on whether directors had a personal interest in the challenged transaction. See Zuckerberg, 262 A.3d at 1055. In Aronson, the court stated that for a director to be disinterested, he “can neither appear on both sides of a transaction nor expect to derive any personal financial benefit from it in the sense of self-dealing, as opposed to a benefit which devolves upon the corporation or all stockholders generally.” Aronson, 473 A.2d at 812. Since Aronson, Delaware courts have largely adhered to the view that, insofar as the “material personal benefit” theory of director interestedness is concerned, director “interest” exists when a director received, or stands to receive, a material personal benefit from a self-dealing transaction that is not shared by the company or shareholders generally.11 See, e.g., In re J.P. Morgan Chase & Co. S'holder Litig., 906 A.2d 808, 821 (Del. Ch. 2005), aff'd, 906 A.2d 766 (Del. 2006); Rales, 634 A.2d at 936; Orman v. Cullman, 794 A.2d 5, 25 n.50 (Del. Ch. 2002).
Delaware courts have also clarified what it means for a personal benefit to be “material.” The benefit must be of such subjective material significance to that particular manager/director that it is reasonable to question whether the manager/director objectively considered the advisability of the challenged transaction to the company or its shareholders/members. See Orman, 794 A.2d at 25 n.50; see also Inter-Mktg. Grp. USA, Inc., C.A. No. 2017-0030-TMR, 2019 WL 417849, at *4 (Del. Ch. 2019) (mem. op.). “Materiality means that the alleged benefit was significant enough ‘in the context of the director's economic circumstances, as to have made it improbable that the director could perform her fiduciary duties to the ․ shareholders without being influenced by her overriding personal interest.’ ” Orman, 794 A.2d at 23 (quoting In re Gen. Motors Class H S'holders Litig., 734 A.2d 611, 617 (Del. Ch. 1999)).
Condon asserts his “standing to assert derivative claims” as follows:
43. Condon brings this claim individually and derivatively on behalf of CKC Partners. Condon brings this action on behalf of CKC Partners because Condon has made a demand to Alpesh – the only other voting member and manager of CKC Partners – to stop sharing CKC's confidential information, yet Alpesh continues to do so. Further, CKC is in a deadlock and any further demand upon Alpesh to bring claims on behalf of CKC against the other Defendants, which include an entity owned by Alpesh, Alpesh's brother, and Alpesh's business partners in businesses that compete with CKC Partners will not succeed. This is so because Condon and Alpesh are co-members, co-officers, and co-managers in CKC Partners, yet Alpesh is not a disinterested manager of CKC Partners. Alpesh is not disinterested because he has taken actions to enrich himself at the expense of CKC Partners.
Conclusory allegations, such as those contained in this paragraph, are not treated as expressly pleaded facts or factual inferences. Wood v. Baum, 953 A.2d 136, 140 (Del. 2008). Instead, a plaintiff must comply with the “stringent requirements of factual particularity.” Id. at 141-42; see Spellman, 2009 WL 418302, at *6 (demand futility pleading requirement not met where plaintiff, in breach of fiduciary duty suit based on defendant's refusal to participate in the refinancing of an existing mortgage, failed to include particularized facts, such as the balance on the mortgage, the interest rate differential, a reasonable estimate of potential savings, whether the interest saved would be material to the LLC, or whether any potential liability would be material to the counter-defendant; allegation that “significant” savings could be achieved was merely conclusory).
Condon additionally points to the following pleaded allegations that he insists satisfy the first Zuckerberg prong:
44. Alpesh has breached his duty of loyalty to CKC Partners by engaging in transactions with the other Defendants for his own personal benefit that circumvented the Royalty Agreement and are harming CKC Partners. As detailed in this petition, Alpesh has profited through his own breaches of fiduciary duty, breaches of the duty of care, intentional misconduct and fraud. He obtained a $500,000 salary from Manticore Fuels in 2019 and a $600,000 salary from Manticore Fuels in 2020, while supposedly working for the Permian-based entity in Palo Alto, California. Alpesh has set up a competing business, CORE, that is reducing the royalty revenues to CKC. He is further acting for his own benefit and jointly with the other Defendants to reduce fees, commissions, and royalty payments owed to CKC Partners. As Condon's allegations below demonstrate, Alpesh would not consent to this suit that:
• Challenges Alpesh's breaches of his duty of loyalty and care by enriching himself (and not CKC Partners or Condon) through the creation of CORE outside of Manticore Fuels (without the consent or participation of Condon or CKC Partners), that has taken Manticore Fuels’ last mile fuel services in violation of the Royalty Agreement and devalued CKC Partners’ interest and royalties under the Royalty Agreement;
• Challenges Alpesh's breaches of his duty of loyalty by taking a $600,000 salary in 2020 from the Manticore business that Alpesh and the other Defendants claim to Condon is defunct and worthless; and
• Challenges Alpesh's breaches of his duty of loyalty when he shared confidential communications with Condon with the other Defendants in order to force Condon out of the Manticore business and leave Condon with nothing.
