LOLA CARS INTERNATIONAL v. KROHN RACING, LLC, 4479-VCN (Del.Ch. 8-2-2010)

C.A. Nos. 4479-VCN, 4886-VCN.Court of Chancery of Delaware.Date Submitted: June 10, 2010.
Date Decided: August 2, 2010.

David E. Wilks, Esquire and Thad J. Bracegirdle, Esquire of Wilks, Lukoff Bracegirdle, LLC, Wilmington, Delaware, Attorneys for Plaintiff.

Rolin P. Bissell, Esquire, Elena C. Norman, Esquire, and Kerrianne M. Fay, Esquire of Young Conaway Stargatt Taylor, LLP, Wilmington, Delaware, and D. Ferguson McNiel, III, Esquire, James A. Reeder, Jr., Esquire, and Stacey N. Vu, Esquire of Vinson Elkins, L.L.P., Houston, Texas, Attorneys for Defendants.

MEMORANDUM OPINION
NOBLE, Vice Chancellor

I. INTRODUCTION
This post-trial memorandum opinion deals with a business relationship gone awry. The parties formed a joint venture for the purpose of constructing and selling race cars. They organized their joint venture in the form of a Delaware limited liability company; the parties shared equal board representation, but management responsibilities were vested primarily in one member. The parties’ relationship has since deteriorated and their dysfunction may be irreconcilable. They have asserted a host of claims against one another — premised on either breach of contract or breach of fiduciary duty. One member seeks termination of the governing operating agreement and subsequent control over the company. It alternatively requests dissolution. The breach of contract and fiduciary duty claims were not proven at trial. For this reason, and because the members agreed upon a contractual mechanism through which the disgruntled party — which notably brought on much of the discord itself — may exit the company, the Court, in the exercise of its discretion, will not order dissolution.

II. BACKGROUNDA. The Parties and the Operating Agreement
Plaintiff Lola Cars International Limited (“Lola”) is a company registered under the laws of England and Wales with its principal place of business in the United Kingdom. Lola is controlled by Martin Birrane (“Birrane”).

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Defendant Krohn Racing, LLC (“Krohn Racing”) is a Delaware limited liability company with its principal place of business in Houston, Texas. It is owned by Tracy Krohn (“Krohn”). Collectively, Lola and Krohn Racing will be referred to as the “Member Parties.”

Nominal Defendant Proto-Auto, LLC (“Proto-Auto”) is a Delaware limited liability company with its principal place of business in Braselton, Georgia. It is governed by a limited liability company operating agreement (the “Operating Agreement”), which was executed by the Member Parties on March 5, 2007.[1] Pursuant to the Operating Agreement, Lola holds 51% of Proto-Auto’s equity while Krohn Racing has the remaining 49%. Despite Lola’s slight majority, the Member Parties agreed upon equal board representation: initially, Rupert Manwaring (“Manwaring”) represented Lola and Jeffrey Hazell (“Hazell”) represented Krohn Racing. At the time of Proto-Auto’s inception, Manwaring served as Lola’s Managing Director.[2] Hazell was Krohn Racing’s team manager. Hazell was also explicitly selected as Proto-Auto’s chief executive officer.[3]

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Proto-Auto’s purpose, as defined by the Operating Agreement, is to manufacture and sell Daytona prototype race cars for competition in the Grand American Rolex Racing Series (the “Grand Am Series”), and to do so on a “sound, profit-making, commercial basis. . . .”[4]
To achieve this end, the Member Parties took on separate, but complementary roles. Lola was responsible for evaluating the vehicle design, developing vehicle performance, organizing the manufacture and sourcing of the vehicles’ parts, and developing a bill of materials.[5] Krohn Racing, on the other hand, was responsible for testing the vehicles to generate information that Lola could use to further enhance performance. Krohn Racing was also tasked with much of Proto-Auto’s day-to-day operations: it agreed to provide, and to pay for, Hazell’s services as Proto-Auto’s chief executive officer;[6] it also agreed to provide, free-of-charge, Proto-Auto’s headquarters and registered office.[7] Finally, Krohn Racing was obligated to ensure the production of certain accounting and budgetary statements and to make sure that Proto-Auto manufactured and held sufficient parts to service the vehicles.

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B. The Story of Proto-Auto
When Proto-Auto entered the Grand Am Series, there were almost thirty prototype cars on the grid for each race. The Grand Am Series governing body, the Grand American Road Racing Association (“Grand Am”), anticipated that the number of prototype cars would expand in 2008 and 2009 to about thirty-five cars.[8] Riley Technologies (“Riley”) was, and remains, the Grand Am Series’ dominant manufacturer: it supplies about half of the cars on the grid. The parties believed that if Lola could develop a car superior to the Riley, as demonstrated by Krohn Racing’s winning performance on the track, then Proto-Auto could compete effectively with Riley and others for the business of both current teams and new entrants. Thus, through Proto-Auto, Krohn Racing and Lola hoped to combine their very different skills and attributes to attain success within a growing market — success measured in terms of both business and sport.

The Member Parties projected that Proto-Auto’s operations would proceed rapidly. Proto-Auto first needed to acquire an official Grand Am constructor’s license, as well as two Daytona prototype chassis and other assets, from third-party manufacturers.[9] The vehicles would then be updated and improved by Lola, after

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which the two vehicles and their parts would be sold to Krohn Racing.[10] The Member Parties agreed that this initial sale would occur no later than the “date of the first race of the 2008 Grand Am Series season to ensure” Krohn Racing’s entry into the competition.[11]

Proto-Auto purchased its Grand Am constructor’s license and Daytona prototype chassis in the spring of 2007 from Multimatic, a Canadian corporation and automotive parts manufacturer.[12]
Multimatic had originally wanted to develop and market the vehicle itself; however, it abandoned this plan and subsequently sold the prototype in part because the vehicle presented aerodynamic problems which Multimatic lacked the funds to address.[13] These problems would frustrate Proto-Auto as well: indeed, the car suffered from several performance and safety problems that required fixing before the vehicle could effectively and safely compete.[14]

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Also frustrating for Proto-Auto was a 2007 Grand Am rule change that affected the vehicle’s roll hoop design.[15] Conformity with the revised rule would require significant redesign of the vehicle’s roll hoop and surrounding structure. Instead of making the necessary adjustment, Proto-Auto, at Hazell’s direction, decided to lobby for an exemption from the rule;[16] these efforts proved futile as Grand Am eventually denied Proto-Auto’s request.[17] The time consumed by Proto-Auto’s lobbying efforts, in addition to delays caused by the vehicle’s other engineering problems, set Proto-Auto off schedule.[18] Indeed, Krohn Racing was unable to drive the Proto-Auto vehicle in the 2008 24 Hours of Daytona;[19] the Proto-Auto vehicle was instead first raced a “few months later,” in either March or April of that year.[20] The design issues also caused the vehicle’s development costs

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to go over budget: roughly $3.1 million was spent developing the vehicle, which greatly exceeded Proto-Auto’s $2 million development budget.[21]

There were other problems. Troubling accounting issues emerged in late spring and summer of 2008: Proto-Auto had difficulty finalizing the pricing and costs of the vehicles and parts sold to Krohn Racing.[22] Efforts to resolve these concerns revealed discrepancies between Proto-Auto’s financial accounting system and its inventory tracking system. Evidence also emerged which showed that parts sales to Krohn Racing exceeded Proto-Auto’s estimates.[23] In response, Lola grew uneasy about the reliability of Proto-Auto’s accounting; it sought to verify the delivery of cars and parts sold to Krohn Racing, and to confirm the accuracy of the cost of sales assigned to those parts by Hazell and Krohn Racing personnel.[24] Representatives on both sides attempted to reconcile the inventory accounting problems, which Turnbull was told were caused in part by “software concerns” and

