Chancery Court Denies TRO After Alleged Defamation to SEC and FINRA

August 20, 2018

Whatever the reason, you leave your broker-dealer for another firm. It may be amicable. It may not. According to industry lore as related around the office water cooler, regardless of how warm and fuzzy the parting is, your former employer will launch a multi-pronged offensive aimed at jamming you up, stealing your clients, and having a court issue a TRO against you and your new employer. Setting aside the dubious wisdom dispensed around the water cooler, TROs can, in fact, be devastating -- which is why courts are not so quick to grant them. In today's featured lawsuit, we got a Complaint filed in the Delaware Court of Chancery, and the Plaintiffs are seeking a TRO because they say that they've been libeled and slandered before the Securities and Exchange Commission, and FINRA got roped into the mess, and there's no end in sight for the defamation and it has to be stopped before the trial begins. 

Vice Chancellor Glasscock III

If you have the time, I urge you to read the wonderful Order penned by Sam Glasscock III, Vice Chancellor of the State of Delaware's Court of Chancery. The Vice Chancellor sure as hell can write, and he provides a surprisingly entertaining and readable narrative of the facts before the Court and his rationale. CapStack Nashville 3 LLC et al. v. MACC Venture Partners et al., (Order, Delaware Court of Chancery, Civil Action No. 2018-0552-SG / August 16, 2018).

Baroque (Court) Chamber Music

We start with a joint venture that has invested in and managed three Nashville, Tennessee apartment complexes. As Vice Chancellor Glasscock explains [Ed: Footnotes omitted]:

[T]he joint venture has a rather baroque organizational structure. Nominal Defendant CSP Nashville 3 LLC ("CSP"), a Delaware limited liability company, is the entity that owns the properties. Nominal Defendant CapStack MACC LLC ("CSM"), another Delaware limited liability company, serves as CSP's managing member. CSM, for its part, has two 50% members: Plaintiff CapStack Nashville 3 LLC ("CapStack") and Defendant MACC Venture Partners LLC ("MACC"). Like CSP and CSM, CapStack and MACC are Delaware limited liability companies. CSM has two managers: Plaintiff David Blatt (appointed by CapStack) and Defendant S. Anthony Azar (appointed by MACC) The properties themselves are managed by Defendant Capstone Multifamily Group, LLC, a North Carolina limited liability company affiliated with Azar and MACC

Page 3 of the Order

SIDE BAR: Get yer programs! Get yer programs here!  So . . . let's try and clarify who's who and their positions on the field: 
  • CSP, a nominal defendant, owns the three properties;
  • CSM, a nominal defendant, is CSP's managing member;
    • Plaintiff CapStack and Defendant MACC each own 50% CSM;
      • Plaintiff Blatt was appointed by CapStack as one of two managers of CSM;
      • Defendant Azar was appointed by MACC as one of two managers of CSM; and
  • Defendant Capstone Multifamily Group, an affiliate of Defendant Azar and Defendant MACC, manages the three properties.

Faulty Foundation

In 2017, Plaintiffs were introduced to Defendants, at which time Defendant Azar allegedly represented that he and the other Defendants had prior experience in managing apartment complexes, hiring staff, and negotiating with contractors. Plaintiffs allegedly relied upon the Defendants professed expertise when they offered the Defendants participation in a joint venture to manage the three apartment complexes, which Plaintiffs purchased in August 2017 -- and, thereafter, the parties created the baroque operating structure. 

If you ask the Plaintiffs, Defendants demonstrated a lack of expertise managing the properties, as was manifested by overestimating the capital expenditures budget and breaching several provisions of the operating agreement.  In simplified terms, Plaintiffs asserted that the Defendants didn't keep them informed and made decisions without first obtaining authorization. Dueling lawyer letters were sent blaming each other, and, as tensions soared, a demand was made that Plaintiff Blatt and Plaintiff CapsStack withdraw as a manager and member of CSM, which they declined to do. 