45. These actions are not the product of a valid exercise of business judgment and constitute intentional misconduct and fraud. Because Alpesh has directly engaged in this wrongdoing and profited from his intentional actions, while also misrepresenting to Condon material facts, it would be futile to expect Alpesh to consent to sue Manticore and Gladieux, which Alpesh owns, for the breach of the Royalty Agreement. These are no “mere threats,” and Delaware courts have repeatedly held that when dealing with a two-member entity, such as CKC Partners, with equal voting power and control, the plaintiff need only show that one director is interested and therefore may prevent litigation in order to excuse demand on the board and allow the disinterested director to sue derivatively.
Condon's allegations continue:
• CKC Partners’ royalty payments and the value of its interests under the change in control provision were ․ reduced to zero because of Alpesh's creation of Core Automated Fueling Solutions (“CORE”) that directly competes with Manticore Fuels and takes profit margin from Manticore, which in turn, competes with and harms CKC Partners’ business interests.
• Alpesh secretly created a new entity, CORE, with the assistance of the other Defendants to provide these automated fueling services. Indeed, CORE is a d/b/a for Permian Global, Inc., in which Alpesh, who is a member, officer, and manager of CKC Partners, is the only listed director. Alpesh created CORE in 2019 while he was President of Manticore Fuels. Alpesh has set up and operates CORE at Manticore Fuels’ Midland yard and facilities, which has taken over Manticore Fuels’ yard completely in the last year Alpesh has also reassigned Manticore Fuels’ general manager ․ to work for CORE.
• At Alpesh's direction, CORE is providing services to Manticore's customers that Manticore Fuels should be providing․ [A]ll of CORE's services are “last mile services” which CORE is prohibited from providing under the Royalty Agreement. In addition to automating a service that Manticore Fuels provides, CORE's financials indicate that it is buying and selling fuel as well. Indeed, instead of Gladieux using Manticore Fuels to distribute Gladieux diesel to West Texas customers, Gladieux is using CORE.
• [I]nstead of promoting Manticore Fuels’ fueling services to existing and potential customers, Alpesh is promoting and selling CORE's automated fueling equipment and services to the same customers. The direct result of Alpesh's actions are that he has transferred the lucrative last mile services that Manticore Fuels was providing to Alpesh's entity, CORE. Alpesh's actions have devalued the value of Manticore Fuels by reducing Manticore Fuels’ margins, but enriched Alpesh's CORE entity by the same or greater amounts. Alpesh neither fully informed, nor sought consent from Condon in accordance with the CKC Company Agreement for these actions that harm CKC Partners’ financial interests under the Royalty Agreement.
• Alpesh has engaged in further actions that have harmed CKC Partners while not disclosing to CKC Partners and Condon the truth. In 2019, Alpesh received a $500,000 salary from Manticore Fuels, which is based in Midland, yet Alpesh works in Palo Alto, California. The Royalty Agreement states that CKC would provide executive, managerial, and leadership services to Manticore Fuels. From July to December of 2018, Manticore Fuels was paying CKC $15,000 per month for management services. However, in January 2019, Alpesh began taking a $500,000 salary for himself and Manticore Fuels no longer paid CKC the $15,000 per month for services. Alpesh did not obtain approval from CKC for this change under section 6.02(b) of the CKC Company Agreement. Alpesh did not tell CKC that he was earning $500,000 from Manticore Fuels and hid this fact from CKC. This was a breach of Alpesh's duty of loyalty.
• Further, CKC Partners had three employees working on Manticore Fuels’ projects for Alpesh in Palo Alto. Manticore Fuels was paying CKC for these employees’ services and earning a profit from these CKC employees’ services to Manticore Fuels. In August of 2018, Alpesh told Condon that CKC Partners no longer needed to employ these persons because Manticore Fuels did not need them. Therefore, Condon agreed to allow Alpesh to fire these employees. Yet, what Alpesh did not tell Condon is that Alpesh's plan was to re-hire these employees as direct employees of Manticore Fuels. Therefore, Alpesh was able to save Manticore Fuels money by hiring these employees directly, yet it cost CKC profits because it was no longer earning a profit on these services.
• Because Condon did not know of Alpesh's true intentions, Condon was interested in evaluating the Defendants’ proposed investment in Manticore Fuels based upon adequate financial information. Condon did not realize that the Defendants had already put a plan in place to exclude Condon from Manticore Fuels’ future success. Alpesh further lied to Condon claiming that Alpesh did not have full knowledge of Manticore Fuels’ financial position, and even denied that he was president of Manticore Fuels, despite earning a $500k salary from Manticore Fuels and despite documents indicating otherwise.
