SCOTTSDALE INSURANCE CO., Plaintiff, -v- PATRICK M. MCGRATH, AH DB KITCHEN INVESTORS LLC, and CASTLEGRACE EQUITY INVESTORS, LLC, Defendants.
19-cv-7477 (LJL)
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
December 11, 2020
USDC SDNY DOCUMENT ELECTRONICALLY FILED DOC #: DATE FILED: 12/9/2020
OPINION AND ORDER
Plaintiff Scottsdale Insurance Company (“Scottsdale“) moves, pursuant to
BACKGROUND
A. Relevant Parties
Scottsdale is the insurer on Business and Management Indemnity Policy number EKS3172343, Dkt. No. 1-1 (the “Watershed Policy“), issued to Watershed Ventures, LLC (“Watershed“). The Watershed Policy affords, subject to its terms, conditions, and exclusions, Directors and Officers and Company Coverage (“D&O Coverage“).
Patrick McGrath (“McGrath“) is an individual.
The dispute concerns a failed restaurant that was to be opened in Aspen, Colorado by a joint venture, Rocky Aspen, LLC (“Rocky Aspen“), whose members were Rocky Aspen Management 2014, LLC (“RAM 204“), a wholly owned subsidiary of Watershed, and AH DB Kitchen Investors
The present motion presents the question of whether McGrath—who was a co-manager of Rocky Aspen until January 5, 2016—is an insured under the Watershed Policy (“Insured“) and entitled to coverage for claims brought against him stemming from the failure of Rocky Aspen in the period between March 26, 2015 and January 5, 2016.
B. Pertinent Policy Provisions
The Watershed Policy, which had a policy period from November 6, 2015 to November 6, 2016, covers Watershed, its subsidiaries, and their directors and officers.
Under the Watershed Policy, “Company” is defined as the “Parent Company” (i.e., Watershed) and any “Subsidiary“. See Watershed Policy, General Terms and Conditions § B(2).
“Subsidiary,” in turn, is defined as:
- Any entity of which more than fifty percent of the outstanding securities representing the present right to vote for the election of such entity‘s directors or managers are owned by the Parent Company, directly or indirectly, if such entity
- was so owned on or prior to the inception date of this Policy; or
- becomes so owned after the inception date of this Policy; and
- any joint venture entity in which the Parent Company, or an entity described in a. above, has an exact fifty percent (50%) ownership of the interests of such joint venture entity and where, pursuant to a written joint venture agreement, the Parent Company or entity described in a. above solely controls the management and operations of such joint venture entity.
The D&O Coverage section of the Watershed Policy defines “Directors and Officers” in pertinent part as any person who was, now is, or shall become “a duly elected or appointed director, officer, or similar executive of the Company, or any member of the management board of the Company.”
The term “Insured” is defined by the D&O Coverage Section as including the Company and Directors and Officers.
The term “Wrongful Act” is defined by the D&O Coverage Section in pertinent part as:
Any actual or alleged error, omission, misleading statement, misstatement, breach of duty or act allegedly committed or attempted by:
a. any of the Directors and Officers, while acting in their capacity as such, or any matter claimed against any of the Directors and Officers solely by reason of his or her serving in such capacity. . . .
Loss . . . on account of any Claim:
h. against any of the Directors and Officers of any Subsidiary or against any Subsidiary alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving any Wrongful Act actually or allegedly committed or attempted by a Subsidiary or Directors and Officers thereof:
before the date such entity became a Subsidiary or after the date such entity ceased to be a Subsidiary; or - occurring while such entity was a Subsidiary which, together with a Wrongful Act occurring before the date such entity became a Subsidiary, would constitute Interrelated Wrongful Acts; . . .
C. Rocky Aspen LLC
Rocky Aspen was formed on or about April 24, 2013 by RAM 204 and AH DB. The purpose of Rocky Aspen was to open and operate a “full service, first class, upscale, cocktail lounge” and “full service, high quality, fine dining, restaurant, maintaining standards consistent with other restaurants of Watershed Ventures LLC” in Aspen, Colorado,. Dkt. No. 47-1 § 2.2.
