Clifford Paper, Inc. v. WPP Investors, LLC

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

CLIFFORD PAPER, INC., )
)
Plaintiff, )
)
v. ) C.A. No. 2020-0448-JRS
)
WPP INVESTORS, LLC; EDGAR [L.] )
SMITH, JR., RICHARD A. BAPTISTE, )
)
Defendants. )

MEMORANDUM OPINION

Date Submitted: March 2, 2021
Date Decided: June 1, 2021

Samuel T. Hirzel, II, Esquire and Elizabeth A. DeFelice, Esquire of Heyman Enerio
Gattuso & Hirzel LLP, Wilmington, Delaware and Matthew M. Oliver, Esquire of
Lowenstein Sandler LLP, Roseland, New Jersey, Attorneys for Plaintiff Clifford
Paper, Inc.

Oderah C. Nwaeze, Esquire, of Faegre Drinker Biddle & Reath LLP (formerly of
Duane Morris LLP), Wilmington, Delaware, Attorney for Defendants
WPP Investors, LLC and Edgar L. Smith, Jr.

SLIGHTS, Vice Chancellor
 In 2004, Plaintiff, Clifford Paper, Inc. (“CPI”), along with Defendants, WPP

Investors, LLC (“Investors”) and its owners, Edgard L. Smith and Richard A.

Baptiste (collectively, “Defendants”), formed World Pac Paper, LLC (“WPP” or the

“Company”) to distribute paper and packaging products and provide printing,

shipping and warehousing consignment services to commercial and retail clients.

CPI and Investors owned 45% and 55% of WPP, respectively. Under the

Company’s Operating Agreement, Smith and Baptiste, along with CPI’s President,

John Clifford, were designated to oversee WPP’s operations as its managers.

Though this arrangement ran smoothly for a time, relations between the

parties soured after CPI and Clifford opposed Smith’s proposal to create a lucrative

position in WPP for his wife with responsibilities duplicating services already

performed for WPP by CPI. Undeterred, Smith and Baptiste unilaterally promoted

Smith’s wife to the position notwithstanding Clifford’s contractual right to vote on

the decision. According to Plaintiff’s Amended Verified Complaint

(the “Complaint”), that act marked the start of a concerted (and wrongful) effort by

Smith and Baptiste to divert profits away from WPP to Investors and railroad CPI

into divesting its interest in the Company. Smith and Investors have moved to

dismiss the Complaint under Chancery Rules 12(b)(6) and 23.1.

1
 At the threshold, CPI insists it has brought direct (as opposed to derivative)

claims because it has challenged wrongful acts that have denied it the right under the

Operating Agreement to vote on key decisions affecting the Company. In most

instances, the denial of the franchise will cause direct harm to the owner, but not

always. When classifying a claim as direct or derivative, Delaware courts focus not

on the nature of the wrong but the nature of the alleged harm flowing from the wrong.

Here, the harm, if any, flowing from the alleged wrongful conduct directly affected

WPP, not CPI. CPI’s claims, therefore, are derivative, not direct. Because CPI was

not a member of WPP when it brought these claims and did not, in any event, make

a demand on the WPP board to pursue the claims, or attempt to plead demand futility,

Smith and Investors’ motion to dismiss must be granted in full. My reasoning

follows.

I. BACKGROUND

I have drawn the facts from the well-pled allegations in the Complaint and

documents properly incorporated by reference or integral to that pleading.1

1
See generally Am. Verified Compl. (D.I. 18) (“Compl.”); see also Wal-Mart Stores, Inc.
v. AIG Life Ins. Co., 860 A.2d 312, 320 (Del. 2004) (noting that on a motion to dismiss,
the Court may consider documents that are “incorporated by reference” or “integral” to the
complaint).

2
For purposes of this motion, I accept as true the Complaint’s well-pled factual

allegations and draw all reasonable inferences in Plaintiff’s favor. 2

A. Parties

Plaintiff, CPI, is a Delaware corporation. 3 At all times relevant to this action,

and prior to his passing in November 2018, non-party, Clifford, served as CPI’s

President and one of WPP’s three “Managers” as defined in WPP’s Operating

Agreement. 4 CPI was at all relevant times the minority (45%) owner of WPP.5

Defendant, Investors, is an Ohio limited liability company.6 It was at all

relevant times the majority (55%) owner of CPI. 7

Defendant, Smith, served as Chairman, Chief Executive Officer and, at all

relevant times, one of three Managers of WPP. 8 Smith owns an 80% equity interest

in Investors.9

2
Savor, Inc. v. FMR Corp., 812 A.2d 894, 896–97 (Del. 2002).
3
Compl. ¶ 15.
4
Compl. ¶¶ 15, 22; D.I. 1, Ex. A (“Operating Agreement”) at 18.
5
Compl. ¶ 16.
6
Compl. ¶¶ 17–19.
7
Compl. ¶ 17.
8
Compl. ¶ 18.
9
Id.

3
 Defendant, Baptiste, served as President, Chief Operating Officer and one of

three Managers of WPP. 10 Baptiste owns a 20% equity interest in Investors. 11

Non-party, WPP, is a Delaware LLC formed by CPI and Investors on June 11,

2004, under the terms of the Operating Agreement.12 Section 7.1 allocates WPP’s

Profits and Losses to Investors and CPI in proportion to their respective ownership

interests.13

B. Investors and CPI Form WPP

In June 2004, WPP was formed by CPI and Investors as a distributor of paper

and packaging products and provider of printing, shipping and warehousing

consignment services to commercial and retail clients. 14 CPI and Investors remained

the only two Members of WPP, with Smith serving as WPP’s Chief Executive

Officer and Chairman and Baptiste serving as the Company’s President and Chief

10
Compl. ¶ 19.
11
Id.
12
Compl. ¶¶ 1, 16, 21.
13
Operating Agreement § 7.1.
14
Compl. ¶¶ 1, 16.

4
Operating Officer. 15 At all relevant times, WPP had three Managers: Smith, Baptiste

and Clifford.16

Section 8 of the Operating Agreement sets out the rights, responsibilities and

procedures related to the Company’s governance.17 Section 8.1 provides that,

“[e]xcept as otherwise provided in this Agreement, all actions by the Managers on

behalf of the Company shall require the consent of [the] majority of the Managers.”18