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problems with “systems integration”;[25] Turnbull visited Proto-Auto’s facility on October 2, 2008 to work through these issues with Weinstein.[26]

During the visit, Krohn Racing personnel performed a physical check of Proto-Auto’s parts, which revealed a discrepancy between the physical inventory and that recorded on Proto-Auto’s books, and which therefore necessitated a $500,000 write-down of Proto-Auto’s inventory.[27] Turnbull testified that the discrepancy “could have been due to quantity differences, or maybe some of it was due to the software issues that Proto-Auto was experiencing.”[28] Weinstein was given responsibility for determining the cause of the discrepancy; roughly two weeks later she “identified the issue with inventory” as the result of an unintended automatic software adjustment that created an “overstatement of inventory and [an]

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understatement” of cost of goods sold.[29] This discovery, however, did not allay all of Turnbull’s concerns: he believed that Proto-Auto’s revised financials still showed a negative gross profit margin, which indicated that parts sales to Krohn Racing were on a “negative margin basis.”[30] Thus, according to Turnbull, the discrepancies in inventory accounting were not entirely caused by the “system integration” problems identified by Weinstein; he thought that there “were some other issues that needed to be resolved.”[31]

Indeed, the inventory accounting problems represented only a subset of the concerns raised by Lola during the summer of 2008. Birrane “became alarmed” at the amount of money owed by Krohn Racing to Proto-Auto, and about a loan imbalance that existed between the Member Parties.[32] He was also disappointed in Proto-Auto’s performance as it related to Lola; he felt that Proto-Auto “had been eating cash.”[33] In late August 2008, Birrane met personally with Hazell and

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demanded that Hazell obtain the repayment of roughly $800,000 owed by Krohn Racing to Proto-Auto.[34]

Birrane’s dissatisfaction with Proto-Auto or, perhaps more accurately, with Hazell grew in the fall of 2008.[35] He was suspicious of Krohn Racing’s explanation of the inventory accounting problems, [36] and frustrated that delays related to the Proto-Auto vehicle had caused Lola to divert attention away from other projects.[37] Turnbull emailed Hazell on October 24, 2008, to relay Birrane’s concerns about outstanding parts invoices owed by Krohn Racing, and Proto-Auto’s running costs and lack of sales.[38] Hazell wrote back the same day: he suggested that Krohn Racing was behind on payments because Lola had failed to produce cost information in a timely manner; he also highlighted Krohn Racing’s efforts to improve vehicle performance, and explained that Proto-Auto had not yet

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achieved any third-party sales because it had thus far not “achieved competitiveness” on the track, which Hazell in turn attributed to the withheld Grand Am approvals.[39] The relationship was beginning to fray.[40]

On October 29, 2008, Howard Dawson (“Dawson”), a Lola director and its chief executive officer, wrote to Hazell to state some deeper concerns about Proto-Auto.[41] Dawson pointed out that Lola’s investment in Proto-Auto had exceeded “original expectations,” while income from Proto-Auto had been “significantly less than budget” and “sales of new cars ha[d] been non-existent.” According to Dawson, “[a] cursory examination of the business today might suggest that the principal objectives have been ignored and Lola is now caught up in a support role for the Krohn Racing Team which is neither viable nor acceptable to Lola.”[42] Dawson demanded that Proto-Auto repay its debts to Lola in full, and he identified the need for a review of Proto-Auto’s business plan and adoption of a “new strategy.”

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In a follow-up email, dated October 31, 2008 and addressed to Hazell, Dawson asked pointed questions regarding Proto-Auto’s possible liquidation or sale; he also probed Krohn Racing’s interest in acquiring Lola’s share of the business.[43] Dawson explained the “need to be realistic about the prospects of this business going forward in the light of the environment we are now in . . . [and] about the size of the market we are selling into.”[44] Dawson concluded his email by stating that Lola would withhold further investment until it reached agreement with Krohn Racing “that there is a viable and profitable business to participate in.”

By November 14, 2008, Krohn Racing had reduced the outstanding loan imbalance to $50,894.[45] Hazell also reviewed Lola’s ongoing engineering projects as they pertained to Proto-Auto; he asked that many of these projects be discontinued.[46] Lola, however, continued to express its frustration over the size of

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the loan imbalance and how long it took for all outstanding sums to be paid.[47] Lola intensified and expanded its criticism in the following weeks. On November 27, 2008, Birrane emailed Hazell to complain about a host of issues related to Hazell’s stewardship of Proto-Auto.[48] In particular, Birrane was concerned as to why Proto-Auto was $2 million “worse off than projected,” and he was critical of the efforts put into Proto-Auto’s original business plan. Birrane demanded the regular submission of monthly statements, which before May 8, 2008, allegedly had never been provided; he asked why there had been no third-party sales in 2008 and 2009 — sales of at least two cars in both years had been forecast in the original business plan; Birrane again raised Hazell’s delay in rectifying the Member Party loan imbalances.[49]
Finally, Birrane expressed how he regretted his decision, in late August, to “preserve the working relationship with Hazell” instead of “tak[ing] this issue up with [Krohn] straight away.”[50]

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Birrane took his concerns to Krohn on December 16, 2008. He told Krohn that Lola had produced a competitive design and that the vehicle could have won by the end of 2008 had it “not been for some accidents, strategy and bad luck.”[51] He proposed replacing Hazell with Turnbull as chief executive officer; he further requested that Stephen Charsley (“Charsley”), Lola’s sales manager in the United States, be commissioned to sell Proto-Auto vehicles. In support of his proposal, Birrane attached a letter that he had sent to Hazell that day in which he detailed all of his grievances regarding Hazell’s management.[52] These grievances were more detailed, severe, and critical of Hazell’s motives and character than any of the previous complaints.

In this letter to Hazell, Birrane blamed him for the engineering delays and overages: he argued that such delays had been brought about by Hazell’s decision to lobby Grand Am for a rule change instead of accepting Grand Am’s revised roll hoop requirements.[53] Birrane also asserted, for the first time, that Hazell had deliberately not pursued potential sales leads or made more vigorous efforts to sell the Proto-Auto vehicles;[54]
according to Birrane, Hazell did so because he wanted to “leave Krohn Racing as the single works team with spare cars and tons of spares

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and no competition from other Proto-Auto Lola teams.” Birrane then blasted Hazell for failing to meet the financial reporting requirements set forth in the Operating Agreement, and for incurring Proto-Auto expenses, “such as accountants, spares man, and the truck,” which should have been paid-for by Krohn Racing. Birrane attributed Hazell’s actions to an invidious motive, [55]
and he contended that Hazell had “failed in [his] administrative and fiduciary responsibilities” to serve the interests of both Member Parties.[56]

Thus, Lola’s open complaints had morphed, in the period of perhaps a month, from concern over loan imbalances, unpaid invoices, and inventory accounting to a full-fledged, expansive assault against Hazell, his management, loyalty, and alleged conspiratorial motives. Krohn met with Birrane a couple of

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weeks later, on either January 2 or 3, to discuss Birrane’s allegations; Krohn, however, deferred considering Hazell’s removal as Proto-Auto’s chief executive until he received more information.[57] A substantial amount of financial information was sent to Krohn on January 16, 2009, including a report on Proto-Auto’s management prepared by Lola personnel.[58] Krohn then met with Lola’s recently-appointed managing director, Robin Brundle (“Brundle”)[59] on January 28, 2009.[60] Krohn, however, again refused to take action until he had sufficient time to evaluate Lola’s claims.[61]

