Court Rejects Attorney’s “Post Hoc Rationalization”

The Delaware Court of Chancery gets more than its share of human and corporate drama as reflected in this recent opinion.

The matter arose in the wake of the fiery death in a car accident of a 30-year-old who had recently pled guilty to a Ponzi scheme and was awaiting sentencing. 

The Los Angeles Times reported

Before his death on November 5, 2017, Michael Llamas owned a 90% member interest in Stone Ash, LLC (the “Company”), and he served as one of its two managers. Defendant Stuart Titus owned the other 10% member interest and served as its other manager. When Michael died, his status as a member terminated, and the economic rights associated with his interest passed to his estate.  Michael’s status as a manager likewise terminated. Titus was left as the sole member and sole manager of the Company.

The Company owned a large block of stock in Medical Marijuana, Inc., an Oregon corporation that is a development-stage, penny-stock issuer involved in cannabis-related businesses. Its shares trade over the counter under the symbol “MJNA,” which this decision uses to refer to the issuer. Through his positions with the Company, Michael managed MJNA’s operations, despite not having any formal position with that entity.

Michael’s death left Titus in control of the Company and, through it, MJNA. Enter James Arabia, one of Michael’s advisors. After learning of Michael’s death, Arabia moved quickly to assert control over the Company. He did so by advising Titus to appoint defendants John Huemoeller and Timothy Scott as additional managers, explaining that they could support Titus and that Michael would have wanted it that way. Huemoeller and Scott are beholden to Arabia, and adding them would give Arabia control over the Company at the manager level. Moreover, under the terms of the Company’s then-operative LLC agreement (the “Original LLC Agreement”), Huemoeller and Scott could remove Titus as a manager, thereby consolidating Arabia’s control.

Titus followed Arabia’s advice. On November 7, 2017, two days after Michael’s death, Titus executed a written consent that appointed Huemoeller and Scott as additional managers (the “November 7 Consent”). Only after signing the November 7 Consent did Titus become concerned about its implications. He reached out to Stephen Silverman, a lawyer who had represented the Company. After meeting with Silverman, Titus understood that he had handed over control to Arabia. He was shocked and dismayed, and he asked Silverman to fix the problem he had created.

Meanwhile, members of the Llamas family learned about Arabia’s coup. A flurry of communications and meetings ensued. On November 13, 2017, Titus and Silverman met with the plaintiffs: Steven Llamas, Michael’s father, and Jeffrey Llamas, Michael’s brother. Titus executed a new LLC agreement for the Company (the “Amended LLC Agreement”). Among other things, it established a board of managers with a maximum of three members. In three locations, it described Titus as the sole member and manager of the Company. The description was inaccurate, because no one ever took action to remove Huemoeller or Scott.

During the same meeting, Titus executed a written consent that purported to appoint Titus, Steven, and Jeffrey as members of the board of managers (the “November 13 Consent”). But it did not first remove any of the incumbent managers. Several days later, Titus told Arabia about the Amended LLC Agreement and the November 13 Consent. Arabia convinced Titus to return to the fold. On November 20, 2017, Titus executed another LLC agreement for the Company (the “Final LLC  Agreement”). On November 21, 2017, Titus executed a written consent that purported tonremove Steven and Jeffrey and replace them with Huemoeller and Scott (the “November 21 Consent”).

In this lawsuit, Steven and Jeffrey contend that they were properly appointed as managers but never properly removed. Although they do not dispute the effectiveness of the Final LLC Agreement, they contend that the November 21 Consent is invalid along with all of the actions that the board of managers subsequently took.

In response to this lawsuit, the defendants have raised an array of arguments and defenses, one of which is dispositive. Assuming for the purposes of analysis that Titus validly adopted the Amended LLC Agreement (which the defendants otherwise contest), the defendants correctly point out that Titus never removed the incumbent managers.

This post-trial decision holds that the November 13 Consent did not appoint Steven and Jeffrey to the board of managers. Once adopted, the Amended LLC Agreement limited the size of the board to three managers. With Titus, Huemoeller, and Scott occupying those seats, there were no vacancies to fill. The November 13 Consent therefore provides no basis to challenge any actions that the managers of the Company subsequently took. Since November 7, 2017, the Company’s managers have been Titus, Huemoeller, and Scott.

The court had to sift through the mess 

All of the witnesses had some type of credibility issue, and many had several. The members of the Llamas family, the named defendants, and Arabia had personal interests in the outcome of the case and strong feelings about each other. Titus was a particularly unreliable witness who repeatedly changed his story and offered dubious interpretations of contemporaneous documents. Arabia, Huemoeller, and Scott were confident witnesses, but they had the air of confidence men. They seemed only to be telling part of the story. Steven and Jeffrey were generally credible, but they had the least first-hand knowledge about significant events, and Jeffrey had some unconvincing memory lapses. Silverman and Priscilla Vilchis, Michael’s girlfriend when he died, testified by deposition. Their accounts were mixed: Some portions seemed credible, others exaggerated, and still others undermined by conspicuous failures of memory.

