IN THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION PLAINTIFF S RESPONSE TO DEFENDANTS PARTIAL MOTION TO DISMISS

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1 IN THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION FONDREN, LLC, individually and derivatively on behalf of Riverbank Realty, LP, Plaintiff, v. RIVERBANK REALTY GP, LLC, ALLEN GROSS, and GFI MANAGEMENT SERVICES, INC., Defendants - and - RIVERBANK REALTY, LP, Nominal Defendant. CIVIL ACTION NO. 4:09-CV PLAINTIFF S RESPONSE TO DEFENDANTS PARTIAL MOTION TO DISMISS Darryl W. Anderson State Bar No J. Benjamin Mitchell State Bar No FULBRIGHT & JAWORSKI L.L.P. Fulbright Tower 1301 McKinney, Suite 5100 Houston, TX Telephone: (713) Facsimile: (713) Dated: April 2, 2010 Counsel for Plaintiff Fondren, LLC, individually and on behalf of Riverbank Realty, LP

2 TABLE OF CONTENTS Page TABLE OF AUTHORITIES... ii NATURE AND STAGE OF PROCEEDING... 1 ISSUES TO BE RULED UPON AND STANDARD OF REVIEW... 1 SUMMARY OF ARGUMENT... 2 BACKGROUND FACTS... 3 ARGUMENT AND AUTHORITIES... 7 I. Plaintiff Has Properly Alleged a Claim for Breach of Fiduciary Duty... 7 A. Plaintiff has Properly Alleged a Derivative Claim on Behalf of Borrower The Law is Clear that Creditors May Assert Fiduciary Duty Claims Derivatively on Behalf of the Debtor Entity, as Plaintiff Has Done There Is No Basis for Defendants to Ignore Plaintiff s Derivative Allegations and Recharacterize Them as Direct Claims... 9 B. Plaintiff Has Properly Alleged Breaches of Fiduciary Duty by Gross and Riverbank GP Plaintiff Has Properly Pled a Breach of the Duty of Loyalty as a Component of Borrower s Fiduciary Duty Claim Plaintiff has Properly Pled a Breach of the Duty of Care as a Component of Borrower s Fiduciary Duty Claim a. Plaintiff s Allegations Comport with Delaware Law Requirements for Pleading a Due Care Violation b. Borrower s Fiduciary Duty Claim is Not Precluded by Plaintiff s Claim for Breach of the Guaranty II. Plaintiff has Alleged Claims for Aiding and Abetting and Conspiracy III. Plaintiff Has Properly Pled that GFI Management is the Alter Ego of Gross CONCLUSION i-

3 TABLE OF AUTHORITIES CASES Page(s) Aronson v. Lewis, 473 A.2d 805 (Del. 1984)...17 Ashcroft v. Iqbal, 129 S. Ct (2009)...1 Asher v. A G Edwards & Sons, 272 F. App x 357 (5th Cir. 2008)...12 Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007)...1 Brehm v. Eisner, 746 A.2d 244 (Del. 2000)...17, 19, 20 Cede & Co. v. Technicolor, Inc., 634 A.2d 345 (Del. 1993)...14, 22 Continuing Creditors Comm. of Star Telecomms. Inc. v. Edgecomb, 385 F. Supp. 2d 449 (D. Del. 2004)...12 Data Management Internationale, Inc. v. Saraga, No. 05C Del. Super. LEXIS 412 (Del. Super. Ct. July 25, 2007)...21 Desimone v. Barrows, 924 A.2d 908 (Del. Ch. 2007)...19 Erickson v. Pardus, 551 U.S. 89 (2007)...1 Garber v. Whittaker, 174 A. 34 (Del. Super. Ct. 1934)...21 Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939)...14 Guttman v. Huang, 823 A.2d 492 (Del. Ch. 2003)...2, 15 In re Katrina Canal Breaches Litig., 495 F.3d 191 (5th Cir. 2007) ii-

4 Lewis v. Vogelstein, 699 A.2d 327 (Del. Ch. 1997)...17 Lovelace v. Software Spectrum Inc., 78 F.3d 1015 (5th Cir. 1996)...2, 15 Martin K. Eby Constr. Co. v. Dallas Area Rapid Transit, 369 F.3d 464 (5th Cir. 2004)...1 Metro Commc n Corp. BVI v. Advanced MobileComm Techs. Inc., 854 A.2d 121 (Del. Ch. 2004)...19 North American Catholic Education Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007)...8, 9, 10, 13 Production Res. Group v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004)...8, 21 Robbins v. Oklahoma, 519 F.3d 1242 (10th Cir. 2008)...2 Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), overruled on other grounds by Gantler v. Stephens, 965 A.2d 695 (Del. 2009)...17, 22 Solomon v. Pathe Communications, 1995 Del. Ch. LEXIS 46 (Del. Ch. Apr. 21, 1995), aff d, 672 A.2d 35 (Del. 1996)...16 Steinman v. Levine, 2002 Del. Ch. LEXIS 132 (Del.Ch. 2002)...12, 16 Sysco Food Serv. of Metro N.Y., LLC v. Jekyll & Hyde, Inc., 2009 U.S. Dist. LEXIS (S.D.N.Y. Nov. 17, 2009)...23, 25 Terrebonne Homecare, Inc. v. SMA Health Plan, Inc., 271 F.3d 186 (5th Cir. 2001)...12 Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004)...8 Torch Liquidating Trust v. Stockstill, 561 F.3d 377 (5th Cir. 2009)...11, 12, 18 RULES AND STATUTES Fed. R. Civ. P. 12(b)(6)...1, 12 -iii-