Section 8.3 sets out the procedure for Manager decisions relating to “Related Party

Transactions,” providing in relevant part:

If any Manager shall have an ownership, financial, or familial
relationship with any party . . . and said party desires or intends to enter
into a material contract or agreement with the Company, then such
Manager with a relationship described above shall not be permitted to
participate in a vote regarding the Company’s participation in said
contract or agreement; provided however that John Clifford shall be
permitted to so participate with respect to the Company’s relationships
with [CPI] and its affiliates.19

15
Compl. ¶¶ 12, 15, 18–19, 21; see also Operating Agreement at 20.
16
Operating Agreement at 20 (identifying Smith, Baptiste and Glen Butler as the three
Managers designated by Investors and Clifford as the Manager designated by CPI); see
also Compl. ¶ 22 (alleging that, while Butler was named as a Manager in Section 8.1(b) of
the Operating Agreement, he resigned in 2006).
17
See generally Operating Agreement § 8.1.
18
Id.
19
Id. § 8.3.

5
 The Operating Agreement does not disclaim any fiduciary duties owed by the

Managers, but Section 8.4 of the Operating Agreement exculpates Managers from

any liability “to the Members or the Company for any mistake of fact or judgment

or for the doing . . . or failure to do any act . . . in conducting the Company’s business,

operations and affairs, which may cause or result in any loss or damage to the

Company or the Members.”20 Managers are not exculpated under the Operating

Agreement, however, for “fraud, gross negligence, willful misconduct or a wrongful

taking.”21 Finally, Section 8.10 states that, “[e]xcept as expressly provided in the

Agreement,” no Manager or Member has authority “to undertake or assume[] any

obligation, debt, duty or responsibility on behalf of [] any Member or the Company,

or to bind the Company in any way, to pledge its credit or to render it liable peculiarly

for any purpose.”22

While the Operating Agreement generally allows Members and Managers to

engage in other business ventures, Section 14 delimits the specific instances where

such outside corporate opportunities are prohibited. Relevant here, Section 14(a) of

the Operating Agreement provides that no Member or “Manager shall directly, or

indirectly through any affiliate or related party . . . solicit sales for, divert or take

20
Id. § 8.4; Compl. ¶ 23.
21
Operating Agreement § 8.4.
22
Id. § 8.10.

6
away any customers from the Company.”23 Specific exceptions are made for CPI

and John Clifford, and for Defendants only as to a separate packaging company

(World Packaging Company LLC) owned by Defendants. 24

C. The Relationship Between Investors and CPI Deteriorates

On June 11, 2004, WPP entered into an Administrative Services & Raw

Material Supply Agreement with CPI (the “Services Agreement”). 25 Under this

agreement, CPI managed all of WPP’s accounts receivable, invoicing, financing and

materials sourcing and coordination, among other administrative tasks.26 The

Services Agreement contained a New Jersey choice of law and forum selection

clause.27 CPI performed its obligations under the Operating Agreement and Services

Agreement without objection or controversy for over thirteen years.28

In September 2016, Smith expressed to Clifford his desire to create a salaried

position at WPP for his wife, Toni M. Robinson-Smith M.D. 29 Though Robinson-

23
Id. § 14(a).
24
Id. § 14(c).
25
Compl. ¶¶ 4, 24–25.
26
Compl. ¶ 24.
27
Compl. Ex. B (“Services Agreement”) § 8(e).
28
Compl. ¶¶ 24–25.
29
Compl. ¶ 26.

7
Smith had served previously at WPP in a minor sales role, Smith proposed that the

Company promote her to Vice President of Administration, a new position with an

annual salary of $185,000.30 Clifford objected on the grounds that her excessive

salary was beyond the means of the Company and her responsibilities would be

duplicative of those contracted out to CPI under the Services Agreement.31

Notwithstanding Clifford’s stated objections, Smith and Baptiste moved unilaterally

to create the role and hire Robinson-Smith to fill it, offering her the full $185,000

salary originally contemplated by Smith (and rejected by CPI). 32

On March 10, 2017, Defendants delivered a letter (the “Termination Letter”)

to CPI’s office giving Plaintiff 90 days’ notice of Smith and Baptiste’s intent on

behalf of WPP to terminate the Services Agreement.33 That same month, Defendants

contacted a key mutual supplier to both WPP and CPI to negotiate an expansion of

the business relationship on behalf of WPP.34 Defendants told the supplier that WPP

30
Compl. ¶¶ 26–27.
31
Compl. ¶ 28.
32
See Compl. ¶¶ 28–29.
33
Compl. ¶ 34.
34
Compl. ¶ 37.

8
would delay pursuing the new business opportunity with the supplier until after

WPP’s Services Agreement with CPI had fully terminated.35

On April 3, 2017, Defendants sent CPI a letter encouraging it to withdraw as

a Member of WPP. 36 Smith then proposed to a CPI representative on behalf of

Investors that WPP should replace the financing CPI had arranged for the Company

with financing from MBE Capital Partners (“MBE”), despite the fact that MBE’s

financing rate was several times higher than the rate CPI had secured for WPP over

the past 13 years.37 CPI responded by pointing Smith to Section 8.10 of the

Operating Agreement, which CPI read to prevent Smith from unilaterally

undertaking “any obligation, debt, duty, or responsibility” on behalf of WPP or from