We conclude the above allegations fail to satisfy the first Zuckerberg prong. One category of misconduct alleged by Condon is the breach of the Royalty Agreement by Manticore and Gladieux. For example, Condon contends that Manticore breached the agreement by stopping royalty payments. But Condon's petition does not contain sufficient factual particularity describing how Alpesh personally benefitted from that alleged breach. On appeal, Condon places the most emphasis on the allegation that Alpesh received a $500,000 salary from Manticore in 2019. Condon says Alpesh's salary accompanied a breach of the Royalty Agreement because Manticore stopped paying $15,000 monthly to CKC for managerial services and instead paid Alpesh a salary. Yet Condon's second amended petition notably does not allege that Manticore's failure to pay a management fee from January 2019 forward breached the Royalty Agreement. As noted, the Royalty Agreement in fact imposes no obligation on Manticore to pay CKC any amount for “executive, managerial and leadership services.” Condon further contends that in accepting a salary from Manticore, Alpesh personally benefitted by breaching his duty of loyalty. But Manticore is entitled to have a president and is entitled to pay that president a salary. And Manticore was not competing with CKC. It is unclear from Condon's allegations how Manticore's payment of a salary to Alpesh constitutes a personal benefit flowing from the alleged misconduct.
Moreover, Condon has not pleaded any particularized facts showing that Alpesh's Manticore salary, assuming it was a personal benefit resulting from the alleged misconduct, was material to him. See Connolly, 257 S.W.3d at 845-46 (explaining that plaintiffs “failed to allege with factual particularity that the compensation received by the non-employee board members was material to each director or outside the norm”); see also In re GGP, Inc. S'holder Litig., C.A. No. 2018-0267-JRS, 2021 WL 2102326, at *17 n.195 (Del. Ch. May 25, 2021) (mem. op.) (“[I]t is black letter Delaware law that Plaintiffs must allege facts from which the Court can reasonably infer a material benefit to an interested director, i.e., an alleged benefit ‘significant enough in the context of the director's economic circumstances, as to have made it improbable that the director could perform her fiduciary duties to the ․ shareholders without being influenced by her overriding personal interest.’ ” (quoting Orman, 794 A.2d at 23)); In re Oracle Corp. Derivative Litig., C.A. No. 2017-0337-SG, 2018 WL 1381331, at *18 (Del. Ch. Mar. 19, 2018) (mem. op.) (“There are no allegations that the director compensation she receives from Oracle—$548,005 in 2016—is material to her. Even this lucrative compensation would form insufficient cause to doubt her impartiality.” (emphasis added)).14 Significantly, Condon does not allege that any personal benefit Alpesh has received from the alleged misconduct is of such subjective material significance to him—taking into account his overall economic circumstances—that it is reasonable to question whether he could have objectively considered a litigation demand by Condon. See Orman, 794 A.2d at 25 n.50.
Further, allegations that managers cannot be expected to sue themselves, such as those contained in the above paragraphs, are likewise insufficient to plead demand futility. E.g., Spellman, 2009 WL 418302, at *5 (“One does not satisfy Delaware's demand futility standards with the oft-employed phrase that one cannot be expected to sue himself.”); Aronson, 473 A.2d at 818. Accepting Condon's view would effectively abrogate the demand requirement. Aronson, 473 A.2d at 818.
Another category of alleged misconduct is the appellees’ competitive activity against Manticore. In particular, Condon alleged that Alpesh's creation of CORE, which essentially took Manticore's customers, violated Alpesh's duty of loyalty to CKC. As a result of the defendants’ actions, Manticore is now alleged to be worthless. Yet the petition does not explain with particularity how Alpesh—Manticore's president and part owner—materially and personally benefits from Manticore's collapse. Any material personal benefit to Alpesh resulting from the alleged competitive activities would have to come from CORE. In that regard, the allegations again fall short. Other than being its director, Alpesh's relationship with CORE is not alleged. Alpesh is not alleged to be CORE's owner, he is not alleged to have a financial interest in CORE, and he is not alleged to have received a salary from CORE. The petition contains no allegation pertaining to CORE's financial health, despite Condon's alleged possession of CORE's “financials.” The petition alleged that Alpesh “created” CORE and that “Alpesh's actions have devalued the value of Manticore Fuels by reducing Manticore Fuels’ margins, but enriched Alpesh's CORE by the same or greater amounts.” These allegations are too vague and conclusory to satisfy the factual particularity pleading requirement. Though Condon has set forth a plausible claim that CORE competed with and harmed Manticore, Condon and CKC lack standing to complain about any injury CORE caused Manticore.
Condon relies on two pre-Zuckerberg cases that he suggests are “consistent with the Zuckerberg test's first disjunctive prong” and support his position that he pleaded sufficient particular facts to meet the demand-futility test: Lola Cars International Ltd., 2009 WL 4052681, and Beneville v. York, 769 A.2d 80 (Del. Ch. 2000). Of these, Beneville is the most favorable to his position.
