Novarus Capital Holdings, LLC v. AFG ME W. Holdings, LLC

NOVARUS CAPITAL HOLDINGS, LLC,a Delaware limited liability company, Plaintiff, v. AFG ME WEST HOLDINGS, LLC, a Georgia limited liability company,ATTICUS FRANCHISE GROUP ME, LLC, a Georgia limited liability company,AFG ME WEST, LLC, a Georgia limited liability company,and MICHAEL DRUM, an individual, Defendants.

C.A. No. 2020-0331-JRS

COURT OF CHANCERY OF THE STATE OF DELAWARE

Date Submitted: March 18, 2021

June 23, 2021

MEMORANDUM OPINION

Kevin M. Coen, Esquire of Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware; Darrell G. Waas, Esquire and Patricia C. Campbell, Esquire of Waas Campbell Rivera Johnson & Velasquez LLP, Denver, Colorado, Attorneys for Plaintiff.

Alan D. Albert, Esquire of O'Hagan Meyer PLLC, Wilmington, Delaware, Attorney for Defendants.

SLIGHTS, Vice Chancellor

In 2005, Eric Kenealy and his wife became franchisees of Massage Envy, a massage and skin care retail chain. Twelve years later, the Kenealys formed Plaintiff, Novarus Capital Holdings, LLC ("Novarus"), to act as an entity through which they would acquire additional Massage Envy clinics. By April 2019, the Kenealys, either individually or through Novarus, owned and operated 18 successful Massage Envy locations employing more than 500 employees.

In recognition of the couple's success, Massage Envy Franchising, LLC (the "Franchisor") offered Novarus the opportunity to enter into an agreement that would provide it preferential access to Massage Envy franchises for sale in designated territories (the "Consolidator Agreement"). The parties entered a non-binding term sheet (the "Term Sheet") describing the transaction in January 2019, contemplating a yet-to-be-executed development agreement. With the expansion of its business as outlined in the Term Sheet in mind, and with the encouragement of the Franchisor, Novarus decided to partner with a private equity firm that could provide the capital necessary to facilitate the anticipated growth of the business.

After a bidding process, Defendants, Atticus Franchise Group ME, LLC ("Atticus") and its managing member, Michael Drum, emerged as Novarus' preferred partner, based in part on various alleged extracontractual representations made by Drum. The parties memorialized their bargain in a Membership Interest Purchase Agreement ("MIPA") and Amended and Restated LLC Agreement(the "Operating Agreement" and, together with the MIPA, the "Agreements") of the newly-formed entity, Defendant, AFG ME West Holdings, LLC (the "Company"). The Company acquired, among other assets, eighteen of the Kenealys' Massage Envy clinics, including those held by Novarus. In exchange, Novarus received approximately $16 million cash consideration and a 20% ownership interest in the Company, with the remaining 80% held by Defendant, AFG ME West, LLC ("AFG LLC"), of which Drum was the managing member.

As stated in the Operating Agreement, Atticus was designated as the Manager of the Company and permitted to draw compensation for that role up to 10% of the Company's "gross operating revenue" per year. The Agreements both contained merger clauses providing that the written contract represented the entire agreement between the parties, and both designated Georgia law to apply to disputes arising out of the contracts.

Soon after its execution, Novarus realized the Operating Agreement capped Atticus' management fee by reference to "gross" operating revenue when the parties had intended to cap its fees at "net" operating revenue. Novarus informed Atticus of the mutual mistake, but Atticus refused to agree to modify the executed Operating Agreement and continued to draw its management fee at 10% of gross operating revenue. Atticus also began to ice out the Company from acquisitions of other Massage Envy clinics. Novarus' complaint in this action followed.

The operative complaint asserts six Counts. First, Novarus brings a claim against the Company and AFG LLC to reform the Operating Agreement to reflect the parties' intent that Atticus' management fees would be capped at 10% of the Company's "net" (as opposed to "gross") operating revenue, relying principally on contemporaneous emails between counsel to demonstrate the existence of a mutual mistake. Second, Novarus seeks a declaratory judgment that clarifies the meaning of the term "net operating revenue" within the Operating Agreement, as Defendants have taken the position that "net" and "gross" operating revenue mean the same thing. Third, Novarus brings claims against Atticus for willful and intentional misconduct (the standard of conduct for the Manager stated in the Operating Agreement) by taking for itself corporate opportunities belonging to the Company and paying itself an excessive management fee. Fourth, Novarus asserts an unjust enrichment claim against Drum, who is not a party to the Operating Agreement but allegedly has been unjustly enriched by Atticus' collection of unauthorized management fees. Fifth, Novarus asserts that Drum is liable for intentional misrepresentations he made to induce Novarus to enter into the MIPA and the Operating Agreement. Finally, Novarus brings a claim against the Company for breach of the implied covenant of good faith and fair dealing by abusing its discretion when compensating Atticus.