The relevant agreement is the Second Amended and Restated Limited Liability Company Agreement, dated March 20, 2015. See Dkt. No. 38-1, Second Amended and Restated Limited Liability Company Agreement (“Operating Agreement“). Under that agreement, AH DB and RAM 204 were the sole members of Rocky Aspen, with AH DB and RAM 204 each owning fifty percent of the company by voting percentage interest. Operating Agreement, Schedule 5.1. RAM 204 was to act as the initial manager of the restaurant and AH DB was to contribute capital.
If those deadlines and other conditions were met, AH DB was entitled to receive additional economic (i.e., non-voting) interests in Rocky Aspen.
Under the Operating Agreement, “management of the Company and the right to bind and exercise the other powers of the Company is vested exclusively in the Co-Managers.”
The single exception—important here—was that “[i]f the Watershed Option becomes exercisable (for avoidance of doubt, regardless of whether the Watershed Option actually exercised [sic]), [AH DB] shall no longer have the right to appoint, remove and/or replace a Co-Manager, in which case the Watershed Member shall have the sole right to appoint, remove and replace Co-Managers.”
The co-managers have the authority to keep the accounting books and records of Rocky Aspen,
The rights of the members themselves were limited under the Operating Agreement. As noted above, the co-managers were not subject to periodic elections and had sole operating and managerial authority. The Operating Agreement provides:
No Member may (i) take part in, or interference in any manner with, the management, conduct or control of the business or affairs of the Company other than, in the case of a Member, granting or withholding that Member‘s Approval with respect to any action to be taken by the Members hereunder or (ii) take any action to bind or otherwise act for or on behalf of the Company.
D. The Rocky Aspen Bankruptcy
It is undisputed that AH DB failed to satisfy its funding obligations to Rocky Aspen by March 25, 2015, the date specified in the Operating Agreement. Thus, by operation of the Operating Agreement, by March 26, 2015, AH DB automatically forfeited 100% of its Voting Units in Rocky Aspen and the Watershed Option became exercisable.
On January 5, 2016, RAM 204 exercised the Watershed Option and purchased an additional 9,000 membership units of Rocky Aspen. Dkt. No. 46 ¶ 9. The letter asserted that Watershed Triggering Events had occurred and purported to remove McGrath as a co-manager of Rocky Aspen. Dkt. No. 14-3.
On or about March 11, 2016, Rocky Aspen—then solely managed by RAM 204—
the Trustee sent a letter to McGrath‘s counsel demanding that he and AH DB pay a particular sum in order to resolve the Adversary Proceedings.
On June 7, 2019, counsel for McGrath and AH DB contacted Scottsdale and tendered the Trustee‘s demand.
PROCEDURAL HISTORY
This action was commenced by complaint filed by Scottsdale on August 9, 2019 against McGrath, Castlegrace, and AH DB. Dkt. No. 1. Scottsdale sought declaratory judgments that McGrath is not an Insured under the Watershed Policy (Count I), that the Trustee‘s demand against McGrath does not allege Wrongful Acts under the Watershed Policy and that accordingly there is no coverage for a Claim under the Watershed Policy (Count II), that there is no coverage for a Claim under the Watershed Policy because a subsidiary exclusion under the Watershed Policy applies (Count III), and that untimely notice of a Claim was provided (Count IV). On October 22, 2019, McGrath, AH DB, and Castlegrace filed an answer, and McGrath filed counterclaims and a third-party complaint. Dkt. No. 14.