“pledg[ing] [WPP’s] credit or render[ing] it liable . . . for any purpose” without the

unanimous consent of WPP’s Managers, including Clifford.38 Defendants

apparently disagreed with that reading, and soon after unilaterally entered into a

financing agreement with MBE and directed customers to remit payments due to

WPP into an MBE-controlled bank account. 39

35
Id.
36
Compl. ¶ 36.
37
Compl. ¶ 38.
38
Compl. ¶ 39.
39
Compl. ¶¶ 39, 40, 57–58.

9
 By letter dated June 26, 2017, Smith and Baptiste informed WPP customers

that Investors was WPP’s new “administrative services and financial agent.” 40 It is

alleged that Defendants thereafter directed multiple longtime WPP customers to

send payments for orders placed with WPP directly to Investors instead of the

Company.41 The termination of the Services Agreement and appointment of

Investors as the administrative services provider is alleged to have harmed Plaintiff

“by diverting funds so that Plaintiff, which was then still a Member of WPP entitled

to share in its profits, could not so share.”42

D. CPI Initiates Litigation in New Jersey

On May 1, 2017, CPI initiated an action against WPP, Investors, Smith and

Baptiste in New Jersey state court asserting various claims arising from WPP’s

alleged breach of the Operating Agreement and the Services Agreement

(the “New Jersey Action”).43 The claims relating to the Operating Agreement were

dismissed without prejudice in accordance with that agreement’s exclusive

Delaware forum selection clause; the claims relating to the Services Agreement are

40
Compl. ¶ 40.
41
Compl. ¶¶ 42–43.
42
Compl. ¶ 44.
43
Compl. ¶ 11.

10
still being litigated in New Jersey. 44 In the course of the New Jersey litigation, CPI

discovered Defendants had falsified versions of the Operating Agreement and

Services Agreement for submission both to the Ohio Minority Business Enterprise

authorities in 2005 and the court in the New Jersey Action in 2017. 45 Smith has

since claimed that he had verbal permission to affix Clifford’s signature from the

original agreements to the altered versions of those documents, which Clifford has

denied.46

CPI also alleges that it learned during the course of discovery in the New

Jersey Action that “Defendants falsely represented to Plaintiff and WPP’s vendors

that WPP had access to a $35 million line of credit through MBE, which it did not

have.”47 It is further alleged that “Defendants continued placing orders with vendors

through WPP based on the false assurance of access to a non-existent line of credit,

and diverted certain associated receivables to Investors, so that Plaintiff could not

share in profits, in violation of Section 14(a) of the Operating Agreement.”48

44
Id.
45
Compl. ¶ 45.
46
Id.
47
Compl. ¶ 46.
48
Id.

11
 E. CPI Withdraws as a Member of WPP

On February 21, 2018, CPI and Investors entered into a Consent and

Acknowledgement to Withdrawal Agreement (the “Withdrawal Agreement”) to

memorialize CPI’s election to withdraw as a member of WPP. 49 Under the

Withdrawal Agreement, CPI “relinquished . . . all ownership interests in [WPP], all

claims to the return of its Capital Contribution, . . . all claims to the distribution of

cash generated by [WPP], and all claims to any economic interests in [WPP] as a

lender to or owner of the Company.”50 The withdrawal was expressly “subject in all

respects to the reservation of all rights and remedies of the parties in respect of any

and all claims, actions or proceedings by and between Investors . . . and CPI, which

in each case are pending as of the date hereof in any court or before any judicial

body of competent authority.”51

49
Compl. Ex. D (“Withdrawal Agreement”).
50
Id.
51
Id. The parties specifically identified the New Jersey Action and agreed that neither
party has “waive[d] or postpone[d]” its rights with respect to that litigation. Id.

12
 F. Procedural History

Plaintiff filed its first Verified Complaint on July 9, 2020,52 which it amended

on September 21, 2020.53 The operative Complaint asserts five Counts.54 Count I

is a claim against Investors, Smith and Baptiste for breach of Section 8.1 of the

Operating Agreement by excluding Clifford from voting on WPP’s hiring of

Robinson-Smith as Vice President of Administration. 55 Count II is a claim against

Smith for breach of Section 8.3 of the Operating Agreement (governing related party

transactions) by participating in WPP’s decision to create a new position for his wife,

whom he appointed unilaterally.56 Count III is a claim against Investors, Smith and

Baptiste for breach of Section 8.10 of the Operating Agreement by preventing CPI’s

representative Manager, Clifford, from voting on WPP’s entry into a financing

agreement with MBE. 57 Count IV is a claim against Investors, Smith and Baptiste

for breach of Section 14(a) of the Operating Agreement by diverting payments from

the Company to Investors following termination of the Services Agreement in the

52
D.I. 1.
53
D.I. 18.
54
Compl. ¶¶ 50–67.
55
Compl. ¶¶ 50–52.
56
Compl. ¶¶ 53–55.
57
Compl. ¶¶ 56–58.

13
summer of 2017. 58 Count V is a claim against Investors, Smith and Baptiste for

breach of the fiduciary duty of loyalty when they: (1) postponed the expansion of a

lucrative business arrangement with a key mutual supplier to both WPP and CPI

until after WPP’s Services Agreement with CPI terminated; (2) unilaterally diverted

sales from longtime WPP customers to Investors; and (3) unilaterally appointed

Investors as WPP’s administrative services agent, replacing CPI without affording

its representative Manager, Clifford, a vote on the decision. 59

Defendants filed their motion to dismiss the operative Complaint on

October 23, 2020.60 After full briefing, oral argument and a supplemental

submission, the matter was deemed submitted for decision on March 2, 2021.61

II. ANALYSIS

Defendants’ showcase argument for dismissal is that CPI lacks standing to

pursue its claims, all of which must be characterized as derivative. Standing “refers

58
Compl. ¶¶ 59–61.
59
Compl. ¶¶ 62–67.
60
D.I. 21 (Defs. WPP Invs., LLC’s and Edgar L. Smith, Jr.’s Opening Br. in Supp. of their
Mot. to Dismiss Pl.’s Am. Verified Compl.) (“Defs.’ Opening Br.”).
61
See D.I. 23 (Pl.’s Answering Br. in Opp’n to Defs.’ Mot. to Dismiss) (“Pl.’s Answering
Br.”); D.I. 25 (Defs. WPP Invs., LLC’s and Edgar L. Smith, Jr.’s Reply Br. in Further
Supp. of their Mot. to Dismiss Pl.’s Am. Verified Compl.) (“Defs.’ Reply Br.”); D.I. 31
(Oral Arg. on Defs. WPP Invs., LLC’s and Edgar L. Smith, Jr.’s Mot. to Dismiss)
(“Oral Arg. Tr.”); D.I. 31 (letter regarding authority mentioned for the first time at oral
argument).