Defendants together have moved to dismiss all counts under Chancery Rule 12(b)(6) for failure to state claims upon which relief may be granted. After carefully considering the motion, the result is a mixed bag. Novarus has well pled bases for reformation and that there exists an actual controversy between the parties regarding the meaning of the term "net operating revenue" within the Operating Agreement that cannot be resolved on the pleadings. Novarus has also well pled that Atticus violated its obligations under the Operating Agreement to refrain from willful misconduct when it paid itself management fees based on a knowingly inflated metric to which the parties did not agree. Those same well pled facts support Novarus' claim for breach of the implied covenant of good faith and fair dealing under Georgia law. But the Operating Agreement bars Plaintiff's corporate opportunity claim against Atticus. And, as to Drum, Georgia law does not support Plaintiff's contention that he can be held personally liable either for unjust enrichment or his alleged extracontractual misrepresentations given the Agreements' explicit merger clauses. My reasoning follows.

I. BACKGROUND

I have drawn the facts from well-pled allegations in the Verified Second Amended Complaint (the "Complaint") and documents properly incorporated byreference or integral to that pleading.¹ On a motion to dismiss, I accept as true the Complaint's well-pled factual allegations and draw all reasonable inferences in Plaintiffs' favor.²

A. Parties

Plaintiff, Novarus, is a Delaware limited liability company, with its principal place of business in Denver, Colorado.³

Defendant, Atticus, is a Georgia limited liability company with its principal place of business in Atlanta, Georgia.⁴ Defendant, AFG LLC, is a Georgia limited liability company with its principal place of business also in Atlanta, Georgia.⁵ Defendant, Drum, is the managing member of Atticus and AFG LLC.⁶

The Company is a Georgia limited liability company with its principal place of business in Atlanta, Georgia.⁷ As specified in the MIPA, AFG, LLC owns 80% of the membership interests in the Company and Novarus owns the remaining 20%.⁸

B. The Kenealys Form Novarus

In 2005, Eric Kenealy and his wife became franchisees of Massage Envy, a massage and skin care national franchisor.⁹ Over the next 10 years, the Kenealys purchased the licenses for several new locations and acquired numerous existing Massage Envy franchises.¹⁰ Each Massage Envy clinic was owned by a single member limited liability company, and managed by an entity known as Novarus Capital Group, Inc. (later changed to Novarus Capital Group, LLC).¹¹ The growth of the business necessitated additional management and more centralized operations.¹² With these considerations in mind, the Kenealys formed the holdingcompany, Novarus, in 2017 to act as the entity through which future Massage Envy clinics would be acquired.¹³

By April 2019, the Kenealys, either individually or through Novarus or related entities, were the franchisees of 18 successful Massage Envy locations employing more than 500 employees.¹⁴ Their success did not go unnoticed. In early 2019, the Franchisor offered Novarus the opportunity to enter into a so-called "Consolidator Agreement" that would provide Novarus several benefits not offered to all Massage Envy franchisees.¹⁵ The Term Sheet describing the transaction was dated January 2019.¹⁶ Although the Term Sheet was expressly non-binding and contemplated a yet-to-be-executed development agreement ("DA"), Massage Envy confirmed it would operate as if the Term Sheet was fully effective.¹⁷

As noted, Novarus enjoyed several benefits as a "Consolidator" under the Term Sheet.¹⁸ For instance, it was given preferential consideration for theacquisition of Massage Envy franchises offered for sale in the consolidated territory, which included Colorado, Utah, Idaho, Wyoming, Montana, New Mexico, Oklahoma and Las Vegas, Nevada.¹⁹ Specifically, it was granted a "right of first refusal" to purchase any existing Massage Envy locations that were for sale in the territory, as well as the exclusive first right to acquire any new locations in the territory that were offered for sale.²⁰

The Term Sheet included a schedule that contemplated the acquisition and development of 17 Massage Envy clinics within the first two years of the five-year agreement, and 50-70 locations by the term's end.²¹ To facilitate its growth, Novarus was encouraged by the Franchisor to partner with a private equity firm that could provide the necessary capital.²² To this end, Novarus determined it would seek an investor willing to acquire a majority interest in the Massage Envy franchises owned by Novarus...