In Beneville, the plaintiff, Edward Beneville, derivatively on behalf of CARNET Holding Corp., sued two former CARNET directors, Michael York and Eli Dabich, for breach of their fiduciary duties to CARNET. Beneville, 769 A.2d at 81. According to Beneville's pleading, Beneville and York founded CARNET to act as an underwriter of car insurance. Id. at 82. CARNET developed an automated automobile insurance policy management software system that it planned to market to other insurance agencies for their use. Id. at 82-83. Instead of pursuing this plan, however, CARNET directors York and Dabich diverted much of the benefit of the software system to another company, SYNERGY, in which they held a majority interest. Id. at 83. York and Dabich, both CARNET board members at the time, caused CARNET to enter into a marketing agreement with a wholly owned SYNERGY subsidiary, with York executing the deal for CARNET and Dabich executing it for SYNERGY. Id. York and Dabich concealed their actions from other members of the CARNET board until after the agreement had been executed. Id. Thus, rather than being able to market and develop the software system itself, CARNET received “stock of dubious value in a non-public SYNERGY subsidiary and a royalty stream in exchange for marketing rights SYNERGY itself valued at nearly one million dollars.” Id.
Beneville had not made a litigation demand prior to filing suit and the issue was whether demand was excused. Beneville argued that York was interested in the contract between CARNET and SYNERGY and therefore could not impartially consider a demand that CARNET sue to rescind and recover damages arising from that transaction. Id. The court agreed, observing that the contract was between CARNET (where York was CEO and a director) and SYNERGY (where York was an owner and director). Id. at 84. This scenario gave rise to a “classic self-dealing interest in the Marketing Agreement” that sufficed to render York interested and disabled from impartially considering a demand.15 Id. Beneville, to the extent it properly construes Aronson, Rales, and their progeny, remains “good law.” Zuckerberg, 262 A.2d at 1059.
Although Beneville involved a self-dealing director and thus provides relevant guidance under Zuckerberg’s first prong, it is distinguishable from the present facts. Condon has not alleged that Alpesh participated in, benefitted from, or expected to benefit from, any transaction between CKC and another entity in which Alpesh had a financial interest. There is no allegation that Alpesh appeared on “both sides” of a transaction with CKC.16 Condon has not alleged that Alpesh has engaged in self-dealing with CKC, certainly not in the “classic” sense of self-dealing that Delaware courts have long considered sufficient to create a disqualifying interest in a director's ability to impartially consider a litigation demand. See Aronson, 473 A.2d at 815 (citing cases). Condon has not directed us to a case, and we have not located one, where a court has found self-dealing by a director under circumstances when: (1) the director's challenged actions are external to the company of which he serves as a director and not taken on behalf of (or in his capacity as a director of) that company, and (2) the director has interests in third parties that allegedly compete with each other, and one of those third parties has a contract with the company.17
Condon also cites Lola Cars International Ltd. There, two companies, plaintiff Lola Cars International and defendant Krohn Racing, LLC, formed a third venture, Proto-Auto, LLC, to acquire and sell certain prototype race cars. See Lola Cars Int'l Ltd., 2009 WL 4052681, at *1. Defendant John Hazell was the manager of Krohn, and Krohn appointed him as a director and CEO of Proto-Auto. Id. After the business relationship between Krohn and Lola fell apart, Lola sued Krohn and Hazell. Id. at *2. Lola alleged that Hazell breached his fiduciary duties of loyalty and care. Id. at *2. The defendants sought dismissal of these derivative complaints on the ground that Lola failed to plead demand futility with particularity as required by Delaware law. Id. at *7. In holding that Lola satisfied Delaware's particularized pleading standard, the court explained:
Without delving into the facts of the First Complaint, it should be emphasized that it pleads with particularity Hazell's failure to maintain appropriate inventory levels, pay state taxes in a timely fashion, and perhaps most importantly, his use of Proto-Auto assets for Krohn's benefit in violation of his duty of loyalty. In fact, Lola details with specificity the amount of profits lost in parts and inventory that it contends Hazell undersold or allowed Krohn to misappropriate.
Id. Although the opinion does not detail all the particularized facts contained in Lola's pleading,18 it makes clear that Lola pleaded with specificity. For example, the opinion states that Lola alleged that, “due to Hazell's mismanagement and fiduciary violations, Proto-Auto sustained approximately $2.2 million in losses from the time of its inception until January 2009.” Id. at *2. Additionally, the opinion notes that Lola alleged that Proto-Auto “is now insolvent as its total liabilities exceed its total assets by more than $2 million.” Id. at *2.