14
to the right of a party to invoke the jurisdiction of a court to enforce a claim or redress

a grievance.”62 “Standing is properly a threshold question that the Court may not

avoid,”63 and “a legal question that is well suited to resolution on a motion to

dismiss.”64 “Where, as here, the question of standing is so related to the merits,”

and asks “not whether the Court can grant the requested relief to any plaintiff, but

rather whether the Court can grant the requested relief to [this] plaintiff[], the

appropriate framework [for deciding a motion to dismiss purported derivative

claims] is under [Chancery] Rule 12(b)(6).” 65

Chancery Rule 12(b)(6) requires dismissal of a complaint if the plaintiff

cannot recover under “any reasonably conceivable set of circumstances susceptible

of proof” based on the complaint’s pled facts. 66 While the court need not accept

conclusory allegations or “every strained interpretation of the allegations proposed

62
Morris v. Spectra Energy P’rs (DE) GP, LP, 246 A.3d 121, 128 (Del. 2021) (quoting
Stuart Kingston, Inc. v. Robinson, 596 A.2d 1378, 1382 (Del. 1991)); see also El Paso
Pipeline GP Co., L.L.C. v. Brinckerhoff, 152 A.3d 1248, 1256 (Del. 2016) (“El Paso
Pipeline II”) (observing that without standing, “the court lacks the power to adjudicate the
matter”).
63
Morris, 246 A.3d at 129.
64
In re AbbVie Inc. S’holder Deriv. Litig., 2015 WL 4464505, at *3 (Del. Ch. July 21,
2015).
65
Id. (emphasis in original) (citation omitted).
66
Beck v. Brady, 860 A.2d 809, 809 (Del. 2004) (TABLE) (quoting Kofron v. Amoco
Chems. Corp., 441 A.2d 226, 227 (Del.1982)).

15
by plaintiff,”67 it “must accept as true all well-pled allegations in the complaint and

draw all reasonable inferences from those facts in plaintiff’s favor.”68 As the Court

considers the viability of Plaintiff’s claims under Rule 12(b)(6), it must remain

mindful that “[t]he party invoking the jurisdiction of a court bears the burden of

establishing the elements of standing.”69

Under Delaware’s Limited Liability Company Act, a claim will be deemed

derivative when it is brought by a member “in the right of a limited liability company

to recover a judgment in its favor.”70 The member’s right to bring the action is

conditioned upon a determination that “managers or members with authority . . .

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.” 71 “The derivative suit is a corporate

concept grafted onto the limited liability company form.”72 As such, “case law

governing corporate derivative suits is equally applicable to suits on behalf of

67
In re Gen. Motors (Hughes) S’holder Litig., 897 A.2d 162, 168
(Del. 2006) (quoting Malpiede v. Townson, 780 A.2d 1075, 1083 (Del. 2003)).
68
In re Rouse Props., Inc., 2018 WL 1226015, at *10 (Del. Ch. Mar. 9, 2018) (citations
omitted).
69
Dover Hist. Soc’y v. City of Dover Planning Comm’n, 838 A.2d 1103, 1110 (Del. 2003).

70
6 Del. C. § 18-1001.
71
Id.
72
Elf Atochem N. Am., Inc. v. Jaffari, 727 A.2d 286, 293 (Del. 1999).

16
an LLC.”73 Thus, it is appropriate to look to our law of corporations when assessing

whether CPI has brought direct or derivative claims and whether it has standing to

prosecute the claims it has brought.

At the threshold, Defendants argue CPI has brought derivative claims but

lacks standing to prosecute them both because it is no longer a member of WPP and

because it has failed to satisfy the procedural imperatives under our law for asserting

claims on behalf of a Delaware LLC.74 More specifically, Defendants argue that

CPI’s claims, while packaged as direct claims, are actually claims belonging to WPP

that CPI no longer has standing to bring derivatively, having withdrawn as a member

of WPP more than three years ago and having released all claims to any interest it

held in the Company. 75 Under 6 Del. C. § 18-1002, “[i]n a derivative action, the

plaintiff must be a member or an assignee of a limited liability company interest at

73
VGS, Inc. v. Castiel, 2003 WL 723285, at *11 (Del. Ch. Feb. 28, 2003).
74
The Withdrawal Agreement reserved CPI’s right to continue to prosecute claims it raised
in the New Jersey Action, but also reserved Investor’s right to raise any and all defenses to
those claims. See Withdrawal Agreement. Thus, even if it is assumed that CPI’s claims
here mirror the claims that were brought and then dismissed in the New Jersey Action, such
that they could be asserted again in Delaware under the Withdrawal Agreement, that same
agreement preserved Investor’s right to raise applicable defenses to the claims, including
that CPI lacks standing to prosecute derivative claims.
75
Compl. ¶¶ 12–15; Withdrawal Agreement.

17
the time of bringing the action.” 76 This requirement reflects the well-understood

canon of our corporations law that “[t]he right to sue derivatively is a property right

associated with share ownership.”77 Thus, to the extent CPI’s claims are derivative,

they fail as a matter of law for CPI’s lack of standing to assert them.