5 Plaintiff Fondren, LLC, individually and derivatively on behalf of Riverbank Realty, LP, files this Response to Defendants Rule 12(b)(6) Partial Motion to Dismiss. NATURE AND STAGE OF PROCEEDING Plaintiff filed its Original Complaint on December 21, On February 26, 2010, Defendants filed their Partial Motion to Dismiss. A status conference is scheduled with the court on April 14, No discovery has been conducted. ISSUES TO BE RULED UPON AND STANDARD OF REVIEW Defendants have filed a partial motion to dismiss encompassing the following issues: 1. Whether Plaintiff has sufficiently pled derivative claims, on behalf of Riverbank Realty, LP, alleging breach of fiduciary duty; 2. Whether Plaintiff has sufficiently pled claims for aiding and abetting breach of fiduciary duty and for conspiracy; and 3. Whether Plaintiff has sufficiently pled that defendant Allen Gross is the alter ego of defendant GFI Management Services Inc. The standard of review for defendants arguments is well-known. To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009) (citation and quotation marks omitted). Factual allegations must be enough to raise a right to relief above the speculative level, on the assumption that all the allegations in the complaint are true (even if doubtful in fact). In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007) (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (quotation marks, citations, and footnote omitted)). When ruling on a defendant s motion to dismiss, a judge must accept as true all of the factual allegations contained in the complaint. Erickson v. Pardus, 551 U.S. 89, 94 (2007). Moreover, the court must view the well-pled facts in the light most favorable to the plaintiff. Martin K. Eby Constr. Co. v. Dallas Area Rapid Transit, 369 F.3d 464, 467 (5th Cir. 2004)

6 (citation omitted). The court may not dismiss on the ground that it appears unlikely the allegations can be proven. Robbins v. Oklahoma, 519 F.3d 1242, 1247 (10th Cir. 2008). Additionally, a defendant may not introduce new evidence for purposes of a motion to dismiss. Normally, in deciding a motion to dismiss for failure to state a claim, courts must limit their inquiry to the facts stated in the complaint and the documents either attached to or incorporated in the complaint. Lovelace v. Software Spectrum Inc., 78 F.3d 1015, (5th Cir. 1996); see also Guttman v. Huang, 823 A.2d 492, 499 (Del. Ch. 2003). SUMMARY OF ARGUMENT Plaintiff Fondren, LLC ( Plaintiff ) has filed a detailed complaint explaining the multiple ways in which defendants Allen Gross ( Gross ) and Riverbank Realty GP, LLC ( Riverbank GP ) have breached their fiduciary duties to nominal defendant Riverbank Realty, LP ( Borrower ). In particular, Gross and Riverbank GP have used their control over Borrower to cause it to distribute significant Borrower funds to defendant GFI Management Services, Inc. ( GFI ), an entity dominated and controlled by Gross himself. In so doing, defendants have disregarded Borrower s legal obligations, and indeed operated it in a manner in violation of those obligations while allowing substantial waster to occur to Borrower s assets. Delaware law expressly authorizes an entity in plaintiff s position to assert derivative claims on behalf of Borrower to recoup these substantial losses. By defendants motion, however, they seek to escape liability for these actions altogether. Improperly relying on factual allegations nowhere found in the Complaint and even contradicted by the Complaint in some instances defendants ask the Court to hold as a matter of law that plaintiffs cannot assert a derivative claim on behalf of Borrower, that the detailed allegations of wrongdoing by defendants are insufficient to state a claim for breach of either the -2-

7 fiduciary duty of loyalty or the fiduciary duty of care, and that, as a result, plaintiff s claims for aiding and abetting liability and conspiracy must also be dismissed. Capping off their motion, defendants ask the Court to hold as a matter of law that Gross does not so dominate GFI as to be its alter ego, notwithstanding the actions of Gross on behalf of GFI alleged in the Complaint and the statements about their intertwined relationship also cited in the Complaint. As explained below, defendants efforts to avoid accountability for their misconduct must be rejected, and their partial motion to dismiss should be denied in all respects. BACKGROUND FACTS As explained in exhaustive detail in the Complaint, the origins of this case date back to 2006, when Borrower borrowed $8.6 million from plaintiff s predecessor-in-interest, 1 to be used in connection with a 320-unit apartment complex located in Harris County. See Compl. 8, 10. As part of the security for this debt, defendant Gross, (1) on behalf of Borrower, executed an Assignment of Leases and Rents, and (2) in his individual capacity, executed a Guaranty Agreement. See id. 9 & Exs The management and control of Borrower is completely in the hands of defendants Riverbank GP and Gross. Riverbank GP is Borrower s general partner and has sole responsibility for management of Borrower. See id. 47 (citing Borrower s partnership agreement). Furthermore, defendant Gross has exclusive management authority over Riverbank GP. See id. 48 (quoting Riverbank GP s LLC agreement). Thus, by the express terms of the agreements, defendant Gross has the exclusive authority to control Riverbank GP, including the authority to dictate how Riverbank GP runs the Borrower. At the same time, these agreements 1 The holder of the promissory note and the various other loan documents that are at issue in this case has changed several times. See Compl. 10. For ease of reference, plaintiff will refer to itself or its predecessors-in-interest as plaintiff, except where context requires otherwise. Likewise, plaintiff will refer to all the various loan documents collectively unless a particular document is at issue. -3-