In his counterclaims, McGrath seeks a declaratory judgment that he is an Insured under the Watershed Policy (Counterclaim I), damages on a theory of bad faith breach of insurance contract (Counterclaim II), and breach of a duty to defend (Counterclaim III). McGrath also brings third party claims against Watershed for aiding and abetting breach of the duty to defend (Counterclaim/Third Party Count IV), fraudulent concealment (Counterclaim/Third Party Count V), and failure to disclose material information (Counterclaim/Third Party Count VI). He brings a claim for equitable lien against all counterclaim-defendants. (Counterclaim/Third Party Count VII). On October 22, 2019, McGrath brought a motion for a temporary restraining order. Dkt
No. 15. That motion was denied by Judge Analisa Torres, to whom the case was then assigned, on October 23, 2019. Dkt. No. 18.
On February 3, 2020, the case was reassigned to the undersigned. On June 22, 2020, Scottsdale filed its motion for summary judgment. Dkt. No. 36. McGrath, AH DB, and Castlegrace filed a memorandum in opposition on July 20, 2020. Dkt. No. 44. On August 3, 2020, Scottsdale filed its reply brief. Dkt. No. 48.
Scottsdale seeks summary judgment on Counts I-III of the Complaint. The parties do not dispute any of the material facts at issue. See Dkt. No. 46. Rather, the motion presents a pure question of law whether, during the relevant time period, Rocky Aspen fell under the definition of Subsidiary
Watershed Policy is incorrect, and because Rocky Aspen was a Subsidiary so-defined upon the occurrence of the Watershed Option Triggering Events, Scottsdale‘s motion is denied.
LEGAL STANDARD
Under
An insurance policy is interpreted under ordinary common law contract principles, giving effect to the intent of the parties as expressed in the clear language of the contract. MBIA Inc. v. Fed. Ins Co., 652 F.3d 152, 158 (2d Cir. 2011). Thus, “[a]s with the construction of contracts generally, ‘unambiguous provisions of an insurance contract must be given their plain and ordinary meaning, and the interpretation of such provisions is a question of law for the court.‘” Vigilant Ins. Co. v. Bear Stearns Cos., Inc., 855 N.Y.S.2d 45, 48 (N.Y. 2008) (quoting White v. Continental Cas. Co., 878 N.E.2d 1019, 1021 (N.Y. 2007)). “[C]ourts should read a contract as a harmonious and integrated whole to determine and give effect to its purpose and intent.” Nomura Home Equity Loan, Inc., Series 2006-FM2 v. Nomura Credit & Cap., Inc., 69 N.Y.S.3d 520, 524 (N.Y. 2017) (quotation marks omitted). “Courts may not, through their
interpretation of a contract, add or excise terms or distort the meaning of any particular words or phrases, thereby creating a new contract under the guise of interpreting the parties’ own agreements.” Id. at 525. “In that regard, a contract must be construed
DISCUSSION
The principal issue in dispute between the parties is whether McGrath is an Insured under the Watershed Policy based on his position as a co-manager of Rocky Aspen. The critical, purely legal question is when Rocky Aspen became a Subsidiary of Watershed as defined in the Watershed Policy. The relevant language appears in Section B.11 of the General Terms and Conditions which defines a Subsidiary to mean:
- Any entity of which more than fifty percent of the outstanding securities representing the present right to vote for the election of such entity‘s directors or managers are owned by the Parent Company, directly or indirectly, if such entity
- was so owned on or prior to the inception date of this Policy; or
- becomes so owned after the inception date of this Policy; and
- any joint venture entity in which the Parent Company, or an entity described in a. above, has an exact fifty percent (50%) ownership of the interests of such joint venture entity and where, pursuant to a written joint venture agreement, the Parent Company or entity described in a. above solely controls the management and operations of such joint venture entity.
Watershed Policy, General Terms and Conditions § B(11)(a) and (b) (hereinafter “Subsection (a)” and “Subsection (b)“).