In a typical case, this court distinguishes between direct and derivative claims

by application of the well-settled test set out in Tooley v. Donaldson, Lufkin &

Jenrette, Inc., 78 where the Court distilled the direct versus derivative analysis down

to two inquiries: “(1) who suffered the alleged harm (the [LLC] or the suing

[member], individually); and (2) who would receive the benefit of any recovery or

other remedy (the [LLC] or the [members], individually)?” 79 CPI, however,

maintains that this is not a typical case. According to CPI, because WPP was a two-

member LLC, Tooley’s two-part test cannot apply because it ignores the reality that

harm to the LLC caused by one member flows directly to the other member.

76
6 Del. C. § 18-1002 (emphasis added); see also CML V, LLC v. Bax, 6 A.3d 238 (Del. Ch.
2010), aff’d, 28 A.3d 1037 (Del. 2011) (upholding a plain reading of Section 18-1002’s
membership requirement.)
77
Urdan v. WR Cap. P’rs, LLC, 2019 WL 3891720, at *8 (Del. Ch. Aug. 19, 2019), aff’d,
244 A.3d 688 (Del. 2020).
78
845 A.2d 1031 (Del. 2004).
79
Id. at 1039; see also Hindlin v. Gottwald, 2020 WL 4206570, at *6 (Del. Ch. July 22,
2020) (applying Tooley in the LLC context).

18
I address this argument first. Because I disagree with CPI that this case is atypical,

I go on to apply Tooley to the claims asserted here.

A. Tooley Applies in the Context of a Two-Member LLC

As noted, CPI asserts that where, as here, claims arise from a dispute between

members of a two-member LLC and only one member is harmed, “the relationships

among the parties [become] so simple and circumstances so clear-cut that the

distinction between direct and derivative claims becomes irrelevant . . . .” 80 Of

course, 6 Del. C. § 18-1001 does not distinguish two-member LLCs from other

LLCs when addressing derivative actions—a distinction our General Assembly

easily could have codified had it been so inclined.81 And CPI’s cited authority

relates only to claims arising from dissolved limited partnerships, whereas WPP

remains a going concern.82 Indeed, in CPI’s favorite case, In re Cencom Cable

Income Partners, L.P., the court declined to apply Tooley only after observing that,

80
Pl.’s Answering Br. at 16 (quoting In re Cencom Cable Income P’rs, L.P.,
2000 WL 130629, at *6 n.14 (Del. Ch. Jan. 27, 2000) (disregarding the direct versus
derivative distinction for claims brought by one former limited partner against the other
former limited partner for wrongdoing associated with the final transaction of a dissolved
limited partnership)).
81
See 6 Del. C. § 18-1001.
82
The only case CPI cites not in the dissolved entity context is Stevanov v. O’Conner, but
the court there deferred (but did not reject) application of Tooley because it required
“a more thorough development of the record [to] clarify the law or its application.”
2009 WL 1059640, at *6 (Del. Ch. Apr. 21, 2009) (internal quotations and citation
omitted).

19
“[w]ith the partnership in dissolution the ‘partnership’ entity is simply an artifice

representing the relationship between two legally juxtaposed parties and is no longer

relevant as a distinct legal creature for the purpose of resolving the final claims

between those parties.” 83 Our courts have since made clear that Cencom is “limited

to its own unique set of facts,” 84 and that the presence of “a partnership that had been

liquidated or dissolved” was a “material[]” distinction in determining the extent to

which Tooley should apply. 85

That distinction was brought to the fore in Dietrichson v. Knott, where then-

Vice Chancellor Montgomery-Reeves applied Tooley’s test to breach of fiduciary

duty claims asserted by one 50% member of an LLC against the other 50%

member. 86 CPI did not address Dietrichson either in briefing or at oral argument,

and no wonder: as a case applying Tooley in the context of a two-member LLC, its

example directly contradicts CPI’s proffered state of Delaware law. Indeed, the

court in Dietrichson dismissed the plaintiff’s fiduciary duty and waste claims after

83
Cencom, 2000 WL 130629, at *6.
84
Agostino v. Hicks, 845 A.2d 1110, 1125 (Del. Ch. 2004).
85
Metro. Life Ins. Co. v. Tremont Gp. Hldgs., Inc., 2012 WL 6632681, at *10 (Del. Ch.
Dec. 20, 2012) (“I see no basis for expanding Cencom to entities . . . [that are] relevant as
[] distinct legal creature[s] for the purpose of resolving the final claims between [the
disputing] parties.” (internal quotation and citation omitted)).
86
2017 WL 1400552, at *1, *4–5 (Del. Ch. Apr. 19, 2017) (dismissing derivative claims
on a motion to dismiss).

20
concluding they were derivative in nature and finding the plaintiff did not make a

demand on the board or attempt to plead demand futility.87 The same analysis is

required here.

B. Tooley’s Application Requires Dismissal of Plaintiff’s Complaint

As noted, the test set forth in Tooley assesses the nature of a claim by reference

to two questions: “(1) who suffered the alleged harm (the [LLC] or the suing

[member], individually); and (2) who would receive the benefit of any recovery or

other remedy (the [LLC] or the [members], individually)?”88 The first prong of

Tooley directs the Court’s analysis to the nature of the alleged harm; the “claimed

direct injury must be independent of any alleged injury to the corporation. The

stockholder must demonstrate that the duty breached was owed to the stockholder

and that he or she can prevail without showing an injury to the corporation.”89 Under

the second prong of Tooley, “[w]here all of a corporation’s stockholders are harmed

and would recover pro rata in proportion with their ownership of the corporation’s

stock solely because they are stockholders, then the claim is derivative in nature.” 90

87
Id. at *4–5.
88
Tooley, 845 A.2d at 1039; Hindlin, 2020 WL 4206570, at *7 (applying Tooley in the
LLC context).
89
Tooley, 845 A.2d at 1039.
90
El Paso Pipeline II, 152 A.3d at 1261 (quoting Feldman v. Cutaia, 951 A.2d 727, 733
(Del. 2008)).