8 both explicitly state that Riverbank GP and Gross owe fiduciary duties to Borrower. See id (quoting agreements). Among the first things that Gross, acting through Riverbank GP, caused the Borrower to do was to hire defendant GFI as the property manager for the apartment complex. See, e.g., id. 32, 49, 66-69, 73. This decision was personally enriching to Gross because he has complete control and authority over GFI. See id. 49, 66, 73. In short, defendant Gross, using his control over the Borrower, secured an $8.6 million note in connection with a multi-unit apartment complex, and then directed payments from the Borrower to an entity he controlled. On or about January 1, 2009, Borrower became insolvent. See id. 60. Furthermore, beginning no later than January 2009, Borrower has been in breach of its obligations under the loan documents; indeed, Borrower has not made a single payment to plaintiff on its debt since December 2008, despite a contractual obligation to make monthly principal and interest payments. See id This failure to make any payments whatsoever to plaintiff was not due to lack of revenue. Instead, with revenue no longer sufficient to cover all of Borrower s debts as they came due, Riverbank GP and Gross knowingly, intentionally, and with gross negligence exercised their authority to cause Borrower to make payments out of the rents and other revenues received to Gross management company, GFI. See id. 64, Defendants decision to use Borrower s income to pay themselves violated Borrower s contractual obligation to make its payments to plaintiff prior to making payments to GFI, Gross management company; making payments to others prior to plaintiff constituted a misappropriation of the income from the property. See, e.g., id , 64, 67, 68, 73, 74. Indeed, the Assignment of Rents, specifically states any Rents so collected by Borrower shall be held in trust by Borrower for the sole and exclusive benefit of Lender and Borrower shall, within -4-

9 one (1) business day after receipt of any Rents, pay the same to Lender to be applied by Lender as hereinafter set forth. See id. at Ex The consequences of this self-interested decision by defendants were severe for Borrower. Money paid to GFI, after all, was money that was unavailable to be used to make repairs to the property. And, as plaintiff describes in the Complaint, the property had suffered significant damage as a result of Hurricane Ike, compounded by the mismanagement of defendants. See id , 39, 64, 67, 69. Had defendants caused Borrower to make the required payments to plaintiff, then plaintiff would have been able to use those funds to make the necessary repairs to the property, which repairs defendants were not themselves making. See id. 64. The property, after all, was plaintiff s collateral for the loan, and plaintiff, unlike defendants, has a vested interest in maintaining the value of the property. See id. 8-9, 64. Even insurance proceeds obtained by Borrower were distributed to GFI, rather than used to repair the property, in violation of the loan documents. See id. 67. As a result, the property, which (prior to foreclosure) was Borrower s sole asset, suffered from significant waste and has been substantially diminished in value. See id The property suffers from foundation issues, mold growth, rotted wood on exterior windows, missing siding, damaged roofs, and water damage to ceilings, walls, carpet, and sheetrock. See id. 35. At the time of filing the Complaint, eight percent of the units were completely unleasable, and over 30% of the units were vacant. See id. 36. The City of Houston has ordered plaintiff to relocate tenants in five of the 21 buildings on the property, and prohibited plaintiff from entering 2 Furthermore, while plaintiff is not required to marshal its evidence to defeat a motion to dismiss, it should be noted that, at trial, plaintiff will present evidence that defendant Gross, on behalf of Borrower, and defendant GFI Management Services executed a Manager s Subordination Agreement that specifically provided that payments would not be made to GFI unless and until plaintiff had been paid in full. -5-

10 into new leases for nearly one-half of the units. See id. Given the significant damage to the property caused by defendants actions, it is not surprising that when plaintiff foreclosed on the property, it sold for approximately 35% of its appraised value as of the origination of the loan, and only 47% of the original principal balance on the note. See id. 37. Several months into 2009, during which Borrower made no payments to plaintiff, plaintiff began to exercise its remedies under the loan documents against Borrower. Thus, on April 9, 2009, plaintiff sent a demand letter to Borrower and to Gross. See id. 15. No payments were made in response to this demand, however. See id. On May 29, 2009, therefore, plaintiff accelerated the note, and filed suit in state court, in Harris County, Texas. See id. 16. In response to plaintiff s request for a temporary restraining order, Borrower agreed to entry of a temporary injunction. See id. Subsequently, on July 10, 2009, plaintiff and Borrower reached agreement on an agreed order appointing a receiver for the property. 3 See id. After significant efforts by the Receiver to rehabilitate the property and mitigate the damage done by defendants, the property was sold at foreclosure on December 1, See id. 17. Plaintiff obtained the property at the foreclosure sale through entry of a credit bid, and the resulting deficiency under the loan was in excess of $6.9 million. See id. Having forestalled further damage to the property through the appointment of the Receiver and subsequent foreclosure, plaintiff now seeks to recover damages on behalf of itself, individually, and on behalf of Borrower, derivatively, for the damage inflicted by defendants. In particular, plaintiff has asserted a direct claim for breach of the guaranty agreement against Allen 3 Defendants seek to avoid the obligation to limit their grounds for dismissal to the facts alleged in the Complaint, asserting that the tenants were unreliable for payment, that their insurer was AIG, that they loaned some of their own money to Borrower, and that they tried to work with plaintiff to renegotiate the loan. See Mem. in Support 7-9. The court will not be surprised to hear that the plaintiff vigorously disputes the accuracy and characterization of these facts, which plaintiff will rebut at the appropriate time. In any event, they cannot be considered on a motion to dismiss. -6-