Scottsdale argues that Rocky Aspen only became a Subsidiary when RAM 204 exercised the Watershed Option on January 5, 2016. Until exercise of the Watershed Option, Scottsdale argues, Rocky Aspen was solely a joint venture between RAM 204 and AH DB, and one in
which each member possessed an exact 50% ownership interest, and as such was governed by Subsection (b). Because prior to January 5, 2016 McGrath remained a co-manager of Rocky Aspen, the argument continues, RAM 204—and, by extension, Watershed—did not “solely control[] the management and operations” of the Rocky Aspen Joint Venture until that date. See Subsection (b). Because all of the alleged Wrongful Acts upon which McGrath bases his claim for coverage commenced prior to January 5, 2016, Scottsdale‘s argument concludes, McGrath was not an Insured under the Watershed Policy during the relevant time period.
McGrath takes a different view. He agrees that he is covered only if Rocky Aspen is properly understood as a Subsidiary under the Watershed Policy and only for Wrongful Acts allegedly committed by him in his capacity as a co-manager thereof. He argues, however, that after the Watershed Option was triggered on March 25, 2015, Watershed was a Subsidiary pursuant to both Subsections (a) and (b). As to Subsection (a), McGrath argues that Watershed owned 100 percent of the Voting Units in Rocky Aspen after the Watershed Option was triggered, meaning that Rocky Aspen satisfied the definition “[a]ny entity of which more than fifty percent of the outstanding securities representing the present right to vote for the election of such entity‘s directors or managers are owned by the Parent Company, directly or indirectly . . .” Subsection (a). As to subsection (b), McGrath contends that because after the Watershed Option Triggering Events RAM 204 was authorized to remove McGrath as a co-manager at any time—including in the event of any deadlock between the co-managers, see Operating Agreement § 3.7—and because RAM
McGrath is correct that after the Watershed Option was triggered—both before and after it was exercised—Rocky Aspen satisfied Subsection (a). The language of Subsection (a) is broad. It applies to “any entity.” Under New York Law, “the word ‘any’ means ‘all’ or ‘every’ and imports no limitation.” Kimmel v. State, 29 N.Y.3d 386, 392 (2017) (citation omitted). It is not limited to public corporations but applies as well to joint ventures and limited liabilities companies such as Rocky Aspen. The only qualifications to Subsection (a) are that an entity have either “directors” (the stewards of public corporations) or “managers” (the stewards of limited liability companies) and that those directors or managers are elected by a parent company holding a majority of outstanding securities representing a present right to vote. Rocky Aspen—and Watershed, as its parent—satisfied those criteria.
Though formed as a result of a joint venture contract, Rocky Aspen had “managers” who were elected by the members who had Voting Units in Rocky Aspen. Pursuant to the Operating Agreement, “[u]pon occurrence of any Watershed Option Triggering Event, the Aristone Member [AH DB] shall forfeit all of its Voting Units without any consideration being paid or provided therefore.” Operating Agreement § 4.2. There is no dispute that the Watershed Option was triggered on March 25, 2015, see supra; pursuant to Section 4.2 of the Operating Agreement, upon such occurrence AH DB forfeited its Voting Units and RAM 204 obtained the sole power to remove and appoint directors of Rocky Aspen. Indeed, Scottsdale conceded as much at oral argument. See Tr. at 13:4-13 (Nov. 23, 2020). Thus, after the Watershed Option was triggered, Watershed, indirectly and through RAM 204, owned “more than fifty percent of the outstanding securities representing the present right to vote for the election of [Rocky
Aspen‘s] . . . managers.” Subsection (a).2 At that
Scottsdale has two responses, neither of which is convincing. First, it argues that Watershed did not own more than fifty percent of the outstanding securities of Rocky Aspen because the units in Rocky Aspen—whether Economic Units or Voting Units—did not satisfy the Supreme Court test for “security” set out in Securities & Exch. Comm’n. v. Howey Co., 328 U.S. 293, 297-98 (1946) and its progeny. The so-called “Howey test” is whether “looking at the economic realities, the transaction involved an investment of money in a common enterprise with profits to come solely from the efforts of others.” All Seasons Resorts, Inc. v. Abrams, 68 N.Y.2d 81, 92 (1986) (quoting Landreth Timber Co. v. Landreth, 471 U.S. 681, 689 (1985)) (internal quotation marks omitted). This definition, however, applies specifically to “investment
contracts.” See Howey, 328 U.S. at 297 (“Section 2(1) of the [Securities Act of 1933] defines the term ‘security’ to include the commonly known documents traded for speculation or investment. This definition also ‘securities’ of a more variable character, designated by such descriptive terms as ... investment contract.“); id. at 298–99 (“[A]n investment contract for purposes of the Securities Act means a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party . . .“); see also Landreth, 471 U.S. at 689 (reciting the Howey test as defining “investment contract“).