21
 When judging a plaintiff’s claim against Tooley’s rubric, the court awards no

style points for artful pleading. Just because a plaintiff stamps the word “direct” on

its plead claim does not make it so. 91 Rather, the court must look past the labels to

discern “the nature of the wrong alleged, taking into account all of the facts alleged

in the complaint, and determine for itself whether a direct claim exists.”92

Plaintiff’s claims can be divided into contract and fiduciary duty claims.

I address each in turn.

Plaintiff’s Contract Claims are Derivative

CPI brings in Counts I–IV claims based on alleged breaches of the Operating

Agreement. The contract claims come in two varieties. First, in Count IV, CPI

alleges Defendants breached Section 14(a) of the Operating Agreement by diverting

payments from WPP to Investors.93 CPI asserts it suffered direct harm because, as

the only member of WPP without equity in Investors, it was “the only party directly

damaged by diversion of funds.”94 Second, in Counts I–III, CPI alleges Defendants

91
Hartsel v. Vanguard Gp., Inc., 2011 WL 2421003, at *16 (Del. Ch. June 15, 2011)
(“The manner in which a plaintiff labels its claim and the form of words used in the
complaint are not dispositive”).
92
Id.; see also Kramer v. W. Pac. Indus., Inc., 546 A.2d 348, 353 (Del. 1988)
(“In determining the nature of the wrong alleged, a court must look to ‘the body of the
complaint, not to the plaintiff’s designation or stated intention.” (citation omitted)).
93
Compl. ¶ 43.
94
Compl. ¶ 42.

22
breached various provisions of the Operating Agreement by denying its Manager,

Clifford, a right to vote on certain decisions.

Count IV’s diversion-of-payments claim is quintessentially derivative.

Because it is the Company’s funds Defendants are alleged to have diverted, the harm

caused by Defendants’ actions flows directly to the Company, and only derivatively

to its members. In the same way, any recovery of such funds would flow first to the

Company only then to be distributed pro rata to its members.95 “Claims are treated

as derivative when they naturally assert that the corporation’s funds have been

wrongfully depleted.” 96 CPI’s attempt to convert a diversion-of-funds claim from

95
See In re Happy Child World, 2020 WL 5793156, at *11–34 (Del. Ch. Sept. 29, 2020)
(calculating damages flowing from derivative claims against a stockholder/fiduciary and
“round tripping” those damages to the company’s stockholders pro rata); see also
Dietrichson, 2017 WL 1400552, at *4–5 (explaining that plaintiff’s recovery for
defendant’s self-interested diversion of funds “would [run to] the Company, not [plaintiff].
[Plaintiff] would only receive his portion of recovery as an indirect benefit and pro rata
according to his membership interest under the Operating Agreement.” (internal citations
omitted)). I note that CPI may have had a basis to argue for direct recovery of any judgment
obtained on the derivative claims if it had standing to pursue those claims. See In re
El Paso Pipeline P’rs, LP Deriv. Litig., 132 A.3d 67, 121 (Del. Ch. 2015) (“El Paso
Pipeline I”) (discussing equitable grounds to allow stockholders to recover on derivative
claims directly, particularly with respect to claims against controlling stockholders), rev’d
on other grounds, El Paso Pipeline II, 152 A.3d 1248. The fact that there may be a basis
to allow the stockholder to recover directly on a derivative claim, however, does not render
the claim any less derivative.
96
Dietrichson, 2017 WL 1400552, at *4 (internal quotations and citations omitted);
see also Kramer, 546 A.2d at 353 (holding claims of corporate mismanagement resulting
in a depletion of corporate funds are derivative because they represent a wrong to the
corporation indirectly experienced by all shareholders); Feldman, 951 A.2d at 735
(Del. 2008) (noting waste claims are derivative in nature).

23
derivative to direct based on its identity as one of two unitholders in WPP fails; for

reasons already explained, an LLC’s two-member status does not preclude

application of Tooley. Where, as here, one of two members brings a claim that the

other member has depleted company assets, that claim is and remains derivative.97

Plaintiff’s voting rights claims require a separate analysis. Counts I and II

relate to Smith hiring his wife over CPI’s objection: Count I alleges breach of

Section 8.1, which entitled Clifford to vote on the hire, while Count II alleges breach

of Section 8.3 for Smith having voted on a related party transaction from which he

was obligated to abstain. Count III alleges breach of Section 8.10 for denying

Clifford an opportunity to vote on WPP’s entry into a financing agreement with

MBE. As to each of these claims, CPI argues that, because its bargained-for voting

rights under the Operating Agreement were denied, the harm flowing from these

breaches was direct.

To be sure, breach of a contractual right to vote may constitute a direct claim

under Tooley.98 But there is a difference between the nature of a breach and the

97
See Dietrichson, 2017 WL 1400552, at *4.
98
See, e.g., Gotham P’rs, L.P. v. Hallwood Realty P’rs, L.P., 1998 WL 832631, at *1, *5
(Del. Ch. Sept. 30, 2013) (holding voting dilution claim constituted direct harm); but see
Hindlin, 2020 WL 4206570, at *7 (holding voting dilution claim constituted derivative
harm).