11 Gross, the guarantor, and against GFI, Gross alter ego. The viability of that claim is not disputed in defendants motion to dismiss. 4 In addition, plaintiff has asserted a derivative claim on behalf of Borrower against Gross and Riverbank GP (and against GFI, as alter ego of Gross) for breach of the fiduciary duties that they owe to Borrower. Plaintiff has also asserted an aiding and abetting claim against GFI for its conduct in facilitating the breach of fiduciary duties by Gross and Riverbank GP, as well as a conspiracy claim against all defendants. These claims are the subject of defendants motion to dismiss. As explained below, the detailed facts alleged by plaintiff amply support its fiduciary duty, aiding and abetting, and conspiracy claims, as well as its alter ego allegation. Therefore, the motion to dismiss should be denied. ARGUMENT AND AUTHORITIES I. Plaintiff Has Properly Alleged a Claim for Breach of Fiduciary Duty Defendants motion is primarily focused on plaintiff s fiduciary duty claim. To understand the nature of their challenge, it is important to note what defendants do not dispute. At least for purposes of their motion to dismiss, defendants do not dispute that Riverbank GP and Gross both owe fiduciary duties to Borrower. Nor do they dispute that plaintiff is a creditor of Borrower and that Borrower is insolvent. Defendants motion is premised on two alternative theories: (1) that plaintiff has not properly alleged a derivative claim; and (2) that plaintiff has not alleged sufficient facts to support breach of the fiduciary duties defendants admit they owe to Borrower. Both of these arguments are without merit. 4 Because defendants do not challenge the sufficiency of the plaintiff s claim for breach of the guaranty, plaintiff will omit a general discussion of the various requirements of that agreement. -7-

12 A. Plaintiff has Properly Alleged a Derivative Claim on Behalf of Borrower 1. The Law is Clear that Creditors May Assert Fiduciary Duty Claims Derivatively on Behalf of the Debtor Entity, as Plaintiff Has Done. The threshold issue raised by defendants motion is whether plaintiff, as a creditor of Borrower, may assert claims derivatively on Borrower s behalf for breach of fiduciary duties owed to Borrower by defendants. In the ordinary case of a solvent corporation, of course, a derivative suit enables a stockholder not a creditor to bring suit on behalf of the corporation for harm done to the corporation. Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1036 (Del. 2004). But the situation is different when the entity is insolvent. By definition, the fact of insolvency places the creditors in the shoes normally occupied by the shareholders that of residual risk-bearers. Production Res. Group v. NCT Group, Inc., 863 A.2d 772, 791 (Del. Ch. 2004). As defendants acknowledge, the question of the standing of creditors of an insolvent entity to assert claims for breach of fiduciary duty was conclusively resolved by the Delaware Supreme Court in North American Catholic Education Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007). In Gheewalla, the court dismissed the claims because the plaintiffs attempted to bring direct claims not derivative claims. In fact, in Gheewalla, [Plaintiff] did not attempt to allege a derivative claim. Id. at 102 (emphasis added). In the Court of Chancery and in this appeal, NACEPF waived any basis it may have had for pursuit of its claim derivatively. Instead, NACEPF seeks to assert only a direct claim for breach of fiduciary duties. Id. at 97 (emphasis added). The fact that creditors do not have a direct claim, however, does not mean that they cannot allege a claim for breach of fiduciary duty. Instead, Gheewalla holds that such claims must be brought derivatively, on behalf of the insolvent entity. As that court made clear, [t]he -8-

13 corporation s insolvency makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm s value. Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation. Id. at (citations and internal quotations omitted). Accordingly, in most, if not all instances creditors of insolvent corporations could bring derivative claims against directors of an insolvent corporation for breach of fiduciary duty. Id. at (attributing this to a chancery court opinion and endorsing the view) (citation omitted). The holding of Gheewalla, then, is that a creditor of an insolvent entity may not bring fiduciary duty claims directly, but, as plaintiff has done here, may bring them derivatively on behalf of the insolvent entity. There is no dispute that plaintiff has asserted its fiduciary duty claim in a derivative capacity in this suit, just as Gheewalla authorizes. In its Complaint, from the outset, plaintiff clearly pled valid derivative claims on behalf of Borrower. 5 Even defendants admit this is the case. See Mem. in Support 26 (grudgingly conceding that Plaintiff has attempted to cast its claims as derivative in nature ). 2. There Is No Basis for Defendants to Ignore Plaintiff s Derivative Allegations and Recharacterize Them as Direct Claims Undeterred by the holding of Gheewalla and the express pleading of plaintiff, defendants ask the Court to ignore the actual allegations in the Complaint and instead treat the Complaint as if plaintiff had alleged direct claims in its individual capacity, rather than derivative claims. According to defendants, plaintiff has disguised direct claims with a derivative band-aid. Id. 5 See e.g., Compl. 1 ( Furthermore Allen Gross and Riverbank Realty GP, LLC owe fiduciary duties to Riverbank Realty, LP, the breaches of which Plaintiff, as a creditor and due to Riverbank Realty, LP s insolvency, hereby asserts derivatively ); 57 ( Plaintiff brings this cause of action derivatively on behalf of Borrower, a Delaware limited partnership, against Borrower GP and Allen Gross. ); 61 ( Furthermore, when Borrower became insolvent, Borrower s creditors, including Plaintiff, as payee under the Note, took the place of Borrower s partners as residual beneficiaries of the partnership. As a result, Plaintiff is authorized to bring this derivative action against Borrower GP and Allen Gross. ). -9-