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Although most of the criticism had come from Lola, Krohn Racing had also put forth its own set of grievances. For example, Hazell complained to Birrane several times about Lola engineering costs and origination delays.[62] Hazell further maintained that Lola had failed to provide parts cost information within a reasonable time and, thus, was to blame for the inventory accounting problems as well as the loan imbalance.[63] Moreover, in December 2008, Lola requested that Multimatic stop shipment of a new vehicle chassis — specifically Chassis 8 — to Proto-Auto in Georgia.[64]
Krohn Racing had consistently requested that Chassis 8 be delivered, [65] but Multimatic would not release it without Lola’s authorization, which Lola continued to refuse to give.[66]
Finally, Krohn Racing demanded that

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Lola relinquish intellectual property that purportedly belonged to Proto-Auto but was held by Lola.[67]

Krohn, Birrane, and other representatives of the Member Parties met again on March 6, 2009, in London in the hope of finally putting their differences to rest.[68] The meeting, however, resolved little: the Member Parties continued to disagree over Proto-Auto’s expenses and the margins it set on parts sales.[69] They

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also remained in disagreement over the appropriate sales strategy[70] and the accuracy of Proto-Auto’s financial statements, [71] but they did agree that an independent auditor should be employed to resolve the latter dispute.[72] Finally, Krohn refused to acquiesce in Hazell’s removal as Proto-Auto’s chief executive officer, even though Lola all but insisted on that as a condition to moving forward.[73] Matters seemed to have come to a head on April 6, 2009, when Birrane, after feeling slighted by Krohn’s apparent lack of responsiveness, accused Krohn of entering the joint venture as part of a scheme to “dupe Lola from the outset.”[74]

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Birrane wrote that Krohn Racing pushed Proto-Auto and Lola into severe losses to force Lola to declare deadlock; this, according to Birrane, would allow Krohn Racing to purchase the company on the cheap; he warned that Lola instead would consider “other options.”

Lola filed suit to dissolve Proto-Auto later that day and to recover damages for alleged wrongdoing by Hazell and Krohn Racing. Despite the suit, Krohn Racing continued to race the vehicle, which had shown marked improvement.[75] Indeed, Krohn Racing won with the Proto-Auto car at a race in New Jersey in May 2009. Also in May 2009, Brundle informed Hazell and Krohn that he had located a potential buyer for a Proto-Auto vehicle.[76]

The next month, the Member Parties retained an independent auditor, Bruce Phillips (“Phillips”), a certified public accountant, to review, and to issue a report on, Proto-Auto’s balance sheets as of March 31, 2009 and 2008, as well as its statement of operations, changes in members’ equity, and cash flows for those years.[77]
Phillips also agreed to apply “supplemental audit procedures (in addition

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to the analytical procedures performed in connection with the review) related to inventory and the costing, and pricing of such.”[78] Phillips tendered his findings as to the inventory on September 8, 2009.[79]

In the meantime, Krohn Racing won with the Proto-Auto vehicle at Watkins Glen in August 2009. That, however, would be the vehicle’s final race of the year. On August 24, 2009, Krohn Racing issued a press release that announced both the lawsuit and its decision to shelve the Proto-Auto vehicle.[80]

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Lola filed its second lawsuit shortly after Krohn Racing’s press release.[81] In its second suit, Lola sought a declaration that it had terminated the Operating Agreement pursuant to § 10.1, and could therefor assume unilateral control over Proto-Auto as its 51% owner. Meanwhile, Hazell and Turnbull continued to exchange, and disagree about, information pertaining to Proto-Auto’s financials.[82] There were also some settlement discussions, but compromise was not reached.[83] Both actions were tried together.

III. CONTENTIONS
Lola claims that Hazell mismanaged Proto-Auto, thereby breaching his fiduciary duties of loyalty and care. Specifically, Lola argues that Hazell’s gross negligence caused crippling inventory problems, which in turn led to parts being

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either lost or misappropriated by Krohn Racing. As a related point, Lola asserts that Hazell under-priced parts sold to Krohn Racing. Lola also contends that Hazell disloyally pursued a passive sales strategy to favor Krohn Racing; this sales strategy, according to Lola, is the reason that Proto-Auto has been unable to sell any vehicles beyond the two provided for in the Operating Agreement. Lola alleges other specific instances in which Hazell either recklessly or intentionally favored Krohn Racing to Proto-Auto’s detriment; it claims that Krohn Racing aided and abetted Hazell’s fiduciary misconduct. Lola also maintains that Krohn Racing owes it interest on loans that have since been repaid, and that Proto-Auto owes it for uncompensated engineering work. Moreover, Lola claims that Krohn Racing breached both the Operating Agreement and its accompanying implied covenant to act in good faith.

Lola seeks several remedies. It requests damages on its breach of fiduciary duty and aiding and abetting claims. Lola further contends that Krohn Racing’s alleged breaches of the Operating Agreement were material, and as such, they triggered a termination right provided in Section 10.1 of the Operating Agreement. Lola believes that it may exercise that right, and upon termination of the Operating Agreement, take control of Proto-Auto. It seeks a declaratory judgment to that effect. Alternatively, Lola asks the Court to exercise its discretion to dissolve

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Proto-Auto and to appoint a liquidating trustee. Finally, it seeks an award of attorneys’ fees.

Krohn Racing has filed several counterclaims. Specifically, it contends that Lola breached the Operating Agreement: 1) by failing to provide a competition-ready car on time and on budget; 2) by withholding intellectual property that rightfully belongs to Proto-Auto; 3) by wrongfully preventing the delivery of a race car chassis from one of Proto-Auto’s suppliers to its headquarters in Georgia; and 4) by wrongfully seeking to terminate the Operating Agreement or, alternatively, to dissolve Proto-Auto. Krohn Racing seeks an injunction requiring Lola furnish the intellectual property that it has allegedly withheld and prohibiting Lola from continuing to block delivery of Chassis 8. Krohn Racing also requests damages and attorneys’ fees under the bad faith exception to the American Rule.

IV. ANALYSIS
Lola failed to prove its individual claims at trial. The legitimate concerns that initially frustrated Lola and aroused its suspicion — the loan imbalance and the inventory accounting issues — have either been rectified or proven immaterial and innocent. From these original grievances, Lola has added a host of complaints that are either insignificant or came about as a result of the economic downturn; several other of Lola’s claims flowed directly from the business structure established by the Operating Agreement, or at worst, were criticisms of decisions that when made

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had the blessing, either express or implied, of Lola’s former board representative, Manwaring. Lola, perhaps reasonably, either wanted out of the business or sought to exert greater control over Proto-Auto’s operations; Lola, however, stretched its concerns well beyond proportion in an attempt to achieve these objectives. For this reason as well, the Court will not order dissolution. Finally, Krohn Racing’s damages claims also lack merit; the Court, however, will grant it the requested, limited injunctive relief.

A. Hazell’s Alleged Breaches of the Fiduciary Duties of Care Loyalty
The parties disagree over whether Hazell, as the manager of a limited liability company, owes the fiduciary duties of care and loyalty, or whether his managerial obligations are defined entirely by the Operating Agreement. A manager of a limited liability company owes the entity and its members the traditional fiduciary duties of care and loyalty; these duties, however, may be limited contractually by agreement among the member parties.[84]
That said, the Member Parties nowhere agreed, either within the Operating Agreement or otherwise, to limit Hazell’s fiduciary duties as the manager of Proto-Auto. For this

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reason, Hazell was bound by the traditional duties that otherwise govern the conduct of corporate fiduciaries: loyalty and care.