Lola is even further removed from the present case than Beneville. The Lola court's holding that Hazell was an interested director was based on the court's conclusion that he faced a substantial likelihood of liability on the claims. See id. at *8. This rationale pertains to Zuckerberg’s second prong, when Condon relies only on Zuckerberg’s first prong.
Further, none of the details present in Lola or Beneville are present in today's case. Instead, Condon asserts in a conclusory manner that Alpesh's actions have reduced both the royalty payments that CKC was to receive from Manticore and the value of CKC's interest in Manticore, without providing any particularized facts showing what Manticore's royalty payments were or what its valuation was before Alpesh allegedly took these actions. In fact, he has not provided any details regarding the ownership interest, if any, that CKC allegedly had in Manticore. See Genworth Fin. Inc. v. Consol. Derivative Litig., C.A. No. 11901-VCS, 2021 WL 4452338, at *12 (Del. Ch. Sept. 29, 2021) (mem. op.) (reiterating that conclusory allegations not supported by allegations of specific fact may not be taken as true when evaluating demand futility). Delaware courts routinely reject a plaintiff's “invitation to play inferential hopscotch” when considering whether the plaintiff has met the “stringent requirements of factual particularity.” See Horman v. Abney, C.A. No. 12290-VCS, 2017 WL 242571, at *12 (Del. Ch. Jan. 19, 2017) (mem. op.).
Finally, Condon contends that Alpesh violated the CKC Agreement and his fiduciary duties by disclosing CKC's confidential information to Ruchir and Hodgson, and by “assign[ing] away CKC Partners’ financial interest under the Royalty Agreement.” The petition, however, does not describe with any factual particularity the content of any alleged confidential information that was shared, when it was shared, to whom, and how Alpesh received a material personal benefit. The allegations are also conclusory as to Alpesh's supposed “assignment” of CKC rights. The petition contains no identification of any assignment executed by Alpesh.
Properly pleading that demand should be excused because it would be futile is a difficult task. See Zuckerberg, 262 A.3d at 1049 (explaining that “the demand requirement is not excused lightly because derivative litigation upsets the balance of power” between directors (here, managers) and shareholders (here, members)); DiBattista v. Greco, No. 20-590-RGA, 2021 WL 327399, at * 5 (D. Del. Jan. 31, 2021); In re Oracle Corp., 2018 WL 1381331, at *1 (noting that it is an “unusual case where the plaintiff can plead specific facts” sufficient to excuse demand because “directors are generally in the best position to determine if pursuit of litigation is in the corporate interest”); cf. Moody, 634 S.W.3d at 274. Although Condon weaves a lengthy story of opportunities allegedly stolen from Manticore that had a rather nebulous impact on CKC and that he suggests benefited Alpesh, Condon simply has not pleaded the particular facts necessary to show that pre-suit demand would have been futile. Cf. Marchand v. Barnhill, 212 A.3d 805, 818-19 (Del. 2019) (explaining that particularized facts showing the close personal ties between company CEO and director “support a reasonable inference that there are very warm and thick personal ties of respect, loyalty, and affection between [the director] and the [CEO's] family, which creates a reasonable doubt that [director] could have impartially decided whether to sue [CEO] and his subordinate [VP of operations]”); Lola Cars Int'l Ltd., 2009 WL 4052681, at *8.
We hold, on this record, that Condon has failed to allege with factual particularity that Alpesh received a material personal benefit from the alleged misconduct and thus Condon cannot prevail under Zuckerberg’s first prong. See Brick, 351 S.W.3d at 604; Connolly, 257 S.W.3d at 840; see also Zuckerberg, 262 A.3d at 1059-64; Horman, 2017 WL 242571, at *12. Accordingly, the trial court did not abuse its discretion by granting appellees’ special exceptions and dismissing Condon's claims. We overrule Condon's first issue.
We affirm the trial court's order dismissing Condon's claims against appellees.
Because the Majority conflates Delaware pleadings standards of “particularized facts” and “materiality” as required in challenging director independence with the standards required to establish interested director status (a director with self-dealing conflict) it places a burden not anticipated or required under applicable Delaware Law. Because Appellants’ pleadings allege credible facts sufficient to support personal benefit from the alleged misconduct the subject of the litigation demand, I would hold the pleadings meet part one of the Zuckerberg three-part “universal test.” Accordingly, I conclude Appellants have plead with particularity sufficient factual allegations to support the proposition Appellees’ business judgment, as related to the litigation demand, was compromised to the point that demand upon Appellee, Alpesh Kadakia was futile. Therefore, I would reverse the judgment of the trial court and remand for further proceedings. Because the majority does not do so, I respectfully dissent.