As noted in Howey itself, see 328 U.S. at 297, the definition of “security” provided in the Securities Exchange Act is much broader, encompassing investment contracts but also other investment vehicles. Under
[A]ny note, stock, treasury stock, security future, security-based swap, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a “security“; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker‘s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited.
See also Howey, 328 U.S. at 297 n.3 (quoting the definition of “security” in the Securities Exchange Act).
e.g., Abercrombie v. Davies, 130 A.2d 338, 344 (1957) (“A review of the Delaware decisions upon the subject of voting trusts shows that our courts have indicated that one essential feature that characterizes a voting trust is the separation of the voting rights of the stock from the other attributes of ownership.“);
Scottsdale‘s interpretation of Subsection (a), moreover, proves too much and, if accepted, would make a hash of the contractual language. There are many corporate vehicles that Scottsdale recognized would qualify as subsidiaries under Subsection (a) but that do not have securities that fit its definition. For example, a corporation can form a limited liability company to conduct business and may own and control more than 50% of it. The securities owned by a parent to such an LLC would be no different from what Watershed held in Rocky Aspen after the Watershed Option Triggering Events. Scottsdale conceded at argument that such entity would be covered by Subsection (a), even though such an entity would not satisfy the Howey test. See Tr. at 9:12-17 (Nov. 23, 2020). In addition, a corporation could incorporate a public company that it wholly owns and controls. No one could contend in that circumstances that such a company would not be a “Subsidiary” of the corporation that founded it as defined by Watershed Policy, notwithstanding that the parent corporation‘s interest in such a company would fail the Howey test. But that is the result that Scottsdale‘s interpretation of “security,” as it appears in the
Watershed Policy‘s definition of “Subsidiary,” would require. That plainly was not the intent of the drafters when they drafted Subsection (a) to cover “any entity,” as opposed to covering only publicly held corporations whose shares are held by passive investors.
Second, Scottsdale suggested in its papers and at argument that because Rocky Aspen is a “joint venture entity,” in the sense that it was formed as a result of a joint venture agreement between RAM 204 and AH DB, it cannot also be “any entity” under Subsection (a) and that because it fails to satisfy the criteria under Subsection (b), it does not satisfy the definition of Subsidiary in the Watershed Policy. This argument is contradicted by the plain language of the definition: as noted above, the term “any entity” is broader than—and comfortably encompasses—the term “any joint venture entity.” See Kimmel, 29 N.Y.3d at 392. Both Subsection (a) and Subsection (b) use the term “entity.” Reading the two paragraphs together, it is evident that the “entity” referred to in Subsection (a) includes an entity formed as a result of a joint venture or a “joint venture entity“, and that the addition in Subparagraph (b) of the words “joint venture” to qualify the word “entity” was intended to identify a subset of Subparagraph (a) entities that might also be covered by Subparagraph (a) and was not intended to limit the types of entities covered under Subparagraph (a).
Subsection (a) because it is formed as a result of a joint venture agreement,3 and is not a Subsidiary by the plain terms of Subsection (b) because no party has “an exact fifty percent (50%) ownership of the interests of such joint venture entity.” Subsection (b).