1. The Cost Overruns and Delays

Lola maintains that Hazell caused Proto-Auto to incur significant delays and cost overruns in the initial development and design of its vehicles. The focus of its claim rests on Hazell’s decision, in the spring of 2007, to challenge, instead of acquiescing in, a then-recently amended Grand Am regulation concerning the vehicle’s roll hoop.[85] Lola argues that Hazell’s effort, which would prove futile, constituted a violation of his duty of care. To prove its claim, Lola must show that Hazell acted with gross negligence, [86]
which has been defined as “reckless indifference” or conduct beyond the “bounds of reason.”[87]

Lola has failed to meet this high standard. Hazell was certainly advised that his efforts were likely to fail, but the evidence shows that there was reason for him to try. Moreton did not believe the lobbying efforts would succeed, and he communicated this opinion to Hazell.[88] Moreton based his belief on his extensive experience in motor-sport, during which he observed that governing authorities are loathe to changing their regulations, especially those recently adopted.[89] Moreton,

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however, understood why Hazell sought the exemption, especially given the Member Parties’ recent investment in a vehicle that would have to be redesigned to material degree.[90] Birrane also grew frustrated with Hazell’s insistence on fighting for an exemption, as he too believed that Grand Am was unlikely to revise one of its rules.[91] But like Moreton, Birrane was annoyed with Grand Am and its rule change.[92]

Especially harmful to Lola’s claim is Manwaring’s testimony. Manwaring did not believe the Grand-Am rule change “was fair,” and he did not “agree with” its decision; he confirmed that Lola personnel “were in agreement with [Hazell]” as they “were all certainly unhappy with the rule changes that the organizers were coming out with.”[93] Manwaring was supportive of Hazell’s efforts because, as Hazell framed it, “if we could achieve what we were looking for, it would save us time and money.”[94]

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Perhaps Hazell was naïve in believing he could sway Grand Am’s collective mind. Perhaps he should have heeded Moreton’s advice. There is no doubt, however, that there were legitimate reasons to lobby for an exemption, and that, if successful, doing so could save Proto-Auto from redesigning the roll hoop. Lola personnel were unified in their opposition to the Grand-Am regulation, even if there was disagreement as to the best means for dealing with the situation. Moreover, although the lobbying decision delayed Proto-Auto’s development, that delay was only a portion of the total aggravation caused by the rule change. On these facts, Hazell’s conduct was neither reckless nor the product of gross negligence.

2. The Inventory

Difficulties with Proto-Auto’s inventory have stood and continue to stand at the heart of this case. Indeed, there have been two significant inventory writedowns in Lola’s history: one of roughly $500,000 in October 2008[95] and another of about $125,000 in February 2009.[96] Lola maintains that approximately $141,000 in inventory has been either lost or taken by Krohn Racing. It concludes

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that Hazell has been grossly negligent in failing to implement an effective internal control system to prevent these losses.[97]

There is, however, no need to review Hazell’s conduct and the adequacy of Proto-Auto’s internal controls. This is because Lola has failed to demonstrate that any parts were actually lost or misappropriated and thus that Proto-Auto was injured. Where there were accounting irregularities, they were caused almost entirely by discrepancies between invoices for parts sold to Krohn Racing and parts as recorded on Proto-Auto’s books, but not by discrepancies between the invoices and the actual inventory on the shelves.

Proto-Auto uses two software programs to follow its inventory: Quickbooks Financial (“Quickbooks”), which is an accounting program, [98] and Quickbooks Point of Sale (“POS”), which is an inventory tracking system.[99] Proto-Auto installed POS four months after it had set-up Quickbooks; it then synchronized the two programs so they could exchange information.[100]

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The interfacing between the two programs contributed to some of the problems. Financials were to be produced for the year ending March 31, 2008.[101] Up until that point, however, Krohn Racing personnel, acting for Proto-Auto, had been entering individual parts into POS with zero cost.[102] Later, when Proto-Auto entered the actual cost of the inventory in POS, Quickbooks automatically

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acknowledged the entry as “another piece of inventory, so it double counted.”[103] Krohn Racing contends that the double count caused the first $500,000 inventory write-off.[104] Lola apparently accepted this explanation, although it remained concerned about the price at which the parts were sold, and consequently the gross profit margins.[105]

A second write-off was made in February 2009 of approximately $124,000. Lola contends that this write-off remains “unexplained,”[106] and that in sum, there exists $141,000 in inventory that Lola believes was lost or misappropriated by Krohn Racing.[107] Krohn Racing, however, has provided an explanation for the second write-off: inventory sold to Krohn Racing for installation on the first two

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vehicles — Chassis 5 and 6 — was inputted into Quickbooks, but not POS.[108] As Weinstein explained, this was because parts for those two vehicles were shipped directly from Lola to Multimatic in Canada;[109] since the parts did not pass through Proto-Auto’s warehouse, they were never booked into the inventory program.[110]
This oversight resulted in another double invoice to Krohn Racing.[111] Likewise, the parts invoiced for Chassis 8 also have not been entered into POS because those parts too have not passed through Proto-Auto’s stores but instead are with Multimatic in Canada.[112] Hazell and Weinstein contend that the parts issued for Chassis 5 and 6 account for $75,000 of the remaining discrepancy, while the parts allocable to Chassis 8 account for another $43,000.[113] This would seem to account for much of the discrepancy.[114]

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Indeed, there is no evidence that any physical inventory has gone missing from Proto-Auto’s stores. Instead, the problems seem confined to how the inventory was recorded across Proto-Auto’s different accounting programs. Phillips, the auditor retained to review Proto-Auto’s books and audit its inventory, [115] confirmed Krohn Racing’s explanation for the discrepancies and write-downs.[116] He recognized that the “physical inventory count was made difficult because of different `locations’ and inventory moving between them.” He further observed that the implementation of Quickbooks and POS was “less than adequate,” but “well-intentioned.” Most important, Phillips concluded that the “differences in book to physical inventory” were “most likely” brought about by poor implementation of the accounting software, and “not necessarily theft or fraud.” He also found that any differences “were not material as a whole.”[117] Lola has offered no evidence to suggest otherwise besides contrary assertions by

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Turnbull.[118] The Court therefore concludes that there are no missing or misappropriated parts.[119]

3. The Separate Issue of Parts Sold Below the AppropriateProfit Margin

Lola also contends that, before July 2009, Proto-Auto sold parts to Krohn Racing at below optimal prices. In July 2009, price adjustments were made to the

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pricing of Proto-Auto’s parts; the prices were revised by Hazell and Charsley.[120] Lola argues that, had Proto-Auto previously sold its parts to Krohn Racing at the revised prices, it would have realized an additional $182,725 in revenue.[121]

Lola, however, presents no evidence that prices should be retroactively adjusted or that some other, higher price should apply.[122] According to Krohn Racing, the prices that Hazell and Charsley agreed upon represented only a three percent increase from the prices that Hazell himself had set for 2009.[123] Moreover, Hazell’s original 2009 prices were themselves only three percent higher than those he set in 2008.[124] Lola does not dispute these assertions. Additionally, the evidence shows that parts prices are regulated by Grand Am, which may take

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action against manufacturers who sell parts at unfairly high prices.[125] Finally, there is evidence that Manwaring knew and accepted Hazell’s original prices.[126] As a whole, there is no evidence that parts prices were inappropriately low during the period before July 2009; Hazell did not violate any fiduciary duty when he set prices before that date.[127]

4. The Failure to Market or Sell Cars

The parties have also vigorously disagreed about third-party sales, or the lack thereof. Indeed, Proto-Auto has sold only two cars since its inception: the two vehicles that Krohn Racing agreed to purchase pursuant to § 3.7 of the Operating Agreement. Lola contends that Hazell intentionally failed to sell any vehicles to third-parties in order to keep Krohn Racing’s competitors from having a superior Proto-Auto car of their own. This conduct, according to Lola, constitutes a breach of the duty of loyalty.