The SEC's Comfort Level

As tempers flared, Defendants sent a letter dated July 18, 2017, reiterating their demand for Plaintiffs' withdrawal and containing this statement:

We believe that investors, and the [Securities and Exchange Commission ("SEC")], would be most comfortable with the situation if David Blatt returned the funds taken at closing and he were no longer involved in the management of the investment.

Page 6 of the Order

Complaint Filed

Viewing the July 18th letter as threatening to disclose to investors and the SEC false allegations, Plaintiffs purportedly filed a Complaint in the Delaware Court of Chancery on July 27, 2017, asserting:

nine claims, including fraud, breach of contract, breach of fiduciary duty, tortious interference with contract, and defamation and/or trade libel. The same day the Complaint was filed, the Plaintiffs moved for a TRO under Court of Chancery Rule 65(b). The Plaintiffs seek an order "temporarily enjoining Defendants and their respective partners, officers, agents, servants, employees, and those persons in active concert or participation with them, from making defamatory and libelous statements about Plaintiffs to the SEC, investors in CSP . . . , or any other third parties." The Defendants oppose the request . . .

Page 7 of the Order


In response to the TRO motion, Vice Chancellor Glasscock penned this lovely opening for his ensuing Order [Ed: footnote omitted]:

Dear Counsel:

The road to a temporary restraining order ("TRO") is well-worn; it typically requires only that a movant show a non-frivolous claim of wrongdoing, and resulting threatened imminent irreparable harm, to trigger equity's solicitude. If a weighing of the equites then demonstrates that injunctive relief to maintain the status quo pending a final hearing is appropriate, Chancery will, typically, enter a TRO, limiting the freedom of action of the responding party.

Preventing harm is a public good, but it is not the only public good. In certain cases, other values trump maintenance of the status quo. In the Anglo-American judicial system, freedom of speech is a jealously guarded right. Historically, equity  denied itself jurisdiction over restraints on speech, leaving determinations of the actionability of potentially slanderous speech to a jury of the speaker's peers at an action at law. Both the Delaware and Federal Constitutions have enshrined the right to speak, casting further doubt on the ability of Chancery to place prior restraints on speech, particularly before a determination of whether the speech is entitled to constitutional protection following a hearing on the merits.

This TRO request illustrates this tension. Essentially, the movants contend that the respondents, the movants' business partners, have made false statements about the movants' conduct of the business, and threaten to make further such statements to investors and regulatory authorities, in an attempt to extort a business advantage. The respondents assert that the statements, and pending statements, are true. The movants' claims are colorable. For a number of reasons, however, I must decline to employ equity in prior restraint of the respondents' speech. I explain below.

Pages 1 -2 of the Order

3-Prong TRO Test

The Court references a three-part test for the issuance of a TRO that a movant must satisfy:
  1. a colorable claim, 
  2. faces a likelihood of imminent, irreparable harm if relief is not granted, and
  3. will suffer greater hardships if the TRO is not granted than the defendants would if the relief were granted.
Walking Wounded Ain't Walking Dead

The Court found that Plaintiffs had failed to establish that they will suffer irreparable harm absent the issuance of a TRO [Ed: footnotes omitted]:

The filings in this case are a matter of public record; none of the parties' papers have been filed under seal. Indeed, the Plaintiffs themselves attached to the Complaint the letters that contain the purportedly defamatory material. As a result, the allegedly false information the Defendants intend to convey to the SEC and other investors is already accessible to the public. It is unlikely, then, that further dissemination of this publicly available information would work irreparable harm on the Plaintiffs. Moreover, the Defendants represented at oral argument that NH Cohen, which received the July letters, has already disclosed the supposedly defamatory allegations to the Financial Industry Regulatory Authority. The Defendants also represented that, as a result of this disclosure, the SEC already has or will initiate an investigation into the allegations. These developments cast further doubt on the efficacy of Plaintiffs' attempt to demonstrate that future speech threatens irreparable harm.