Delaware law is well developed in the area of corporate governance. For this reason, many large organizations, particularly those with many officers and directors choose to incorporate in Delaware. Delaware law establishes that directors 1 are generally in the best position to determine if pursuit of litigation is in the corporate interest. “[T]he ‘cardinal precept’ of Delaware law [is] that independent and disinterested directors are generally in the best position to manage a corporation's affairs, including whether the corporation should exercise its legal rights.” United Food & Commercial Workers Union & Participating Food Indus. Employers Tri-State Pension Fund v. Zuckerberg, 262 A.3d 1034, 1056 (Del. 2021).
Directors, not shareholders should control corporate assets. “A court must be wary of permitting stockholders, rather than directors, to control litigation assets of the company.” In re Oracle Corp. Derivative Litig., No. CV 2017-0337-SG, 2018 WL 1381331, at *1 (Del. Ch. Mar. 19, 2018) (mem. op.).
Delaware law creates a demand requirement on shareholders prior to initiation of a shareholders’ derivative action. Del. Ch. Ct. R. 23.1. (“The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff's failure to obtain the action or for not making the effort.”). Demand is a substantive requirement tied to protections from strike suits. Zuckerberg, 262 A.3d at 1047.“The demand requirement is a substantive requirement that “ ‘[e]nsure[s] that a stockholder exhausts his intracorporate remedies,’ ‘provide[s] a safeguard against strike suits,’ and ‘assure[s] that the stockholder affords the corporation the opportunity to address an alleged wrong without litigation and to control any litigation which does occur.’ ” Id. (first quoting Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984), overruled on other grounds by Brehm v. Eisner, 746 A.2d 244 (Del. 2000) and then quoting Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 730 (Del. 1988)).
Demand is excused where it would be futile. Delaware Law recognizes at least three circumstances in which demand is futile. Self-interest, lack of independence and/or potential liability are all bases upon which demand is excused.
Where, however, the directors are disabled (by self-interest, lack of independence, or potential liability in the action itself) from acting in the corporate interest, derivative litigation can be value-adding to the corporation, and may be the only way the litigation asset can be usefully employed. In the unusual case where the plaintiff can plead specific facts leading to a reasonable doubt that the directors are able to exercise business judgment, therefore, demand is excused under Rule 23.1, and the litigation (to the extent the complaint otherwise states a claim) may proceed derivatively.
In re Oracle, 2018 WL 1381331, at *1 (emphasis added).
The Majority cites to the Zuckerberg opinion as if this is a redefining of demand futility; it is not. The Zuckerberg opinion reviews the history of demand futility and the nuances of what conflict is required in a demand case. It reviews the two primary cases, Aronson, 473 A.2d at 811 and Rales v. Blasband, 634 A.2d 927 (Del. 1993), but concludes by adopting a three-part test. “Blending the Aronson test with the Rales test is appropriate because “both ‘address the same question of whether the board can exercise its business judgment on the corporat[ion]’s behalf’ in considering demand”; and the refined test does not change the result of demand-futility analysis.” Zuckerberg, 262 A.3d at 1058 (emphasis added). The Zuckerberg opinion continues, “The purpose of the demand-futility analysis is to assess whether the board should be deprived of its decision-making authority because there is reason to doubt that the directors would be able to bring their impartial business judgment to bear on a litigation demand.” Id. at 1059.
The Delaware Supreme Court adopted a universal three-part test to determine if demand is futile under Delaware law. “This Court adopts the Court of Chancery's three-part test as the universal test for assessing whether demand should be excused as futile.” Id. at 1058. The three-part test was enumerated as follows: (i) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand; (ii) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and (iii) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand. Id. at 1059.
In this case, the Appellants cite to Zuckerberg prong one (self-interest) as the basis of demand futility. We therefore limit our analysis solely to prong one.
When directors are independent and non-interested in the transaction the “particularized facts” must establish either liability or influence that overcomes the presumption of their respective independent business judgment.
The majority of Delaware Supreme Court cases discussing “demand futility” address “particularized facts” as required to overcome either “business judgment” or a subset, director independence from a controlling director.2 In either case, “The business judgment rule is a presumption that in making a business decision, not involving self-interest, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Spiegel v. Buntrock, 571 A.2d 767, 774 (Del. 1990) citing Grobow v. Perot, 539 A.2d 180, 187 (Del. 1988) overruled on other grounds by Brehm, 746 A.2d at 244 and Aronson, 473 A.2d at 812 (emphasis added). As noted, this presumption is not applicable to allegations of self-dealing. “The protections of the business judgment rule can only be invoked by disinterested directors.” Spiegel, 571 A.2d at 774 n.14.
Where, as here, there is an interested director, the presumption of the business judgment rule is inapplicable. “Certainly, if this is an ‘interested’ director transaction, such that the business judgment rule is inapplicable to the board majority approving the transaction, then the inquiry ceases. In that event futility of demand has been established by any objective or subjective standard.” Aronson, 473 A.2d at 815 overruled on other grounds by Brehm, 746 A.2d at 244.