After signing away control, Titus had talked to the company’s outside counsel

During the meeting, Silverman explained the implications of appointing Huemoeller and Scott, including that they could outvote Titus on the Executive Committee and remove him as a manager. Id. at 7–8; Titus Tr. 201–02. Until his meeting with Silverman, Titus thought that Huemoeller and Scott were serving as business advisors; he did not realize they could outvote him, much less fire him. Titus asked Silverman to “undo” what he had done and “fix it.”

Silverman agreed to look into it. After the meeting, Titus sent Silverman an email that attached a copy of the November 7 Consent. See JX 33. In the body of the email, Titus offered a confused and unpersuasive rationalization about why he did not believe he had done anything meaningful by signing it, positing that it related to a different entity. See id. Titus also sent Silverman the Original LLC Agreement.

They met the next day

On the morning of Monday, November 13, 2017, Titus met with Silverman and Vilchis for breakfast at the Fairmont Grand Del Mar. Jeffrey joined the meeting partway through. Titus was shocked and upset that he had signed the November 7 Consent and worried about the implications of turning over control of the Company to Arabia.  The group discussed reconvening that evening at Jeffrey’s house.

After the meeting, Silverman asked a Delaware attorney for an informal reaction to Titus’s suggestion that the November 7 Consent related to a different entity. See JX 46. Not surprisingly, Titus’s rationalization did not pan out.

Silverman had a first-year associate prepare drafts of what became the Amended LLC Agreement and the November 13 Consent. JX 47; see Silverman Dep. 122. Silverman made a few changes to the draft Amended LLC Agreement; he did not make any changes to the draft November 13 Consent.

That evening, Titus, Silverman, Steven, Jeffrey, and Jeffrey’s wife, Shannon Llamas, gathered at Jeffrey’s house. Silverman brought with him an unexecuted copy of the Amended LLC Agreement and an unexecuted copy of the November 13 Consent.

After food was delivered, the group gathered around a kitchen island. Titus said he had made a “terrible mistake” by giving Arabia control. Steven Tr. 65–66. Silverman summarized the documents. He told Titus that the documents removed Huemoeller and Scott and elected Steven and Jeffrey. Id. at 67, 71; Silverman Tr. 22–33. Titus skimmed them quickly, then signed.

The Original LLC Agreement had established a manager-managed structure, vested management authority in an “Executive Committee” of “not more than five (5) members,” and designated each member of the Executive Committee “as a Manager.” JX 10 § 5.1. The Amended LLC Agreement abandoned the language of the Executive Committee and provided instead that the “sole Member and Manager may appoint a Board of Managers” of “up to three (3) Managers.” JX 41 § 7. It described Titus as the sole member and manager. That description was only half right: Titus was the sole member, but he was not the sole manager. By executing the November 7 Consent, Titus had appointed Huemoeller and Scott as additional managers.

But the amended agreement did not protect Titus as intended

The November 13 Consent did not purport to remove Huemoeller or Scott as managers. Silverman testified that in his opinion, by reciting that Titus was the sole manager, the Amended LLC Agreement removed every manager other than Titus. As a result, he believed that Titus could fill the vacancies by executing the November 13 Consent. See Silverman Tr. 29.

In my judgment, Silverman’s opinion is a post hoc rationalization. I think the first year associate overlooked the issue of removing Huemoeller and Scott, and Silverman did not catch it. They were working quickly, and it is particularly easy to make drafting mistakes when dealing with LLCs, which often involve bespoke governing documents. If Silverman or his associate had spotted the issue, then they would have taken the easy step of providing expressly for the removal of Huemoeller and Scott. There was no need to risk having the validity of their fix turn on the prospect of an inaccurate recital having substantive effect. Silverman and his associate similarly did not spot a problem that the defendants would fixate on in this litigation, namely that the Amended LLC Agreement provided that “[i]n each Fiscal Year of the Company, all profits and losses shall be allocated to the sole Member.” JX 41 § 3. Although it was true that Titus was the sole member as a result of Michael’s death, it was not true that all profits and losses would go to him. Instead, as the holder of an assignee interest resulting from the transfer of Michael’s units by operation of law, Michael’s estate would receive its pro rata share. By adopting this provision, the Amended LLC Agreement erroneously purported to divest Michael’s estate of its economic interest in the Company, which no one intended.

Danger malpractice alert

Silverman and his associate failed to draft the documents necessary to effectuate the changes that they sought to have Titus implement. Because there were lawyers on both sides, this is not a case where evidence of intent should override the documents themselves.

Here

…there is no basis to challenge the validity of the actions taken by the managers after that date based on claims that Steven and Jeffrey became managers and were never properly removed.

The parties will confer regarding next steps in the case. If there are other outstanding issues that the court needs to address before a final order can be entered, then the parties shall submit a joint letter within fourteen days that identifies them and proposes a path to bring this case to a conclusion at the trial level. Otherwise, the parties shall submit a form of order implementing the rulings in this decision.

(Mike Frisch)