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Lola begins its argument by showing how Hazell’s loyalty is conflicted between Proto-Auto and Krohn Racing. Hazell, for all of Proto-Auto’s existence, has served as a paid consultant to Krohn Racing.[128] Hazell in fact serves as something of a lieutenant to Krohn and describes his primary role within Krohn Racing as “looking after Tracy Krohn’s interests.”[129] Hazell previously served as the team manager for Krohn Racing’s Grand Am team; although he resigned from that post in 2007, [130] it appears that he still performs a number of managerial duties that are critical to Krohn Racing’s team operations.[131] His involvement is substantial enough that he could be considered Krohn Racing’s de facto team manager.

Lola then gives several reasons to believe that Hazell’s failure to sell any Proto-Auto vehicles was motivated by his loyalty to Krohn Racing. First, Lola

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argues that Hazell pursued a passive sales strategy.[132] It supports this argument primarily through Hazell’s deposition testimony in which he opined that the Grand Am circuit is “not an environment where you can hard sell your product”;[133] Hazell further described his sales approach as one in which he speaks with potential customers, but leaves it to them to pursue the sale further if they are interested.[134] Lola, on the other hand, believes that a more “structured” approach is necessary;[135] it cites the success of Bill Riley, who deploys a “semi-aggressive” approach and whose vehicles comprise a majority of all Grand Am entries.[136]

Second, Lola contends that Hazell created the impression among potential Proto-Auto customers that Krohn Racing was Proto-Auto’s “works team” — a team funded by the manufacturer of the vehicle it races.[137] According to Lola, Hazell achieved this impression by placing a Proto-Auto parts trailer next to the Krohn Racing trailer and by Hazell’s visible role during races as Krohn Racing’s de facto

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team manager.[138] Brundle testified that works teams possess unique and significant competitive advantages by virtue of their special relationship with the manufacturer; these advantages include testing priority and the first opportunity to use newly-engineered parts and components.[139] Thus, Brundle believes that Krohn Racing’s position, real or perceived, as Proto-Auto’s works team served to cool outside interest among potential customers who were, of course, also Krohn Racing’s competitors.[140]

Third, Lola complains of missed Proto-Auto promotional opportunities. For example, Lola cites Hazell’s decision not to allow potential customers to test drive the Proto-Auto cars at two “open days” sponsored by Grand Am in 2008 as a showcase for series constructors. Lola also argues that Hazell deliberately sabotaged a promotional opportunity in August 2009 when he allowed a journalist for the widely-circulated Autosports magazine to test drive the vehicle. Lola contends that Hazell permitted the test drive knowing that the vehicle’s setup was inadequately configured, leading to poor handling on the track. Indeed, Hazell

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had been informed by one of Krohn Racing’s professional drivers immediately before the journalist’s test drive that the professional driver disliked the car’s handling.[141] Lola contends that Hazell had adequate time to reconfigure the vehicle’s settings, but neglected to do so. Consequently, the vehicle received a poor review in Autosports magazine, which Lola believes hampered sales.[142]

Finally, Lola claims that the August 2009 press release and Krohn Racing’s temporary decision to cease using Proto-Auto vehicles virtually destroyed Proto-Auto’s chances of completing a sale for the remainder of 2009.[143] Lola also complains that Hazell omitted material information from the press release. Indeed, it argues that the press release, as written, suggests that Lola affirmatively cut off engineering services and other assistance to Proto-Auto when it was Hazell who demanded that Lola cease much of its ongoing work related to the vehicle.[144] Lola claims that the alleged material omission amplifies the disloyalty reflected in the press release.

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As Lola did, the Court begins by briefly reviewing Hazell’s divided loyalties. Hazell was certainly not independent of Krohn Racing. His lack of independence and his potential conflicts, however, were known from the outset: Hazell was not only selected as Proto-Auto’s chief executive, but he was also appointed by Krohn Racing to serve as its representative on the Proto-Auto board.[145] In fact, Krohn Racing’s right to select Proto-Auto’s chief executive was a condition to its acceptance of a minority ownership stake.[146] These background facts diminish the concerns the Court might otherwise have regarding Hazell’s loyalties based merely on his association with Krohn Racing.[147]

Turning to Lola’s substantive claim, there is insufficient evidence to conclude that Hazell deliberately, or even recklessly, stunted Proto-Auto’s sales efforts as a means of furthering Krohn Racing’s interests. Before discussing Lola’s specific arguments, its claim must first be placed within the appropriate economic context. Economic conditions declined, in some sectors significantly, from the time of Proto-Auto’s formation in March 2007 to the early spring of 2008 when

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Proto-Auto had developed a competitive vehicle and was in position to sell to potential customers. In Proto-Auto’s original business plan — which was drafted by Manwaring — it was expected that Proto-Auto would sell two vehicles to third parties in 2008, and another two vehicles in 2009.[148] Indeed, in 2006, Grand Am’s president had predicted that the number of vehicles raced in the Grand Am circuit would increase over the next several years.[149] The total number of cars that raced in the Grand Am circuit, however, dropped from an average of 26 cars per race in 2006 to only 13 cars per race in 2009.[150] Total car sales within the Grand Am circuit diminished accordingly: only six cars were sold by Proto-Auto’s competitors to third-parties in 2008 and only two cars were sold in 2009.[151] It should thus come as no surprise that Lola’s own efforts to sell Proto-Auto vehicles have been unsuccessful as well.[152]

As for Hazell’s sales strategy, although it may not have been as aggressive as Lola would have preferred, it was neither unreasonable nor was it quite as simplistic as Lola suggests. Hazell explained that the motorsport community presents “an extremely well-developed network,” with a uniquely high level of

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familiarity among and between its members.[153] Hazell further described how his marketing approach takes into account the tendencies and personality of the individual customer.[154]
Moreover, Hazell explained his belief that selling cars in the Grand Am market depends in large part on the manufacturer’s reputation and the vehicle’s demonstrated performance on the track.[155] This strategy is not, on its face, misguided. In addition, it is not so different from the sales approach sponsored by Manwaring.[156] For this reason especially, Hazell’s sales efforts can be considered reasonable, even if they were not, as Lola argues, optimal. This conclusion undermines Lola’s argument that Hazell’s strategy exemplified conduct used to benefit Krohn Racing at Lola’s expense.

As for the negative Autosports article, it is difficult to draw a causal connection between the article and Proto-Auto’s inability to sell any vehicles. Assuming the Autosports
article was in fact detrimental to Proto-Auto’s reputation,

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the Proto-Auto vehicle redeemed itself with its victory at Watkins Glen a mere two days after the test run.[157] The Court is unconvinced that the Autosports article actually harmed sales in light of the vehicle’s actual success on the road.[158] As for Hazell’s decision not to allow the cars to be raced at the two Grand Am “open days” in 2008, this was Krohn Racing’s decision to make as the vehicles’ owner, not Proto-Auto’s choice as the supplier. Hazell feared that potential customers would wreck Krohn Racing’s vehicles, and, after consulting with Brown, Krohn Racing’s official team manager, chose not to make the vehicles available.[159] Although Hazell owed Proto-Auto his utmost loyalty, he is not required to commandeer or otherwise make business decisions on Krohn Racing’s behalf simply to serve Proto-Auto’s interests.[160]

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With respect to Lola’s argument that Hazell disloyally established Proto-Auto as a works team, the nature of its development was substantially predictable from the start.[161] Part of Proto-Auto’s success was predicated on its affiliation with Krohn Racing — a winning, well-known race team whose success with the Lola vehicle would give the car the visibility needed to compete against entrenched manufacturers like Riley.[162] The Court understands that Lola may have soured on this arrangement as time went on; indeed, its reservations about works teams make sense. Although the perception of Krohn Racing as something of a Proto-Auto’s works team may have been regrettable in hindsight, since it was anticipated by the parties it could not have been the result of Hazell’s disloyalty.