In directly conflicted director status, “[t]he Court should draw all reasonable inferences in the plaintiff's favor” Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1048 (Del. 2004) (emphasis in original). Zuckerberg's three-part test incorporates Aronson's first prong. “In order to satisfy Aronson's first prong involving director disinterest, see Aronson, 473 A.2d at 812, plaintiffs must plead particularized facts demonstrating either a financial interest or entrenchment on the part of the [ ] directors.” Grobow, 539 A.2d at 188 overruled on other grounds by Brehm, 746 A.2d at 244.
“The first prong of Aronson focuses on whether the directors had a personal interest in the challenged transaction (i.e., a personal financial benefit from the challenged transaction that is not equally shared by the stockholders). This is a different consideration than whether the directors face a substantial likelihood of liability for approving the challenged transaction, even if they received nothing personal from the challenged transaction.” Zuckerberg, 262 A.3d at 1055.
Appellants’ Pleadings Allege Self-dealing
The active pleading in the trial court alleged Appellees breached contractual and tort duties by Appellee, Alpesh Kadakia, as manager of a limited liability company, and by third parties owned or associated with Alpesh Kadakia or his children. Specifically, Appellants provided detailed factual allegations describing, with sufficient particularity, Appellees’ self-dealing and participation in transactions in which Kadakia received a direct personal benefit at the detriment of the business and Appellants. These pleadings raise issues of self-dealing between CKC and various other entities to which Alpesh Kadakia was associated.
Appellants’ pleadings below are more than sufficient to raise a question as to the business judgment of Appellee, Alpesh Kadakia. As stated in another Delaware case dealing with similar issues, the Delaware court wrote:
These allegations support a reasonable inference that [interested director] planned the [ ] acquisition to benefit himself at the expense of [ ] other stockholders. Not only did he stand on both sides of the transaction; he also directed [others] to manipulate the [ ] process so that he could monetize his investment ․. [Interested director's] plan succeeded. While [interested director] recused himself from the Special Committee's deliberations and the final vote on the transaction, that does not mean the Complaint fails to support a reasonable inference that he acted disloyally toward [company]. Thus, the Complaint states a claim for breach of the duty of loyalty against [interested director], and I decline to dismiss him from the litigation at this stage.
In re Oracle, 2018 WL 1381331, at *21.
I conclude Appellants’ pleadings allege both self-dealing and personal financial enrichment on the part of the Appellee, Alpesh Kadakia. I would hold that Appellants’ pleadings are sufficient to support the proposition Appellee Alpesh Kadakia's business judgment, as related to the litigation demand was compromised to the point that demand upon Appellee Alpesh Kadakia was futile. Therefore, I would reverse the judgment of the trial court and remand for trial on the merits.
1. Condon and Alpesh each hold 45% of CKC's “class A” membership interests; Tammie Milum is a non-voting member who holds the remaining 10% “class B” interest.
2. Because the CKC Agreement is attached to Condon's petition, we include it in our review of the special exceptions ruling. See Tex. R. Civ. P. 59 (documents attached and referred to in a pleading are deemed part of the pleading “for all purposes”); Anderson-Dunham, Inc. v. Lee Rubber & Tire Corp., 378 S.W.2d 99, 102 (Tex. App.—Dallas 1964, writ ref'd n.r.e.).
3. Appellees assert on appeal that Hodgson died on November 7, 2020, before the trial court signed the order dismissing the claims against appellees on December 11, 2020, and thus they assert that any judgment against him would be “void.” However, they have not filed a suggestion of death. See Tex. R. Civ. P. 152. “[W]hen a defendant dies, the trial court loses personal jurisdiction over the deceased defendant, not subject-matter jurisdiction over the case.” In re Coats, 580 S.W.3d 431, 436 (Tex. App.—Texarkana 2019, orig. proceeding). The proper remedy upon the filing of a suggestion of death is substitution of the decedent's administrator, executor, or heir. See Tex. R. Civ. P. 152; In re Coats, 580 S.W.3d at 436. Because appellees did not file a suggestion of death in the trial court, however, nothing indicates that Condon was aware of Hodgson's death. Thus, he was not required to seek a writ of scire facias. Under these circumstances, we proceed to decide this appeal as if all parties were alive. See Tex. R. App. P. 7.1(a).
4. The Royalty Agreement is also attached to Condon's petition.
5. The Royalty Agreement contains no payment obligation associated with CKC's provision of “executive, managerial and leadership” services.
6. Any obligation of Manticore to pay CKC for use of its employees is not contained in the Royalty Agreement.
7. The agreement states that it “is governed by and shall be construed in accordance with the law of the State of Delaware.”
8. Appellees ask us to reject Condon's demand-futility arguments for the independent reason that the CKC Agreement bars derivative claims. We need not address this argument given our disposition. See Tex. R. App. P. 47.1.