14 This argument fails for multiple reasons. First, it is premised on facts contradicted by the actual allegations in the Complaint. Second, it is based on a misreading of the lone case defendants cite as support for recharacterizing the allegations made in the Complaint. There is a wide gulf between the facts defendants imagine plaintiff pled and the actual allegations found in the Complaint. Defendants ask the Court to hold that plaintiff has failed to allege any harm to the Borrower, and to disregard the allegation that Borrower suffered nearly $7 million in damages because that damage figure is also the amount of damages alleged to have been suffered by plaintiff. See id The unstated (and mistaken) premise is that a derivative claim is improper if the injury to the entity on whose behalf the lawsuit is brought also resulted in an injury to the derivative plaintiff. This argument turns Gheewalla on its head. By definition, every creditor of an insolvent entity is owed money by that entity. As such, the creditor is, by definition, injured when the insolvent entity is injured, such as by having its funds misappropriated or its assets wasted. In fact, this is the precise reason that the Gheewalla court held that creditors do have standing to bring a derivative claim. See Gheewalla, 903 A.2d at ( The corporation s insolvency makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm s value. Therefore, equitable considerations give creditors standing to pursue derivative claims against the directors of an insolvent corporation. ) (citations and internal quotations omitted); see also id. at 103 ( Creditors may nonetheless protect their interest by bringing derivative claims on behalf of the insolvent corporation. ) (emphasis added). Thus, the fact that plaintiff was injured by virtue of the breaches of fiduciary duty to Borrower is not a reason to dismiss plaintiff s derivative claim as improper. It is instead the very reason that Delaware courts authorize creditors such as plaintiff to bring these claims derivatively in the first place. -10-

15 The case that defendants cite as authority for disregarding plaintiff s derivative damages allegations does not stand for that proposition. See Torch Liquidating Trust v. Stockstill, 561 F.3d 377 (5th Cir. 2009). To properly appreciate defendant s misplaced reliance on Torch, it is critical to note the Fifth Circuit s pronouncement that, unlike this case, this is not a derivative suit. The Trust is the plaintiff neither a shareholder nor a creditor is the plaintiff. Id. at 388 n.11. The Fifth Circuit dismissed the claims in Torch, not because the plaintiff pled both direct damages (on behalf of itself) and derivative damages (on behalf of the corporation), but rather because the Torch plaintiff failed to allege any actual, quantifiable damages suffered by the corporation. Id. at 390. This deficiency was especially glaring because [w]hen asked during oral argument to identify any specific pleading permitting an inference of injury to Torch, plaintiff could identify none. Id. (emphasis added). Moreover, it was clear that the Fifth Circuit was suspicious of the complaint and its allegations plausibility because the plaintiff acknowledged that, when amending its complaint, rather than engaging in substantive analysis and investigation of the claims it alleged, it simply replaced nearly all of its prior references to creditors with new references to creditors and shareholders. Id. Even more absurdly, the plaintiff also assured the court that, if necessary, it could easily amend its complaint further by engaging in another find and replace exercise to allege whatever damages to the corporation the court specified. Id. at 382, 391. Unlike Torch, this Complaint contains derivative allegations which specify actual, quantifiable damages suffered by Borrower which arise from validly pled derivative causes of action. See, e.g., Compl. 64, 69, 74. Despite what defendants motion to dismiss argues, the pleading of both direct and derivative damage amounts in the same pleading does not in any way -11-

16 invalidate the derivative damages allegations contained in the Complaint. 6 The derivative damages suffered by Borrower are plausible, actual, and quantifiable damages no mere bandaid and are sufficient to satisfy the pleading standards of Rule 12(b)(6). 7 In short, defendants cannot refashion the Complaint in a manner that better suits their dismissal briefing by pretending that, like the plaintiff in Torch, absolutely no actual, quantifiable damages to the corporation were alleged within it. The Fifth Circuit has noted on many occasions that plaintiff is the master of his complaint. Asher v. A G Edwards & Sons, 272 F. App x 357, 359 (5th Cir. 2008) (citing Terrebonne Homecare, Inc. v. SMA Health Plan, Inc., 271 F.3d 186, 189 (5th Cir. 2001)). A defendant is not entitled to a dismissal based on the deficiencies that they wish had been pled. Here, plaintiff properly pled derivative claims, not disguised direct claims as Defendants wish. 8 6 Defendants attempt to make something out of the fact that plaintiff alleged the same damage amount for Borrower on the derivative claim as for plaintiff on its direct claim. It is true, of course, that the evidence may ultimately establish that defendants breaches caused damages to Borrower greater than the amounts that Borrower owed to plaintiff, so that there may ultimately be a recovery sufficient for Borrower to comply with its obligations to plaintiff and to fulfill additional obligations that may arise thereafter as well. And perhaps defendants believe they will be able to provide evidence showing that their breaches damaged Borrower in an amount less than the full amount Borrower owed to plaintiff. But plaintiff pleaded damages based on the best information available to it at this time as to the impact of the misappropriation of funds and the waste suffered by the property due to defendants actions. Whatever the evidence ultimately reveals on this point, merely because defendants disagree with the amount plaintiff pleaded is not a reason for dismissal for failure to state a claim. 7 The alleged breaches of the duty of care found in the Complaint, for example, are premised on corporate waste and corporate mismanagement prototypical derivative claims under Delaware law. Continuing Creditors Comm. of Star Telecomms. Inc. v. Edgecomb, 385 F. Supp. 2d 449, 457 (D. Del. 2004) (citing Steinman v. Levine, 2002 Del. Ch. LEXIS 132, at 41 n.50 (Del.Ch. 2002) (noting that events affecting all stockholders in the same way, such as corporate waste and mismanagement, falls squarely within the definition of a derivative action. )). 8 Even if defendants were correct, it appears from defendants Memorandum that their argument extends only to the allegations that defendants breached the duty of care component of their fiduciary duties. See Mem. in Support 34 ( [A] closer look at the breach of fiduciary duty of care claim shows that Plaintiff is complaining about alleged actions by the Defendants that harmed the Plaintiff, not the Borrower. ) (first emphasis added). Defendants challenge to the duty of loyalty claim, see id , contains no such argument. This concession that plaintiff has properly asserted a derivative claim based on a breach of the duty of loyalty means that plaintiff s claim for breach of fiduciary duty cannot be dismissed. -12-