24
alleged harm flowing from that breach; to determine whether a claim is direct or

derivative, Tooley instructs that our courts train their focus on the latter.99

In this case, CPI alleges that Robinson-Smith’s hiring was “[i]n furtherance

of [Defendants’] plan to divert scarce WPP resources away from Plaintiff in order

to fund Robinson-Smith’s excessive salary.”100 “The hiring of Robinson-Smith,”

CPI alleges, “provided substantial economic benefit to Smith” (through his spouse),

and Smith’s actions were taken to enrich himself to WPP’s detriment. 101 CPI further

alleges that it opposed Robinson-Smith’s hiring because it “would be duplicative

[of work already contracted to CPI] . . . and that in any event, WPP could not afford

to create the position, given its then-marginal profitability.” 102 Viewed through

99
See, e.g., In re J.P. Morgan Chase & Co. S’holder Litig., 906 A.2d 766, 771–73
(Del. 2006) (classifying as derivative a disclosure claim in the context of a merger because,
“[e]ven if it were assumed that improper proxy disclosures induced JPMC’s shareholders
to approve the merger (including the $7 billion overpayment), the harm resulting from the
overpayment was to JPMC.”).
100
Compl. ¶ 7. I note that, although CPI alleges Smith “suggested that Plaintiff reduce its
Administrative Fee [under the Services Agreement] to make available funds to pay
Robinson-Smith’s proposed $185,000 annual salary,” it does not allege Smith actually
reduced CPI’s fee to fund Robinson-Smith’s salary upon her hiring. See Compl. ¶¶ 28–29.
To the extent Defendants wrongfully caused WPP to terminate the Services Agreement to
make way for Robinson-Smith, that claim can be litigated as a breach of the Services
Agreement in the New Jersey Action.
101
Compl. ¶ 33; see also Compl. ¶ 27.
102
Compl. ¶ 4; see also Compl. ¶¶ 27–28 (“Clifford . . . explained to Smith that creating
the position would not be economically viable for WPP due to the excessive salary figure,
and that the position’s responsibilities would be duplicative of functions Plaintiff was
already performing for WPP under the Services Agreement.”).

25
Tooley’s lens, the harm of wastefully hiring unnecessary personnel accrues to the

Company, with any recovery in the first instance running directly to the entity. That

is a derivative claim.103

Confronted with its own (amended) pleadings, CPI raised for the first time at

oral argument Fletcher International Ltd. v. ION Geophyiscal Corp.104 to support its

argument that it was directly harmed by Defendants’ hiring of Robinson-Smith.105

In Fletcher, then-Chancellor Strine calculated the expectation damages flowing from

a company’s violation of a shareholder-hedge fund’s consent rights with respect to

a bridge loan extended to maintain the company’s solvency until it received a more

103
See Dietrichson, 2017 WL 1400552, at *4–5; see also J.P Morgan, 906 A.2d at 771
(observing that “claims of waste are classically derivative”); Protas v. Cavanaugh,
2012 WL 1580969, *6 (Del. Ch. May 4, 2012) (noting that corporate waste claims are
derivative as they rest on harm to the corporation).
104
Fletcher, 2013 WL 6327997 (Del. Ch. Dec. 4, 2013).
105
Oral Arg. Tr. at 48:11–50:4. The only other case CPI cites in support of its theory that
the hiring of Robinson-Smith gave rise to a direct claim is Gotham Partners, L.P. v.
Hallwood Realty Partners, L.P., where the court construed as direct a plaintiff’s claim that
its vote was diluted when the limited partnership’s corporate general partner allegedly
engaged in a series of unfair and self-dealing unit transactions aimed to increase its
ownership stake in the limited partnership. 1998 WL 832631, at *1, *5. The court reasoned
that “the disputed transactions impinged upon the unit holder’s right to terminate the
general partner. The injury is specific to the unit holders as a class as opposed to a harm
inflicted upon the limited partnership.” Id. at *5. Unlike Gotham, CPI’s claim in this case
is that its right to vote was denied and it seeks compensatory damages for the Company’s
resulting wasteful expenditure of resources on unnecessary personnel. See Compl., Prayer
for Relief ¶ A (seeking compensatory damages for its claims); see also J.P. Morgan,
906 A.2d at 772–73 (classifying as derivative a claim of voting dilution where the plaintiff
sought compensatory damages identical to those suffered by the company).

26
substantial cash infusion. 106 The hedge fund’s theory of damages was that it could

have leveraged its consent right over the bridge loan to extract for itself outsized

financial benefits.107

As noted, however, CPI’s pled theory is different. Specifically, CPI

affirmatively pleads that it would “not consent to the creation or funding of

Robinson-Smith’s position”108 because the position “would be duplicative” of work

already being performed for WPP and “WPP could not afford to create the position,

given its then-marginal profitability.” 109 Thus, CPI’s allegations not only belie its

contention that it would have extracted (and so was denied) a direct benefit in

exchange for its vote, but also demonstrate that, to the extent any negotiation

occurred, CPI would have negotiated for the benefit of the Company, not itself. That

fact is underscored by the damages CPI seeks: while the hedge fund in Fletcher

sought expectation damages for loss of its consent rights, CPI seeks compensatory

damages for losses incurred by WPP as a result of Defendants’ breach of the

106
Fletcher, 2013 WL 6327997, at *1–2, *17–25.
107
Id. at *13–16 (“[The hedge fund’s expert’s] entire report was premised on the notion
that [the hedge fund] was willing to strap a bomb onto its chest and blow up the entire []
deal, force [the company] into bankruptcy, and decimate its own investment portfolio if it
was not paid a ransom in exchange for its consent to a transaction that was already expected
to create substantial value for it.”).
108
Compl. ¶ 5.
109
Compl. ¶ 4.

27
Operating Agreement. 110 “[T]he fundamental principle governing entitlement to

compensatory damages . . . is that the damages must be logically and reasonably

related to the harm or injury for which compensation is being awarded.” 111 As pled,

those damages would flow from the hiring of Robinson-Smith, which could only

have occurred in the first instance at the Company’s expense. Because the ultimate

harm of Defendants’ actions accrued to WPP, and any remedy would run first to

WPP, Counts I and II are both derivative.