9. In re Vaxart, Inc. Stockholder Litigation, Consol. C.A. No. 2020-0767-PAF, 2021 WL 5858696, at *14-15 (Del. Ch. Nov. 30, 2021) (mem. op.).
10. Connolly v. Gasmire, 257 S.W.3d 831, 839 (Tex. App.—Dallas 2008, no pet.); see also City of Warren Police & Fire Ret. Sys. v. Tenet Healthcare Corp., No. 05-19-00260-CV, 2020 WL 5757197, at *8 (Tex. App.—Dallas Sept. 28, 2020, no pet.) (mem. op.) (affirming granting of special exceptions and dismissal of derivative suit for failure to adequately plead demand futility); In re Brick, 351 S.W.3d 601, 607-08 (Tex. App.—Dallas 2011, orig. proceeding) (granting writ of mandamus ordering trial court to vacate its order denying relators’ demand-futility special exception and render an order granting the special exception); In re Denbury Res., Inc., No. 05-09-01206-CV, 2009 WL 4263850, at *2 (Tex. App.—Dallas Dec. 1, 2009, orig. proceeding) (mem. op.) (same); cf. In re Crown Castle Int'l Corp., 247 S.W.3d at 355 (granting mandamus when trial court erroneously “order[ed] [the defendant] to respond to discovery before the shareholders ha[d] met Delaware's heightened pleading requirement for demand futility”).
11. This consideration is distinct from Zuckerberg’s second prong, which focuses on whether the director faces a substantial risk of liability for engaging in the conduct that the derivative claim challenges, even if he did not actually receive or stand to receive any benefit from the transaction or conduct. See Zuckerberg, 262 A.3d at 1055, 1057; Rales, 634 A.2d at 936. Condon has clearly disavowed any attempt to rely on Zuckerberg’s second prong.
12. Although Condon mentions “demand” here, Condon acknowledges that he did not demand that CKC file this lawsuit before he filed his derivative suit.
13. Although Condon mentions the word “fraud,” he does not assert a fraud claim against Alpesh. See Wood, 953 A.2d at 141.
14. Oracle cites to another Delaware case, Robotti & Co., LLC v. Liddell, C.A. No. 3128-VCN, 2010 WL 157474, at *15 (Del. Ch. Jan. 14, 2010) (mem. op.), for the proposition that “director compensation alone cannot create a reasonable basis to doubt a director's impartiality.”
15. At the time of the lawsuit's filing, York and another “concededly disinterested, independent director” were CARNET's only two board members; Dabich had left the CARNET board before suit was filed. Id. at 82.
16. To be sure, Alpesh was on all sides of the Royalty Agreement because, according to the petition, he was a manager of CKC, an officer and part owner of Manticore, and a part owner of Gladieux. But Condon is not challenging any aspect of the Royalty Agreement transaction. Condon wants the Royalty Agreement to be enforced; he is not seeking to rescind it or claiming CKC was damaged by its execution.
17. In e4e, Inc. v. Sircar, a corporate parent brought a derivative suit on its subsidiary's behalf, alleging that one of the subsidiary's directors set up a “competing venture” and sought to persuade some subsidiary employees to join. 2003 WL 22455847, at *1. While not directly on point, Sircar involves allegations in a similar vein to those alleged by Condon. The court in Sircar held that demand was futile, but on the grounds that the defendant directors faced a “substantial risk of liability” or lacked independence. Id. at *2. Thus, the court's analysis pertains to Zuckerberg’s second and third prongs, which Condon has not invoked.
18. For example, the opinion quotes the following specific facts contained in the petition: “From its inception through February 2, 2009, the company realized gross profits of only $120,736 on part sales to Krohn of $1,450,076 ․ [when] it should have realized gross profits of $715,799 on sale of parts.” Id. at *2 n.9.
1. As used herein, the term “directors” is used to represent an organization's decision-making authority, regardless of the actual organizational structure. It applies similarly to managers/members of an LLC, or partners of an LLP.
2. At the time of this opinion, twenty-eight Delaware Supreme Court cases addressed “particularized facts” in the same sentence as demand futility. In all of these cases the analysis considers a plurality of directors and most relate to either business judgment or director independence, either to the board as a whole, or to “other” directors improperly influenced by a controlling director. Only one case, Heineman v. Datapoint Corp., 611 A.2d 950, 954 (Del. 1992), overruled on other grounds by Brehm, 746 A.2d at 244, relates to self-dealing, finding, “Dismissal of this claim for failure to make demand represents a too stringent application of the standards governing demand and, in our view, constitutes an abuse of discretion.” Id.
Kevin Jewell, Justice
(Zimmerer, J., dissenting).
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Docket No: NO. 14-21-00014-CV
Decided: January 19, 2023
Court: Court of Appeals of Texas, Houston (14th Dist.).
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