Fairstead Capital Mgmt. LLC v. Blodgett

288 A.3d 729

FAIRSTEAD CAPITAL MANAGEMENT LLC and FCM Affordable LLC, Plaintiffs,

v.William BLODGETT, Defendant.

C.A. No. 2022-0673-JTL

Court of Chancery of Delaware.

Date Submitted: October 13, 2022

Date Decided: January 6, 2023

Ryan Stottmann, Thomas P. Will, MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Michael B. Carlinsky, Rollo C. Baker, Jonathan Feder, Alison Lo, QUINN EMANUEL URQUHART & SULLIVAN, LLP, New York, New York; Attorneys for Plaintiffs.

David E. Ross, Holly E. Newell, A. Gage Whirley, ROSS ARONSTAM & MORITZ LLP; Wilmington, Delaware; Jacob W. Buchdahl, Elisha B. Barron, SUSMAN GODFREY L.L.P., New York, New York; Attorneys for Defendant.

LASTER, V.C.

The investment fund complex at the center of this case operates under the trade name "Fairstead." Like many fund complexes, Fairstead is a thicket of affiliated entities. Until the dispute giving rise to this case, three human principals controlled the structure, but there was and remains no single, overarching entity. Many of the entities are special purpose vehicles created for specific investments.

Complexity breeds inconsistency, and inconsistency breeds disputes. Fund complexes are particularly fecund. The proliferation of entities strews rights and obligations across multiple agreements, which only the divine could align. Further complicating matters, the different legal cultures that take the lead on the different agreements embrace different norms. For forum selection, entity lawyers favor the courts of the chartering state. Employment lawyers favor mandatory arbitration. A typical fund principal serves in multiple roles with entities in the fund complex and holds a range of interests in those entities, then has some form of employment agreement on the side. That combination sets the stage for a dispute-resolution collision.

This decision addresses such a collision. The fund principal's employment agreement contains an expansive and mandatory agreement to arbitrate all claims relating to his employment.¹ The LLC agreements governing two Delaware entities that owned the carried interests in various investment vehicles contain mandatory forum selection clauses calling for litigation in this court.

The fund principal's partners (used colloquially) terminated him for cause for allegedly violating his employment agreement. They also declared that they had canceled the fund principal's member interests in the LLCs (or alternatively repurchased them for nothing) because the fund principal had breached his employment agreement.

The fund principal commenced an arbitration in which he sought to litigate whether he had breached his employment agreement and whether his former partners could cancel his member interests. His arbitral demand relied on both the employment agreement and the LLC agreements.

The former partners refused to arbitrate. They caused the LLCs to file suit here for breach of the LLC agreements. Despite having previously relied on breaches of the employment agreement as the basis for terminating the fund principal's interests, they now rely scrupulously on the LLC agreements.

More importantly for present purposes, the LLCs sought a permanent injunction barring the fund principal from arbitrating the breaches of the LLC agreements, including the question of whether his member interests were properly canceled. The fund principal countered that the entire dispute should be in arbitration because it related to his employment and thus fell within the scope of the arbitration agreement. He further argued that because the arbitration agreement delegated arbitrability determinations to the arbitrator, the court's only role was to order all of the parties to arbitrate that issue.

The parties filed cross motions for summary judgment to resolve the forum-selection dispute. Each side seeks a mandatory permanent injunction implementing its preferred regime. No one disputes the propriety of issuing that form of relief. They only disagree about what the correct answer is to the forum question.

Although the LLCs filed this action, it is easier to analyze the issues using the fund principal's framework. Normally, the fund principal's reliance on an arbitration agreement that delegates all issues of arbitrability to an arbitrator would be a clean winner. A court must respect such an agreement even if the claim of arbitrability seems wholly groundless.

The LLCs respond that they are not parties to the employment agreement and cannot be forced to arbitrate any issues. Although no Delaware court has spoken clearly on this question, federal precedent interpreting the Federal Arbitration Act (the "FAA") holds that a court must decide whether an arbitration agreement exists. Issues of contract formation cannot be delegated to an arbitrator; they are always for the court. Other issues of arbitrability can be delegated to the arbitrator, including questions of contract validity (i.e. , the question of whether the contract that validly came into existence is enforceable). Under these cases, the court must determine whether the LLCs are bound by the arbitration agreement.