17 B. Plaintiff Has Properly Alleged Breaches of Fiduciary Duty by Gross and Riverbank GP Under Delaware law, the two main fiduciary duties owed are: (1) a duty of care; and (2) a duty of loyalty. Even when a company is navigating through the so-called zone of insolvency, the focus for Delaware directors of corporations does not change under Delaware law, directors must continue to discharge their fiduciary duties. See Gheewalla, 930 A.2d at 101. Plaintiff has alleged, on behalf of Borrower, that Riverbank GP and Gross have breached both their fiduciary duty of loyalty and their fiduciary duty of care to Borrower. A properly pled breach of either of these duties is independently sufficient to support plaintiff s breach of fiduciary duty claim. Thus, defendants are not entitled to dismissal unless they can establish as a matter of law, accepting the well-pled allegations of the Complaint as true, that plaintiff will not be able to establish a claim for breach of either of these components of Riverbank GP s and Gross fiduciary duties. As explained below, they fail to do so. 1. Plaintiff Has Properly Pled a Breach of the Duty of Loyalty as a Component of Borrower s Fiduciary Duty Claim The duty of loyalty prohibits self-dealing and the usurpation of corporate opportunities by directors. Delaware courts have defined the duty of loyalty as follows: Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests....a public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it, or to enable it to make in the reasonable and lawful exercise of its powers. The rule that requires an undivided and unselfish loyalty to the corporation demands that there be no conflict between duty and self-interest. -13-

18 Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. 1939). In sum, the duty of loyalty mandates that the best interests of the corporation and its shareholders takes precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the stockholders generally. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). In seeking dismissal of the duty of loyalty aspect of plaintiff s claim for breach of fiduciary duty, defendants do not dispute that Gross received a personal benefit from payments to GFI or that the management contract is a self-interested transaction. See, e.g., Compl Their sole contention is that the payments made to GFI were lawfully owed, and they imply that plaintiff is merely complaining that Borrower paid one valid claim over another. Defendants assert that there are no allegations that these payments were not fair or that the Borrower was not contractually obligated to make the payments, nor are there any allegations that Plaintiff took any steps under the loan documents to stop such payments. Mem. in Support 46. The Complaint does, however, make those allegations: Borrower GP and Allen Gross allowed and or caused Borrower to make payments to GFI Management and to Borrower s attorneys, which payments were funded out of the rents and revenues from the Property. This conduct by Borrower GP and Allen Gross was willful, intentional, and/or grossly negligent. Borrower GP and Allen Gross made these payments on behalf of Borrower despite having actual knowledge that the receivership was imminent and that Borrower was contractually obligated to pay all rents and revenues received from the Property to Noteholder. Compl Indeed, the Assignment of Rents, attached as Exhibit 3 to the Complaint, makes clear that defendants cannot use proceeds from rents to pay GFI if Borrower s obligations under 9 See also id. 25 (alleging Borrower misapplied security deposits in violation of Receivership Order); id. 32 (alleging Borrower used rents to pay GFI, contrary to obligations of Deed of Trust and Assignment of Rents); id. 67 (alleging payments were made to GFI instead of repairing property, despite a contractual obligation to make payments to plaintiff, which could have used the money to make the needed repairs); id. 74 (alleging that GFI s acceptance of payments constituted a violation of the loan documents). -14-

19 the loan documents have not first been satisfied, because those rents shall be held in trust by Borrower for the sole and exclusive benefit of Lender. Id. at Ex. 3. Unable to support their motion based on the actual allegations in the Complaint, defendants attempt to allege facts of their own as a basis for dismissal. Thus, they assert that GFI was approved by the Lender and not removed prior to the appointment of the Receiver. See Mem. in Support 45. Reliance on such facts outside of the Complaint is not proper on a motion to dismiss. See, e.g., Lovelace, 78 F.3d at The merits of that well-known rule are particularly apparent in this case. For the evidence will show that plaintiff secured an agreement from GFI in which GFI agreed that it was not entitled to any payments until plaintiff was fully paid. 11 This Manager s Subordination Agreement provides that: The Manager agrees that the liens of the Loan Documents, and Lender s right to payment under the Loan Documents, shall be superior to and have priority over the Management Agreement as well as any claim, security interest or right to payment of the Manager arising out of or in any way connected with its services performed under the Management Agreement. In furtherance of the foregoing, the Manager hereby fully and completely subordinates to the lien of the Loan Documents, and to Lender s right to payment under the Loan Documents, the following: (a) the Management Agreement; (b) any such claim or security interest the Manager may now or hereafter have against the Property and/or the rents, issues, profits and income therefrom; and (c) any right to payment of the Manager arising out of or in any way connected with its services performed under the Management Agreement. Ex. A, Manager s Subordination Agreement 4 (emphasis added). 10 Delaware courts likewise refuse to consider allegations outside the complaint when ruling on motions to dismiss challenging fiduciary duty claims. I am obliged to turn down the defendants invitation to use these allegations as a factor in my analysis of their motion to dismiss. Instead, I will consider their motion against a record confined to the well-pled allegations of the complaint. Likewise, I will draw all reasonable inferences from the non-conclusory factual allegations of the complaint in the plaintiffs favor. Guttman v. Huang, 823 A.2d 492, 499 (Del. Ch. 2003) (footnotes omitted). 11 A copy of this agreement is attached hereto as Exhibit A. Plaintiff attaches this document solely to demonstrate that its factual allegations will be supported by evidence at trial. -15-

