W.D.C. Holdings, LLC d/b/a Northstar Commercial Partners, et al. v. IPI Partners, LLC, et al., C.A. No. 2020-1026-JTL (Del. Ch. June 22, 2022), Laster, V.C.—The Delaware Court of Chancery’s decision in W.D.C. Holdings proves valuable to litigators, transactional attorneys, and business persons alike. While the decision reminds litigators of the procedural lens through which a court evaluates a plaintiff’s claims, it also highlights the importance of language in an operating agreement and the strategy employed by parties to exercise their contractual rights. The defendant’s strategy did not lead to a successful outcome at the initial stage of this case. Only time will tell whether the defendant will prevail in the end.
Amazon awarded Northstar Commercial Partners and several of its affiliates the right to construct nine data centers. Having obtained the award, the Northstar entities formed a joint venture with IPI Partners, LLC, named NSIPI Data Center Venture, LLC, to fund construction. The NSIPI operating agreement conferred authority upon a Northstar affiliate over the day-to-day affairs of the joint venture, while an IPI affiliate controlled the board of managers and retained the ability to terminate the Northstar affiliate’s involvement upon the occurrence of a “Cause Event.” The operating agreement defined the term “Cause Event” to include, among other things, an act or omission of gross negligence, willful misconduct, or fraud by Brian Watson, Northstar’s founder and chief executive officer, which results in material damage to NSIPI. Upon the occurrence of a Cause Event, IPI would obtain control over NSIPI and an immediate financial benefit.
Following the completion of several data centers, two Northstar employees expressed concern to IPI Partners regarding payments Northstar made to a trust established by an individual who played a role in awarding Northstar the construction contracts. The employees believed that the payments were illegal kickbacks. Soon thereafter, the Federal Bureau of Investigation executed a search warrant at Watson’s home related to the payment scheme. IPI Partners declared a Cause Event related to Watson, immediately removed the Northstar affiliate from management of NSIPI, and terminated several agreements between the Northstar affiliates and IPI Partners. IPI Partners relied exclusively upon the Cause Event provision specific to Watson for its decision. Northstar challenged IPI Partners’ determination and filed suit for breach of contract. IPI Partners moved to dismiss the complaint.
At this initial stage, the Court of Chancery is charged with evaluating the complaint in a light most favorable to Northstar in order to determine whether the plaintiff could recover “under any reasonably conceivable set of circumstances susceptible to proof.” The reasonably conceivable standard is akin to a possibility of success. In this case, Northstar concedes the existence of the payment scheme, but denies Watson’s involvement and knowledge of the scheme. Northstar argues that no Cause Event occurred, and thus, IPI Partners’ determination was invalid, because Watson could not have acted grossly negligently, willfully, or fraudulently if he lacked knowledge of the scheme. IPI Partners contends that Watson was a participant. However, at this stage of the proceeding, the court is limited to the allegations in the complaint, and it can be reasonably inferred from the pleadings that Watson was unaware of the scheme.
Alternatively, IPI Partners seeks dismissal of the complaint based on an exculpatory provision in the operating agreement, which precluded certain individuals and entities from being liable to NSIPI for any loss, damage, or claim, except through gross negligence, fraud, or willful misconduct. IPI Partners argues the existence of the payment scheme and resulting FBI investigation justified the declaration of a Cause Event and triggered the protection of the exculpatory provision. However, the complaint includes allegations that IPI Partners created a pretext to terminate Northstar’s involvement in NSIPI. The court concludes that the complaint allowed for competing inferences, which precludes the dismissal of the litigation at this initial stage. As a result, Northstar may pursue discovery in furtherance of its breach of contract claims.
The W.D.C. Holdings decision is not only a case study in the legal framework employed by the Delaware courts regarding a motion to dismiss, but also a reminder of the importance of the language in an operating agreement. The facts of this case could have allowed for a declaration of a Cause Event under other provisions of the operating agreement, but those provisions provided a 30-day right to cure. Additionally, while the FBI search was likely of great concern, the operating agreement did not allow for the removal of Northstar unless there was a guilty plea or conviction. The drafters of the operating agreement intended to use criminal proceedings as a basis for declaring a Cause Event. Had the drafters employed less stringent language, IPI Partners could have invoked this provision to justify its removal of Northstar. This possibility shows how every word counts.
IPI Partners learned of payments that Northstar made to a trust. The trust was established by an individual who purportedly played a role in the selection of Northstar to construct the data centers. In 2020, after several data centers were completed, IPI Partners became aware of Northstar’s payments to a trust established by Christian Kirchner, who had introduced Northstar to Amazon through his brother Casey. Northstar employees claimed such payments were improper kickbacks.
After such allegations of fraud, the Federal Bureau of Investigation raided Northstar founder and CEO Brian Watson’s home. Soon after the search, IPI “removed Watson and its affiliates from their roles with Joint Venture and terminated other agreements between Join Venture’s affiliates and other Northstar affiliates.” IPI argued that a “Cause Event” had occurred through Watson’s alleged negligence or fraud. Under the Joint Venture Agreement, IPI moved to dissolve the joint venture and exercise its full rights to the business without Northstar.
On the other hand, Watson and Northstar argue that there was no “Cause Event” because Watson believed that the payments to Christian Kirchner’s trust were legal commissions. Watson asserts that he never considered these payments to be fraud. In fact, Northstar claims that IPI and Amazon used the fraud allegation as a “Watson Cause Event,” committing the torts of conversion and civil conspiracy.
The court denied the motion to dismiss the breach of contract claim, holding that Northstar showed sufficient evidence to prove that no “Watson Cause Event” had occurred. It found that IPI Partners merely used the alleged fraud as a pretext to improperly remove Northstar from its rights to the business. However, the court dismissed the tort claims because there were no facts to support a tort separate from the parties’ contractual relationship.