Finally, the Court addresses Hazell’s authorship of the August 2009 press release. This action was not a breach of Hazell’s fiduciary duty of loyalty. Lola had already initiated litigation against Hazell and Krohn Racing; the press release more or less disclosed this non-confidential fact. The Court is hesitant to hold Hazell liable for explaining that Lola had raised issues regarding Proto-Auto and

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had sought to redress its grievances through legal action when Lola, in fact, had pursued that very course.[163] Indeed, the Court is wary of prescribing a general rule that would hold a fiduciary liable for making truthful disclosures to the public of non-confidential facts.[164]

Lola’s claim for lost sales therefore fails both because Lola has been unable to show that Hazell’s conduct was in any way part of a disloyal scheme engineered by or for Krohn Racing, and also because it is impossible to disentangle the “lost” sales from the broader, depressed economic context.

5. The Expenses

Lola next argues that Hazell improperly caused Proto-Auto to incur $439,326 in expenses that should have been paid for by Krohn Racing. Lola devoted only a sentence in its opening post-trial brief in support of this claim, [165] and it did little to flesh out the contention at trial. Instead, Turnbull merely

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directed the Court to a list he had compiled of the various disputed expenses incurred until February 3, 2009;[166] he also complained that, after that date, Proto-Auto acquired a Catia license for $27,835.[167] Turnbull explained that Catia is a computer engineering design system; he contended that Proto-Auto had no need for such a system because Lola is the “design authority” for the vehicle.[168] Krohn Racing, however, counters that the software is necessary for Proto-Auto to read computer aided design or “CAD” engineering files sent from Lola.[169]

Starting with the Catia license, the Court disagrees with Lola that this expense was charged inappropriately to Proto-Auto’s account. The record shows that Lola, perhaps not frequently, but certainly from time to time, sent Proto-Auto CAD files for specific parts.[170] While Moreton testified that the CAD information could be sent in a format that would obviate the need for a Catia license, he did not dispute that Proto-Auto has a need for some CAD files.[171] Perhaps, to Proto-Auto,

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the Catia license is not worth its cost. That, however, is not a determination for the Court to make: Hazell is Proto-Auto’s chief executive; absent a showing of disloyalty or gross negligence, there is no ground to hold him liable for the purchase of the challenged license.[172] As for the other expenses, given the abject lack of supporting evidence, the Court finds that Lola has failed to satisfy its burden of proof on the remainder of its claim.[173]

6. The Engineering Work for the Porsche Engine

Lola also contends that it has performed work for Proto-Auto for which it has not been paid. Specifically, Lola had undertaken engineering efforts on the

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vehicle chassis to support the installation of a Porsche engine.[174] It contends that Hazell has wrongfully refused to cause Proto-Auto to pay Lola $41,904 for engineering work that it expended in this effort. Hazell responded that this work was invoiced to Proto-Auto after he had put a stop order on Lola’s engineering projects in November 2008; for this reason, Hazell contends that the work was unauthorized.[175]

Although the invoice for the Porsche installation was certainly sent after Hazell’s stop order, [176] most of the engineering work was performed before Hazell took that action.[177] Moreover, Hazell knew of the Porsche installation in August 2008.[178] There is no evidence that Hazell objected to the Porsche-related work before it began or during its progression, until, of course, he issued the stop order

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in November 2008.[179] Thus, Proto-Auto owes Lola for its work up until that point.[180]

7. The Interest

Finally, Lola argues that Krohn Racing owes it interest in the amount of $11,792. This interest, according to Lola, accrued by virtue of the historic loan imbalance that existed between the Member Parties, and was not corrected until the fall of 2008.[181]

Lola and Krohn Racing agreed, pursuant to § 8.3 of the Operating Agreement, that if Proto-Auto’s audited balance sheets for any financial year show that its liabilities exceed the value of its assets, they would loan Proto-Auto the difference, and do so in proportion to their respective ownership interests. If either member failed to extend its required share of the loan, then the other party could lend all or some of the difference or terminate the Operating Agreement pursuant to § 10.3.[182]
Under § 8.4 that party would also be entitled to be paid a commercial

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rate of interest on the amount it loaned which exceeded its pro rata obligation; it could then can recover “the amount as a debt from the non-payer.”

Proto-Auto no doubt owed Lola significant sums from much of its early existence until November 2008. There was an imbalance between the Member parties. This has been conceded by Krohn Racing.[183]
The $11,000 interest figure appears reasonable given the amount of the imbalance historically. Krohn Racing offers no facts in rebuttal except to suggest, with little support, that Lola in fact owes money to Proto-Auto. Krohn Racing is therefore liable to Lola for the disputed interest.

B. The Alleged Material Breaches and Section 10.1
Lola seeks a declaratory judgment that it has terminated the Operating Agreement pursuant to § 10.1(a) and may lawfully assume control of Proto-Auto. Under § 10.1(a), either Lola or Krohn Racing may terminate the Operating Agreement by written notice if the other party:

has committed a material breach of any of the terms of [the Operating Agreement] or the Articles [of Organization], and it has been advised in writing of the breach and the consequences of failure to rectify the breach, and it did not rectify the breach within 21 days of receipt of such advice (for the purposes of this clause a breach is rectified if the relevant obligation is performed or the breach put right within the 21-day period).

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On September 22, 2009, Lola sent to Krohn Racing written notice that Krohn Racing had materially breached the Operating Agreement. Those breaches were alleged as follow:

1) Krohn [Racing’s] failure to furnish Lola with track and performance data as required by Section 3.7(b) of the Operating Agreement; 2) Krohn [Racing’s] failure to furnish Lola or its representative on the Proto-Auto Board with proposed budgets, comparative analysis of projected and actual accounts or profit and cash flow forecasts for Proto-Auto as required by Article 6 of the Operating Agreement; 3) Krohn [Racing’s] failure to furnish Lola with Proto-Auto financial statements in a timely fashion as required by Section 6.6 of the Operating Agreement; 4) Krohn [Racing’s] failure to cause Proto-Auto to repay Lola its disproportionate share of the members’ loan imbalance as required by Section 11.3 of the Operating Agreement; and 5) Krohn [Racing’s] failure to cause Proto-Auto to hold regular meetings of its Board as required by Section 5.3 of the Operating Agreement.[184]

Lola further informed Krohn Racing that it had until October 13, 2009, to cure the breaches; otherwise, Lola would terminate the Operating Agreement pursuant to § 10.1(a) and take action to assume control of Proto-Auto.

As a threshold matter, Lola miscalculated the amount of time that Krohn Racing had to cure the alleged breaches. The Operating Agreement defines “days” as business days, not including Saturday, Sundays, or “any holiday recognized by

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the Federal Government of the United States.”[185] Thus, Krohn Racing had until October 22, 2009, to cure the purported breaches.

This miscalculation is relevant because Krohn Racing attempted to cure the alleged breaches by two separate efforts, both of which occurred within the 21-day cure period.[186] Nevertheless, Lola maintains that Krohn Racing’s curative efforts were insufficient. Lola also claims that Krohn Racing has breached the covenant of good faith and fair dealing implied in the Operating Agreement, which Lola contends establishes the materiality of Krohn Racing’s other breaches.