Pages 7 - 8 of the Order

Essentially, Plaintiff's were dead in the water because notwithstanding the dissemination of allegedly defamatory information to the SEC, FINRA, investors, and others, Plaintiffs appeared in court very much alive and kicking. You folks may well have been harmed, but it's not looking irreparable. Sort of the distinction between the Walking Wounded and the Walking Dead

Enjoining Libel

Moving on from the irreparable-harm standard, the Court notes the [Ed: footnotes omitted]:

"traditional maxim that equity will not enjoin a libel." This rule traces back to equity's traditional refusal "to exercise jurisdiction over a claim for defamation based on a prayer for injunctive relief." The rule now rests on additional considerations, primarily "the importance afforded to the constitutional protections of speech." Regardless of the rationale supporting the rule, "[t]he upshot is the same: a court of equity generally cannot issue an injunction in a defamation case."

Page 9 of the Order

Vice Chancellor Glasscock notes that many courts are particularly wary of enjoining libel on a pretrial basis. He explains that [Ed: footnotes omitted]:

When an injunction against speech is entered before a full trial on the merits, "it is almost always treated as an unconstitutional prior restraint." The reason is  straightforward: while such an injunction is in force, it "restrain[s] even speech that may ultimately prove to be protected."  Likewise, "since preliminary injunctions are often easier to get than final determinations on the merits and are granted based on less evidence and less deliberation, the danger that the court will get it wrong and mistakenly restrict protected speech is even greater." Thus, "[i]n all but the most exceptional circumstances, an injunction restricting speech pending final resolution of constitutional concerns is impermissible."  This rationale applies with equal force to First Amendment protections as well as the protections of speech and press found in the Delaware Constitution. . .

Page  10 - 11 of the Order

A Matter of Privilege

After an ample discussion of the relevancy of so-called "trade libel" to the instant case and the rejection of same, Vice Chancellor Glasscock considers Plaintiffs argument concerning the need to restrain the Defendants from defaming them in communications with the SEC. In dismissing that argument, Glasscock offers this compelling rationale [Ed: footnotes omitted]:

[I] assume that the Defendants are at least conditionally privileged to reveal these allegations to the SEC. Like other administrative agencies, the SEC performs quasi-judicial functions. The Complaint suggests that the Defendants seek to have the SEC investigate the allegations about Blatt, and perhaps initiate proceedings against him. Under the Second Restatement, "[a] witness is absolutely privileged to publish defamatory matter concerning another in communications preliminary to a proposed judicial proceeding or as a part of a judicial proceeding in which he is testifying, if it has some relation to the proceeding." By contrast, many jurisdictions, perhaps including this one, have held that such communications receive only a qualified privilege. In any event, the possibility that the statements the Defendants wish to make to the SEC are privileged weighs against entry of the TRO.

Pages 17 - 18 of the Order

Bill Singer's Comment

Vice Chancellor Glasscock's wordsmithery deftly presented the underlying facts in this pending lawsuit and the competing considerations that resulted in his denial of the requested TRO. In the end, the TRO is denied but that is merely a preliminary aspect of the case before the Court of Chancery. There has not been any final adjudication on the merits, which will come during a trial (unless the parties reach a settlement). The best way for laypersons to view this stage of the lawsuit is to equate it to the coin flip that starts a football game. There is an advantage gained by Defendants in the Court's denial of the TRO, but it along the lines of who kicks first and which end zone you start off defending. The whistle has not yet blown to start the trial. No meaningful plays have been run or blows landed. 

Notwithstanding the accumulated wisdom around an office water cooler, as Vice Chancellor Glasscock's Order makes clear, courts are not so quick to grant TROs, even when there is an allegation that one party may have used threats of defamation in order to attempt extort something from the other. Plaintiffs may have their day in court and prove their claims. Defendants may well carry the day by showing that their assertions were correct. The trial is yet to be gaveled to an open.