The same analysis applies to Count III, where CPI alleges that Defendants’

decision to replace WPP’s then-financial services provider, M&T Bank, with MBE

resulted in “a rate several times that which Plaintiff had secured for WPP under the

Services Agreement.” 112 Again, while the alleged breach was the denial of CPI’s

voting rights, the alleged harm was suffered by the Company, which ultimately was

forced to shoulder a higher financing rate. Any recovery would thus run first to

WPP, benefiting its stockholders derivatively.113 “Where all of a corporation’s

stockholders are harmed and would recover pro rata in proportion with their

110
See Compl., Prayer for Relief ¶ A.
111
J.P. Morgan, 906 A.2d at 773.
112
Compl. ¶ 38.
113
Again, to the extent this conduct violated the Services Agreement, or some other
separate commitment running from WPP to CPI, CPI may assert that claim in the New
Jersey Action.

28
ownership of the corporation’s stock solely because they are stockholders, then the

claim is derivative in nature.” 114

For the foregoing reasons, all of CPI’s contract claims are derivative. That

leaves CPI’s fiduciary duty claim in Count V, which, as explained below, is also

derivative.

Plaintiff’s Fiduciary Duty Claims are Derivative

Count V asserts Defendants breached their fiduciary duty of loyalty in three

respects. First, Defendants allegedly “postpone[d] the [Company’s] expansion” of

a “lucrative business” opportunity with a “key” supplier until after WPP terminated

its Services Agreement with CPI and then appointed Investors as the new

administrative services provider.115 Second, Defendants allegedly “breached their

duty of loyalty when they unilaterally diverted sales from longtime WPP customers

to Investors,” thereby “denying Plaintiff’s right to share in WPP’s profits earned

from those sales.”116 Third, Defendants allegedly violated their duty of loyalty by

“unilaterally appoint[ing] Investors . . . as WPP’s new administrative services agent,

replacing Plaintiff without affording Plaintiff’s representative Manager, John

114
El Paso Pipeline II, 152 A.3d at 1261 (quoting Feldman, 951 A.3d at 733).
115
Compl. ¶¶ 37, 64, 66–67.
116
Compl. ¶ 65.

29
Clifford, a vote on the transaction.” 117 CPI argues these are direct claims because

Defendants prevented CPI from duly exercising its rights under the Operating

Agreement and, in doing so, made material misrepresentations to CPI.118

The harm suffered by Defendants’ disloyal postponement of a lucrative

business expansion and diversion of business from WPP to Investors runs first to

WPP, as profits from both opportunities would accrue to the Company. It follows

that the Company would also receive the benefit of any resulting recovery, with CPI

benefiting from such opportunities derivatively, in proportion to its equity stake in

WPP. Under Tooley, then, these fiduciary duty claims are derivative.

In the same vein, CPI alleges Defendants terminated the Services Agreement

“[i]n furtherance of their plan to divert scarce WPP resources” to themselves,119

resulting ultimately in “WPP’s actual losses to total $1,225,049 . . . .” 120 CPI further

alleges that “[t]he termination of the Services Agreement and appointment of

117
Compl. ¶ 66.
118
Compl. ¶¶ 45–46, 62–67. CPI admits that there is “overlap between the breach of
contract claims and the breach of fiduciary duty claims in the Amended Complaint.”
Pl.’s Answering Br. at 38.
119
Compl. ¶ 7.
120
Compl. ¶ 8; see also El Paso Pipeline II, 152 A.3d at 1261 (“[T]he alleged overpayment
left the Partnership $171 million poorer. Any economic harm to [plaintiff] devolved upon
him as an equity holder in the form of the proportionally reduced value of his units—
a classically derivative injury.” (internal citations and quotations omitted)).

30
Investors as the administrative services provider . . . damaged Plaintiff by diverting

funds so that Plaintiff, which was then still a Member of WPP entitled to share in its

profits, could not so share.”121 By the Complaint’s own pleading, then, the harm

flowing from Defendants’ self-interested assumption of responsibilities enumerated

in the Services Agreement flowed to WPP directly. Any resultant compensatory

recovery for such harm, therefore, would flow first to the Company and only

derivatively to its members. This is the very definition of a derivative claim under

Tooley.

* * * * *

Under 6 Del. C. § 18-1001, only members (or assignees) may bring derivative

claims on behalf of a Delaware LLC. CPI lacks standing because it is no longer a

member of WPP (nor was it when it initiated this litigation). Moreover, 6 Del. C.

121
Compl. ¶ 44. To be clear, CPI does not allege Defendants violated their fiduciary duties
by terminating the Services Agreement. And, while CPI perhaps could have alleged direct
harm against Defendants through their tortious interference with the Services Agreement,
it has elected to litigate its Service Agreement-related claims against WPP (and Investors)
in New Jersey. Compl. ¶ 11. Rather, CPI alleges in Count V that Defendants breached
their fiduciary duties by contracting to themselves work for which they were overpaid by
WPP. Compl. ¶ 8 (alleging that replacing CPI under the Services Agreement cost WPP
“actual losses to total $1,225,049”); Compl. ¶ 41 (alleging Defendants’ breached their
fiduciary duties by reference to Section 8.3 of the Operating Agreement, which sets forth
WPP’s Related Party Transactions voting policy); Compl. ¶ 44 (alleging Defendants’
replacing the Services Agreement “directly damaged Plaintiff by diverting funds so that
Plaintiff, which was then still a Member of WPP entitled to share in its profits, could not
so share. This self-serving termination and purposeful, wrongful diversion of funds to
Investors breached Smith’s and Baptiste’s fiduciary duties.”).

31
§§ 18-1001 and 18-1003 require that the member make a pre-suit demand or plead

demand futility before filing derivative claims. 122 Because CPI undisputedly did not

make a pre-suit demand or plead demand futility, Smith and Investors’ motion to

dismiss the Complaint must be granted in full.

III. CONCLUSION

For the foregoing reasons, Defendants’ motion to dismiss Counts I–V is

granted.

IT IS SO ORDERED.

122
6 Del. C. §§ 18-1001, 18-1003.

32