In analyzing Lola’s claims, the Court first looks to whether a breach in fact occurred. It then turns to whether the breach was material, and finally, whether the breach was cured within § 10.1’s cure period. Neither “materiality,” “material,” nor “material breach” is a defined term within the Operating Agreement. As such, the Court will look to the factors enumerated in Section 241 of the Restatement (Second) of Contracts for guidance:[187]

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1) the extent to which the injured party will be deprived of the benefit which he reasonably expected; 2) the extent to which the injured party can be adequately compensated for the part of that benefit which he will be deprived; 3) the extent to which the party failing to perform will suffer forfeiture; 4) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances; and 5) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.[188]

1. The Testing Data

In accordance with § 3.7(a) of the Operating Agreement, Krohn Racing was required to test the vehicles purchased from Proto-Auto and to “assist Lola to achieve the improvements in performance and safety of the [vehicles] by providing to Lola all data and any other information obtained from such testing.” Krohn Racing had regularly delivered this information to Lola until sometime in late 2008 or early 2009, when Krohn Racing significantly reduced the quantity of information transmitted.[189] As set forth previously, [190] after receiving Lola’s September 22, 2009, letter, Krohn Racing forwarded to Lola a disk containing testing data on October 16, 2009. According to Moreton, the information was of little use to Lola; specifically, he stated that it did not capture “the full picture.”[191]

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Krohn Racing’s decision to withhold the testing data for much of the 2009 racing season constituted a breach of the Operating Agreement. The Court thus turns to the question of whether or not this breach was material. The first Restatement factor looks to the extent to which the non-breaching party may be deprived of his reasonably anticipated benefit. By receiving test data, Lola sought to improve upon the Proto-Auto vehicle’s performance. The benefits derived from Lola’s potential efforts were two-fold: first, through improvement, the Proto-Auto vehicle would become more competitive, and thus marketable, which would in turn generate increased sales through which Lola would share in the profits; second, Lola would also be compensated for its design and engineering work. Lola has failed to demonstrate that the Proto-Auto vehicle required additional engineering to enhance track competitiveness; Krohn Racing actually won two races with the Proto-Auto vehicle in 2009. Lola cannot reasonably expect a steady stream of design business when there is no demonstrated need for such efforts.[192] For these

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reasons, the Court finds that the breach was not material and thus could not be the basis for a § 10.1(a) termination.[193]

2. Krohn Racing’s Failure to Furnish Budgets and OtherFinancial Documents

Article 6 of the Operating Agreement places upon Krohn Racing, as the member party whose board representation includes Proto-Auto’s chief executive officer, several budgetary and financial reporting obligations. Under § 6.1(a) specifically, Krohn Racing must ensure, before the commencement of each financial year, that there is prepared a projected profit and loss account, an estimate of working capital requirements, an operating budget, a projected balance sheet for the end of that financial year, a business review, and a summary of business objectives as well as a business plan. Pursuant to § 6.1(b), Krohn Racing is required to submit the budget to Proto-Auto’s board for its approval within one month before the beginning of the financial year. Further, Krohn Racing must ensure the production, within twenty-one days of the end of each month, of

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monthly management accounts;[194] such accounts must be forwarded to each member of Proto-Auto’s board within three days of their being produced.[195]

Hazell admitted that he had never delivered an annual budget as required under the Operating Agreement until October 16, 2009;[196] Turnbull went even further and testified that neither Krohn Racing nor Hazell had ever produce any of the documents listed in § 6.1(a).[197] Moreover, evidence at trial showed that the monthly financial statements either were not produced at all or were frequently submitted late.[198]

The evidence, however, also shows that financial information was frequently exchanged between Hazell and Manwaring during the first two years of Proto-Auto’s existence. Manwaring provided a detailed business plan in January 2007,

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before the Operating Agreement was even entered into.[199]
Manwaring produced a similar business plan on February 23, 2007, [200] to which Hazell responded three days later with some suggestions and revisions.[201] This give and take continued for about a year as Manwaring and Hazell worked to determine accurate origination and parts costs, and attendant working capital requirements.[202] Although the communications between Manwaring and Hazell technically concerned Proto-Auto’s “business plan,” that term in this context was given an expansive meaning as the parties dealt with the nitty gritty of constantly evolving budgetary forecasts and costs.[203] Manwaring continued his involvement with the business plan up until

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his departure from Lola.[204] Thereafter, on November 17, 2008, Hazell updated the business plan and provided an accompanying cash flow projection.[205]

The record demonstrates additional exchanges of financial information between Lola and Krohn Racing. For example, on May 20, 2008, Weinstein sent to Turnbull a balance sheet, profit and loss statement, and business review for the fiscal-year ended March 31, 2008.[206] During 2008 and 2009 while Lola and Krohn Racing attempted to resolve Proto-Auto’s inventory accounting problems, Turnbull was in frequent communication with Krohn Racing personnel; as discussed previously, he also twice visited Proto-Auto’s facility, and, for a short period at least, had a productive working relationship with Weinstein.[207] Indeed, the record shows that during this time there was a significant exchange of financial information between Lola and Krohn Racing.[208]

Thus, insofar as Krohn Racing may have breached certain of Article 6’s technical requirements, any such breach was immaterial. Article 6 existed to

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ensure that Lola was kept aware of Proto-Auto’s financial condition.[209] The evidence shows a considerable amount of cooperation between Krohn Racing and Lola both before, and after, their relationship soured in the late summer and fall of 2008. This cooperation and the fact that Lola made little of the technical deficiencies regarding Krohn Racing’s financial information exchange until after filing its first lawsuit, severely undermine its position. The Court has been given no basis upon which it can conclude that Lola was deprived of material financial information for any noteworthy period of time. The Article 6 breaches were, almost by definition, immaterial.

3. The Loan Imbalance

As stated previously, counsel for Lola concedes that there no longer exists a material loan imbalance between the Member Parties.[210] Lola, however, insists that at the time of its September 22, 2009, termination letter, there remained a material loan imbalance.[211] If true, Lola would have the right to terminate the Operating Agreement under § 8.4.[212] The record, however, demonstrates that the

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loan imbalance was almost nonexistent by December 2008, and that any imbalances that arose after that time were timely paid back by Krohn Racing.[213] The loan imbalance, therefore, may not be cause for termination.

4. The Board Meetings

Finally, Lola and Krohn Racing agreed that the Proto-Auto board would hold “meetings . . . at least three-monthly.”[214] They also agreed that any director “may request that a board meeting be called or propose items for inclusion in the agenda.”[215] By the time of trial, Proto-Auto had never held a formal meeting of its board.[216] Turnbull, however, attempted to call a meeting of the Proto-Auto board in March 2009 to discuss Hazell’s replacement, but he was rebuffed by Krohn Racing.[217] Lola maintains that Krohn Racing refused to recognize the meeting or

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to permit Hazell’s attendance as its board designee. This refusal, according to Lola, constituted a material breach of the Operating Agreement.

Lola’s argument fails for two reasons. First, Turnbull’s attempt to call a meeting of the Proto-Auto board in March 2009 was defective. He selected the March date because it coincided with a scheduled meeting between Krohn and Birrane that was to take place in London.[218] Turnbull’s email suggested that the so-called full board meeting would include himself, Birrane, and Krohn. Krohn responded to Turnbull’s request for a board meeting by agreeing to meet with Birrane regarding Proto-Auto; Krohn, however, rightfully refused to “accept any such meeting as a so called `Board of Directors’ meeting.”[219] This is because Birrane and Krohn were not at that time, or ever, Proto-Auto board members. Turnbull agreed to postpone the meeting; he instead scheduled an “informal meeting in London on Friday 6th March between Mr. Birrane and Mr. Krohn,” with both Turnbull and Brundle available for part of the meeting.[220] The Court fails to understand how Krohn Racing’s conduct during this series of events constituted a breach of the Operating Agreement, especially considering Turnbull’s defective request for a board meeting and his subsequent agreement to postpone the requested board meeting in order to have an informal meeting in its place.