Applying principles of equitable estoppel, this decision concludes that the LLCs are bound by the arbitration agreement. Principles of equitable estoppel support binding a non-signatory to an arbitration agreement when the non-signatory has accepted a direct benefit under the contract containing the arbitration agreement. The doctrine of equitable estoppel prevents the non-signatory from accepting the benefits of the contract without also accepting its burdens, including the arbitration agreement. In this case, the LLCs accepted the benefits of the services that the fund principal provided under the employment agreement. That agreement contemplated the formation of the LLCs, called for the former fund principal to provide services to the LLCs, and specified that in return for his services, the fund principal would receive member interests in the LLCs. That is exactly what happened. The LLCs therefore cannot evade the arbitration agreement.

The LLCs argue that the parties subsequently agreed to litigate disputes under the LLC agreements in this court. That too is an issue for this court because it presents another question about the existence of the arbitration agreement that only a court can resolve. But assuming that an arbitrator could decide the issue, it raises a question of substantive arbitrability. An arbitrator only has authority to decide an issue of substantive arbitrability if the arbitration agreement contains clear and unmistakable evidence of an intent to delegate that issue to an arbitrator.

The arbitration agreement in this case broadly delegates all disputes arising out of or relating to the employment agreement to an arbitral tribunal whose rules grant the tribunal the power to determine all issues relating to arbitrability. Normally, that would be sufficient to require that the court defer to the arbitrator. But here, the LLC agreements introduce a competing forum selection provision that calls for litigation in this court. Delaware precedents hold that when multiple agreements contain conflicting and overlapping forum selection clauses, the record lacks clear and unmistakable evidence of an intent to delegate the issue of arbitrability to an arbitrator.

The court therefore must decide which claims must be litigated here and which claims are arbitrable. Sadly, the answer is a mixed bag, which means that litigation will proceed inefficiently in at least two fora.

The claims for breach of the LLC agreements must be litigated in this court. The LLC agreements were executed after the employment agreement, contain integration clauses that wipe out any prior agreements, and provide expressly for litigation here.

Any disputes over whether the fund principal breached his employment agreement are for the arbitrator to decide. The LLCs have hinted that they may seek to litigate those issues in this court by seeking declarations that they validly canceled the fund principal's member interests. There are some potential bases for cancellation that do not implicate the employment agreement and which this court could resolve. But to the extent the LLCs rely on a predicate breach of the employment agreement, the court will not resolve that issue. Once an arbitrator has answered that question, then the parties can return to this court with the result. At that point, the court will use any determination regarding the breach of the employment agreement as an input and make any rulings necessary to adjudicate the parties’ remaining claims.

That outcome is wasteful and inefficient. It would be better if one decisionmaker adjudicated the entire dispute. In my experience, fund principals like secrecy, which a public court cannot provide. The obvious answer is to agree to arbitrate all disputes as if they were being litigated in this court. If the parties cannot agree to that result, then they will have to live with the suboptimal outcome that their dispute-resolution collision created.

I. FACTUAL BACKGROUND

The following facts are drawn from the record that the parties submitted in support of their cross motions for summary judgment. The parties agree that there are no genuine issues of material fact that are pertinent to disposition of the cross motions. In this situation, Court of Chancery Rule 56 contemplates that the court "shall deem the motions to be the equivalent of a stipulation for decision on the merits based on the record submitted with the motions." Ct. Ch. R. 56(h).

A. The Fund Complex

Stuart Feldman, Jeff Goldberg, and William Blodgett saw a business opportunity in affordable housing. Each brought something to the proverbial table. Feldman was a hedge fund manager with capital. Goldberg was an attorney with legal savvy. Blodgett was an entrepreneur with energy and vision.

Together, they formed a Delaware limited liability company called Fortitude Realty Management LLC ("Fortitude"). They...