The more logical interpretation of Subsection (b) is that, whereas Subsection (a) applies to any entity that is majority-owned by a parent, Subsection (b) applies to any joint venture entity that is owned by two members equally, but as to which the parties have contractually allocated control of management and operations to only one member. That member does not own more than fifty percent of the voting interests, so the entity is not its Subsidiary pursuant to Subsection (a), but it does own fifty percent of the interests and enjoys sole control, so the entity is its Subsidiary pursuant to Subsection (b). Unlike Scottsdale‘s interpretation, this reading of the Watershed Policy does not preclude identifying as a Subsidiary any entity formed as the result of a joint venture agreement but as to which one member owns more than fifty percent of the interests. Under the correct interpretation, such an entity would be a Subsidiary of the majority owner pursuant to Subsection (a), as the interests such an entity would presumptively carry the power to vote on the entities’ managers and directors.
Defendants’ alternative argument is that Rocky Aspen satisfied Subsection (b). Until Watershed exercised the Watershed Option, both parties still owned 50 percent of the Economic Units of Rocky Aspen. It follows, Defendants argue, that in addition to being an entity whose voting interests were wholly controlled by Watershed, in satisfaction with Subsection (a), Rocky Aspen was also a joint venture as that phrase is used in Subsection (b). Defendants’ argument continues that, under the language of the Operating Agreement, Watershed had sole control of
the management and operations of Rocky Aspen, thus satisfying the definition of Subsidiary under Subsection (b). Defendants arrive at that conclusion from two places in the contractual language. First, Defendants point to the language that provides that after the Watershed Option Triggering Events, Watershed alone had the right to remove McGrath as a manager and for any reason. See Operating Agreement § 3.6 (“If the Watershed Option becomes exercisable ... the Watershed Member shall have the sole right to appoint, remove and replace Co-Managers.“). Defendants thus argue that because McGrath was serving at Watershed‘s will after March 25, 2015, Watershed had effective sole control and management of the joint venture entity. Second, Defendants point to Section 3.7 of the Operating Agreement, which provides that in the event that “the Co-Managers are unable to agree jointly on a course of action with respect to one
Defendants’ argument, however, does justice neither to the language of the Watershed Policy nor the language of the Operating Agreement. The language of the Watershed Policy includes under Subsection (b) only those entities where, pursuant to the joint venture agreement, the parent company or another subsidiary solely controls the management and operations of the joint venture entity. It does not refer to effective control, or voting interests. Voting interests are covered by Subsection (a). That control over management and operations is distinct from possession of voting interests is reflected in the Operating Agreement.
may (i) take part in, or interference in any manner with, the management, conduct or control of the business or affairs of the Company other than, in the case of a Member, granting or withholding that Member‘s Approval with respect to any action to be taken by the Members hereunder or (ii) take any action to bind or otherwise act for or on behalf of the Company.“). Pursuant to the Operating Agreement, until McGrath was removed, he was a manager and able to participate in and affect decisions pertaining to Rocky Aspen management. To be sure, he could be removed. But there could be any number of reasons why Watershed might disagree with one or another of his decisions and still prefer—on balance—that he be maintained as a manager. Until he was removed by Watershed, McGrath, in his capacity as AH DB‘s selected co-manager, partially controlled Rocky Aspen. Therefore Watershed, via RAM 204, also partially—not solely—controlled Rocky Aspen.
Section 3.7 of the Operating Agreement does not change that analysis. Pursuant to Section 3.7, in the event of a disagreement between the co-managers of Rocky Aspen that “may materially and adversely affect the ability of [Rocky Aspen] to operate effectively,” the members may “attempt to replace the Co-Managers pursuant to the terms of [the Operating Agreement].”
CONCLUSION
For the foregoing reasons, Scottsdale‘s motion for summary judgment is DENIED. The Clerk of Court is respectfully directed to close the motion at Dkt. No. 36. Pursuant to the Case Management Plan, all discovery is scheduled to be completed no later than December 31, 2020. See Dkt. No. 42. The Court will hold a post-discovery status conference by TELEPHONE CONFERNECE on January 6, 2021 at 4:00 p.m. At that date and time the parties are directed to dial the Court‘s teleconference
SO ORDERED.
Dated: December 11, 2020
New York, New York
LEWIS J. LIMAN
United States District Judge