Schiff v. ZM Equity Partners, LLC

Background

Jay Schiff sued ZM Equity Partners, LLC, Centre Lane Partners, LLC, Quinn Morgan, and 10 Lane Partners, LP. He relied on diversity jurisdiction and asserted breach-of-contract claims, claims for breach of the implied duty of good faith and fair dealing, tortious-interference claims, and two requests for declaratory relief.

Schiff’s 2009 employment agreement with ZM Equity Partners named him co-president of 10 Lane Finance Co., LLC and provided that he would receive 20% of the incentive compensation received by 10 Lane Partners. The incentive compensation vested over five years, and Schiff alleged that it was fully vested when he left his position in February 2015. He claimed that the defendants improperly continued investments after the investment period ended, delayed selling assets and distributing proceeds, sold assets at a discount to an entity controlled by Morgan, and charged excessive professional fees. He sought approximately the incentive compensation he said these actions reduced or withheld.

ZM Equity Partners was dissolved in 2016, and Delaware officials filed its certificate of cancellation on December 30, 2016. The court also noted that 10 Lane Partners was ZM Equity’s successor in interest. Schiff claimed that Centre Lane Partners was ZM Equity’s alter ego, meaning a separate entity that could be held responsible because the corporate form was misused.

Rule 12(b)(6) standard

The defendants moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint alleges enough facts to state a plausible legal claim. The court accepted the complaint’s factual allegations as true and viewed reasonable inferences in Schiff’s favor, but it did not accept bare legal conclusions.

Employment Agreement

The court held that ZM Equity Partners could not be sued because, under Delaware law, an LLC generally loses the capacity to sue or be sued after its certificate of cancellation is filed. Schiff alleged that the company had been wound up improperly, but the court found that allegation conclusory and unsupported by facts. All claims against ZM Equity Partners were therefore dismissed.

The court also rejected Schiff’s attempt to hold Centre Lane Partners liable as ZM Equity’s alter ego. Although Schiff likely alleged enough facts at this stage to suggest domination, the court found that he did not adequately allege misuse of the corporate form, fraud, or another wrongful act by Centre Lane Partners connected to his injury. The declaratory claim concerning Centre Lane Partners’ status as ZM Equity’s alter ego was dismissed.

The court allowed Schiff’s employment-agreement breach claim against 10 Lane Partners to proceed. The agreement said that Schiff “shall be entitled to receive 20%” of the incentive compensation received by 10 Lane Partners, while separately stating that ZM had discretion over bonuses and over compensation calculations and determinations. The court found the agreement ambiguous about whether the defendants could reduce Schiff’s share through calculations, fees, or expenses. It also found that the agreement did not clearly authorize conditioning payment on a release, particularly because contract changes had to apply equally to similarly situated employees. The employment-agreement claim was dismissed as to all defendants except 10 Lane Partners.

Implied covenant and tortious interference

The court dismissed Schiff’s claims for breach of the implied duty of good faith and fair dealing. Allegations that the defendants reduced or withheld incentive compensation or failed to provide information duplicated the express contract claim. Other allegations concerned duties under the LLC Agreement rather than an implied duty under the Employment Agreement. The court also dismissed the implied-covenant claim concerning the Confidentiality Agreement.

The court dismissed the tortious-interference claims. Under New York law, 10 Lane Partners could not interfere with a contract it had assumed, and Morgan was not a stranger to the Employment Agreement because he signed it for ZM Equity. Schiff’s allegations that Morgan acted for personal interests and with malice were conclusory and did not meet the heightened pleading standard. Under Delaware law, the tortious-interference claims concerning the LLC Agreement also failed because Morgan was connected to that agreement and the complaint did not adequately allege that he acted outside his authority or that Centre Lane Partners committed an independent tort.

LLC Agreement and derivative claims

The court held that several allegations concerning the LLC Agreement described harm to 10 Lane Finance itself, including reduced investment-asset value, delayed proceeds, and excessive fees. Those claims were therefore derivative claims, meaning claims brought on behalf of the company rather than for Schiff’s individual injury. Schiff had not made a demand on the company’s managers or pleaded why such a demand would have been futile. The court dismissed the LLC Agreement breach claim in its entirety, including the related implied-covenant claim.

Motion to amend and jurisdiction

Schiff moved to amend to add claims against Morgan and Centre Lane Partners and, alternatively, to allege that a demand would have been futile. The court denied the proposed amendments adding Morgan and Centre Lane Partners as futile because Schiff did not explain how those amendments would cure the defects.

The court did not immediately resolve the proposed amendment concerning demand futility. It directed Schiff and the defendants to submit supplemental briefing about joining 10 Lane Finance, the company on whose behalf the derivative claims would be brought, and whether the case should be returned to New York State Supreme Court. The court explained that 10 Lane Finance might be a necessary or indispensable party under Rule 19, but joining it would likely destroy complete diversity because it shared citizenship with Schiff and Morgan. The supplemental briefing was due September 2 and September 8, 2020, respectively.

Confidentiality Agreement

The court found that the agreement’s 12-month non-solicitation provision had expired in February 2016, making a declaration about that provision’s enforceability moot. But the court allowed Schiff’s declaratory claim concerning the agreement’s remaining confidentiality provisions to proceed. Those provisions broadly restricted disclosure or use of confidential information, and the court could not determine from the record which information required indefinite protection. Because Schiff alleged that the defendants had told him he might be violating the agreement, the court found an actual controversy that a declaration could clarify.

Disposition

The court granted in part and denied in part the defendants’ motion to dismiss. All claims against ZM Equity Partners were dismissed. The Employment Agreement breach claim was dismissed as to every defendant except 10 Lane Partners. The LLC Agreement breach claim, implied-covenant claims, tortious-interference claims, and declaratory claim concerning Centre Lane Partners’ alter-ego status were dismissed. Schiff’s declaratory claim concerning the Confidentiality Agreement could proceed. Schiff’s motion to amend was otherwise denied, and the parties were ordered to provide supplemental briefing concerning the proposed derivative claim, joinder of 10 Lane Finance, and possible remand.