20 In light of plaintiffs actual allegations, the cases relied on by defendants are simply inapposite. For instance, defendants cite Steinman v. Levine, 2002 Del. Ch. LEXIS 132 (Del. Ch. 2002), for the proposition that a payment to an insider or self-interested director without more is not a breach of the duty of loyalty. Mem. in Support 43. Here, unlike in Steinman, there is more. In Steinman, the court noted that the plaintiff makes no claim for waste and does not even claim that [the self-interested payment] was not entirely fair. Id. at *45. Plaintiff s Complaint is replete with such allegations. Defendants had a clear obligation not to make payments to themselves, which they ignored. Their actions causing the Borrower to make payments to GFI ultimately resulted in further waste to the partnership while profiting Gross, individually. Indeed, they continued to do so even while agreeing to the appointment of a Receiver, ensuring that as much as possible of the Borrower s assets were transferred to GFI before the Receiver took over. See Compl. 68. Similarly, Solomon v. Pathe Communications, 1995 Del. Ch. LEXIS 46 (Del. Ch. Apr. 21, 1995), aff d, 672 A.2d 35 (Del. 1996), is of no assistance to defendants argument. Indeed, that case spelled out the type of allegations that would survive a motion to dismiss, which allegation are present in this case: [P]laintiff would state a claim if he alleged that [defendant] had valid legal grounds to oppose or forestall the foreclosure, which it did not exercise. In that event a breach of loyalty would arguably be provable. But here there is no allegation that [defendant] did possess rights or claims that could have been used by [defendant] legitimately to thwart the [challenged transaction]. Solomon, 1995 Del. Ch. LEXIS 46, at *17. The Complaint adequately alleges a claim for breach of fiduciary duty based on violations of defendants duty of loyalty, and therefore the motion to dismiss plaintiff s fiduciary duty claim must be denied. -16-

21 2. Plaintiff has Properly Pled a Breach of the Duty of Care as a Component of Borrower s Fiduciary Duty Claim To fulfill their duty of care, it has long been the law in Delaware that fiduciaries must: inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed, they must then act with requisite care in the discharge of their duties. While the Delaware cases use a variety of terms to describe the applicable standard of care, our analysis satisfies us that under the business judgment rule director liability is predicated upon concepts of gross negligence. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984); see also Brehm v. Eisner, 746 A.2d 244, 259 (Del. 2000) (explaining Delaware jurisprudence that, in making business decisions, directors must consider all material information reasonably available, and that the directors process is actionable only if grossly negligent ); Smith v. Van Gorkom, 488 A.2d 858, (Del. 1985) (holding that a director s duty to exercise an informed business judgment is in the nature of a duty of care ), overruled on other grounds by Gantler v. Stephens, 965 A.2d 695, 713 n.54 (Del. 2009). In addition, a fiduciary violates his or her duty of due care under Delaware law when a plaintiff can establish corporate waste. See Brehm, 746 A.2d at 263. As the Delaware Supreme Court has explained, Most often the claim is associated with a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift. Id. (quoting Lewis v. Vogelstein, 699 A.2d 327, 336 (Del. Ch. 1997)). Plaintiff has alleged that defendants violated their duty of due care in two principal respects: (1) by allowing the property to waste; and (2) by causing Borrower to violate its contractual obligations, which required Borrower to pay to plaintiff all rents and revenues from the property, to remit to plaintiff insurance proceeds, and to otherwise comply with the terms of the loan documents. See Compl. 63. Defendants knew that a failure to repair the property after the hurricane would result in waste of the property, and they likewise knew that the terms of the -17-

22 loan documents prohibited payments to GFI unless and until plaintiff had been paid. See 64, 67. Notwithstanding this knowledge, they made the decision grossly negligent at best, if not willful and intentional to redirect the assets of Borrower to GFI. See id. 65. Defendants argue these allegations fail to state a claim for breach of the duty of care on several grounds. First, defendants claim that plaintiff has not pled a proper duty of care claim because plaintiff has not alleged facts regarding the process by which defendants reached their decision to cause Borrower to disregard its contractual obligations under the loan documents. See Mem. in Support 33. Second, defendants argue that a duty of care claim based on the waste they caused the property to suffer is precluded because plaintiff, in its individual capacity, has a claim against defendant Gross under the guaranty agreement. See id. 37. Lastly, they allege that plaintiff has failed to plead sufficient facts to overcome the application of the business judgment rule. 12 See id All of these arguments are without merit. a. Plaintiff s Allegations Comport with Delaware Law Requirements for Pleading a Due Care Violation Defendants argument that plaintiff failed to allege facts challenging the process by which they decided to cause Borrower to disregard its contractual obligations is refuted by abundant Delaware authority. A number of cases have recognized that a decision-making process by which a fiduciary determines to flout legal obligations is a violation of the duty of care. As one court has explained: Although directors have wide authority to take lawful action on behalf of the corporation, they have no authority knowingly to cause the corporation to become a rogue, exposing the corporation to penalties from criminal and civil regulators. Delaware corporate law has long been clear on this rather obvious notion; namely, 12 Defendants also challenge plaintiff s duty of care allegations on the ground that they are not a proper derivative claim, relying on the Torch decision. See id Because this contention is rebutted in the preceding section, plaintiff will not repeat that argument here. -18-

23 that it is utterly inconsistent with one s duty of fidelity to the corporation to consciously cause the corporation to act unlawfully. Desimone v. Barrows, 924 A.2d 908, 934 (Del. Ch. 2007) (footnote omitted); Metro Commc n Corp. BVI v. Advanced MobileComm Techs. Inc., 854 A.2d 121, 131 (Del. Ch. 2004) ( Under Delaware law, a fiduciary may not choose to manage an entity in an illegal fashion, even if the fiduciary believes that the illegal activity will result in profits for the entity. ). The Metro Communication decision is particularly instructive. The facts of that case are complicated, but the core allegation was that the fiduciaries of a limited liability company known as Fidelity Brazil caused Fidelity Brazil to violate a contractual obligation to disclose to plaintiff Metro a material adverse event. The court found this conduct to constitute a breach of the duty of care:... [T]he proposition that the managers of an LLC have no fiduciary duty at all to ensure that the LLC lives up to its contractual duties is one that is difficult to accept and that is certainly not supported by prior precedent. How can an LLC perform a contract except through its managers and officers? * * * In addition to any contractual duties owed by Fidelity Brazil and its managers, the managers owed a fiduciary duty of loyalty and care to Fidelity Brazil. Those duties obviously include the requirement to make good faith efforts to ensure that the LLC fulfilled its contractual duty to its members. Metro Commc n, 854 A.2d at 141 n.32, 153 (footnotes omitted). Even the case cited by defendants as the basis for their dismissal argument demonstrates that dismissal is not appropriate in this situation. In Brehm, one of the allegations made was that Disney s board violated its duty of care by causing Disney to make a severance payment to its terminated president, Michael Ovitz, rather than terminating him for cause and refusing to make the payment. The court found that [c]onstrued most favorably to plaintiffs, the best plaintiffs had alleged was that the Board had arguable grounds to fire Ovitz for cause. Brehm, 746 A.2d at -19-

24 265. As a result, the Complaint fails on its face to meet the waste test because it does not allege with particularity facts tending to show that no reasonable business person would have made the decision that the New Board made under these circumstances. Id. at 266. In this case, by contrast, plaintiff has alleged that Borrower had an express contractual obligation to make payments first to plaintiff, prohibiting payments to GFI until the obligation to plaintiff had been satisfied. That is more than sufficient to satisfy the requirements for pleading a violation of the duty of care. b. Borrower s Fiduciary Duty Claim is Not Precluded by Plaintiff s Claim for Breach of the Guaranty Defendants also argue that the fact that plaintiff has a direct claim for breach of the guaranty against Gross somehow bars Borrower s claim, asserted derivatively by plaintiff, for breach of fiduciary duty, calling it bootstrapping. See Mem. in Support 37. Defendants rely on Kuroda v. SPJS Holdings, LLC, for this proposition. 971 A.2d 872 (Del. Ch. 2009). However, in Kuroda, unlike here, one plaintiff used a single direct injury to allege both a breach of contract claim and a tort claim. See id. at 889. There, the court recognized that although the plaintiff attempted to plead a tort claim for conversion, it was really duplicative of [plaintiff s] breach of contract claim. Id. The court in Kuroda further explained that plaintiff s tort claim was barred because it arose solely from a breach of contract. Id. (emphasis added). On the other hand, the court instructed, when a plaintiff alleges that a defendant violated an independent legal duty, apart from the duty imposed by contract, the claim may stand. Id. (emphasis added). Here, plaintiff s contract claim and Borrower s fiduciary duty claim are claims that belong to two different parties, under two different causes of action, for two entirely different injuries. The fiduciary -20-

25 duties of care and loyalty that defendants owe to Borrower are completely independent of the contractual duty that Defendants owe to plaintiff. Defendants also quote Data Management Internationale, Inc. v. Saraga, No. 05C Del. Super. LEXIS 412 (Del. Super. Ct. July 25, 2007), to support this argument. Mem. in Support 37. However, Data Management stands for exactly the opposite proposition, and in fact, the court denied the defendant s motion to dismiss and held that both the tort and contract claim could stand. The court explained that a tort claim may be asserted alongside a contract claim where the plaintiff alleges the defendant breached a tort duty independent of any obligations imposed by the contract. Id. at *11. That is exactly the case here. Defendants fiduciary obligation to Borrower did not arise by the mere agreement between Gross and plaintiff which is memorialized in the guaranty. See id. at *13, n.32 (citing Garber v. Whittaker, 174 A. 34, 36 (Del. Super. Ct. 1934)). Borrower was not even a party to the Guaranty. 13 Finally, defendants cannot defeat plaintiff s breach of the duty of care allegation based on the business judgment rule. Defendants appear to suggest that a plaintiff must plead additional facts to overcome the business judgment rule, separate and apart from what it must plead to establish a violation of the duty of care (and the duty of loyalty, as well). If that is defendants argument, it is mistaken. As the Delaware Supreme Court has explained: The [business judgment] rule posits a powerful presumption in favor of actions taken by the directors in that a decision made by a loyal and informed board will not be overturned by the courts unless it cannot be attributed to any rational business purpose. Thus, a shareholder plaintiff challenging a board decision has the burden at the outset to rebut the rule s presumption. To rebut the rule, a 13 Nor does Production Resources, 863 A.2d 772, aid defendants argument. See Mem. in Support 37. In that case, the court simply made the unsurprising observation that plaintiff s allegation that defendants reneged on a promise to sell stock was more properly a contract or misrepresentation claim and not a claim for breach of fiduciary duty. Id. at 79 n.88. Nothing in that decision supports the contention that a valid fiduciary duty claim becomes invalid if there is a separately valid, independent contract claim. -21-