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Second, even if Krohn Racing had inappropriately refused a Proto-Auto board meeting, and thus breached the Operating Agreement, there is no evidence that such a breach would at all have been material. Key persons within Lola and Krohn Racing actually met on March 6, 2009 — the date Turnbull had set for a board meeting. The evidence also demonstrates frequent communication between the parties, particularly Turnbull, Hazell, and, earlier, Manwaring. The presumed purpose of frequent board meetings is to give the board members an opportunity to listen and be heard.[221] Given the ample communications described throughout this memorandum opinion, Lola has failed to demonstrate that the lack of Proto-Auto board meetings deprived it of any expectation it did not achieve through other means.[222]

In sum, Lola has failed to demonstrate that any breach identified in its September 22, 2009, termination letter was material. For this reason, it not entitled to terminate the Operating Agreement under § 10.1.

5. Krohn Racing’s Good Faith

Although not contained in its September 22, 2009 notice, Lola has consistently argued that Krohn Racing breached the implied covenant of good faith and fair dealing by refusing to consider Hazell’s replacement as Proto-Auto’s chief

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executive. The implied covenant of good faith attaches to every contract.[223] Determining whether it has been breached, however, involves the “cautious enterprise” of inferring contractual terms not contained within the contract and handling contractual gaps not anticipated by the parties.[224] The Court will “only imply contract terms when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.”[225] The record demonstrates that Krohn Racing expressed willingness to consider Hazell’s replacement or resignation, but refused to take that step without more information — in particular, proof of misconduct through the production of audited financials.[226] On these facts, and considering that Lola failed to prove the vast majority of its claims at trial, Krohn Racing did not breach the implied covenant of good faith.[227]

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C. Krohn Racing’s Breach of Contract Counterclaims
1. Did Lola Breach the Operating Agreement by Failing toProduce a Competition-Ready Car on Time and on Budget?

Krohn Racing contends that Lola failed to meet the targets set for the Proto-Auto vehicle’s redesign and engineering both in terms of time and cost. Krohn Racing was unable to compete with the vehicle at the 2008 24 Hours of Daytona, which was the date set in the Operating Agreement for its debut race.[228] Moreover, Lola’s engineering costs for 2007 and 2008 alone exceeded Proto-Auto’s entire development budget.[229] These shortcomings, according to Krohn Racing, constitute a breach of the Operating Agreement.

Krohn Racing, however, has given the Court little reason to hold Lola liable for the timeline and budgetary shortcomings. Regarding the timeline, the Member Parties certainly envisioned, pursuant to § 3.8 of the Operating Agreement, that the Proto-Auto vehicle would be raced in the first race of the 2008 season — a milestone that was not met.[230] That said, even if Lola was responsible for

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providing a competition-ready vehicle by the beginning of the 2008 Grand Am series season, Krohn Racing has not demonstrated how the design delay caused it any quantifiable injury or frustrated any of its expectations. Krohn Racing was still able to race in the 24 Hours of Daytona, albeit with another car.[231] Thus, any delay did not cost Krohn Racing a competitive opportunity. In addition, the Court has already discussed Proto-Auto’s struggles to generate sales, including the frustration brought on by the economic recession. Again, the broader economic context makes it difficult to assess the extent to which either of the Member Parties’ conduct hampered Proto-Auto’s sales efforts.

As for the hefty engineering expenses, Lola was not obligated under the Operating Agreement to keep its engineering fees within Proto-Auto’s budget. Instead, it was Krohn Racing’s duty, as the party “whose Board Representation” included Hazell as Proto-Auto’s chief executive, to “procure that [Hazell] does not authorize or commit [Proto-Auto] to [an] expenditure which is not contained in the relevant budget.”[232] There is therefore no legal basis for holding Lola accountable for the engineering overages.[233]

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Moreover, Krohn Racing has provided little evidence that the timeline and budgetary shortcomings were Lola’s fault. Although there are several early emails from Hazell that demonstrate his frustration with delays by Lola in supplying parts, [234] these emails do little to prove that Lola was to blame for the lag time.[235] Indeed, the record shows that not only the unexpected delays, but also the overages, occurred because of the roll hoop issue and the aerodynamic problems that plagued Multimatic and which caused it to sell its Daytona prototypes in the first place.[236]

2. The Withheld CAD Files

Next, Krohn Racing argues that Lola withheld CAD files rightfully belonging to Proto-Auto. It premises its argument on § 12.4 of the Operating Agreement, which provides that “Intellectual Property developed by either Member Party during the Term relating to the Vehicles shall be the property of the

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Despite this acknowledgement, Lola claims that Krohn Racing has not demonstrated why Proto-Auto requires the information, which Lola contends is used almost exclusively for manufacturing purposes.[239] Moreover, Lola fears that Krohn Racing would use the CAD drawings to counterfeit Lola parts for the Proto-Auto vehicle. It bases this allegation on allegedly counterfeit parts it found during a post-trial inspection of Proto-Auto’s premises.[240]

First, the Court notes that the evidence submitted into the re-opened trial record does not demonstrate counterfeiting.[241]
Second, nothing in the Operating

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Agreement permits Lola to hold on to the CAD files for itself. The files are plainly Proto-Auto’s property. Krohn Racing’s request for injunctive relief on this claim is therefore granted.

3. Chassis 8

Krohn Racing also seeks an injunction preventing Lola from blocking the shipment of Chassis 8 from Multimatic to Proto-Auto in Georgia.[242] Indeed, the evidence shows that Lola, acting on Proto-Auto’s behalf, requested that Multimatic

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halt the chassis’ shipment to Proto-Auto, and return it to Canada. Lola contends that it blocked the shipment out of respect for an agreement Proto-Auto had made with Multimatic by which Multimatic would assemble the vehicle; it also is concerned that Krohn Racing will overcharge for the assemblage.

Lola, however, has presented no evidence of such an agreement between Proto-Auto and Multimatic;[243] nor has it explained why the authority to stop delivery does not belong to Hazell as Proto-Auto’s chief executive.[244] Lola must therefore cease its efforts to prevent delivery of Chassis 8.

4. Lola’s Liability for Bringing Claims for Dissolution and/orTermination

Krohn Racing maintains that Lola violated the Operating Agreement by bringing its first lawsuit for dissolution in April 2009. It contends that § 10.1’s notice and cure provision “vests in either party the right to cure any alleged material breach of the Operating Agreement before the other party can invoke” the Operating Agreement’s termination provision, and that before Lola’s filing of the April 2009 complaint, it had made no attempt to comply with this provision. Thus, according to Krohn Racing, Lola breached the Operating Agreement by depriving

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Krohn Racing of its contractually-defined cure rights.[245] Krohn Racing further contends that Lola breached the Operating Agreement by refusing to follow the deadlock procedure contained in § 10.2 of the Operating Agreement.[246] According to Krohn Racing, this is because § 10.2 is the only contractual mechanism for exiting Proto-Auto absent a material breach of the Operating Agreement.

The Court is not persuaded by Krohn Racing’s position. Lola did not predicate its first complaint on § 10.1 termination; thus, there was no reason for it initially to have followed the notice and cure requirements contained within that

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provision. Moreover, § 10.1, like the deadlock procedure contained in § 10.2, is permissive, [247] and neither provision precludes the filing of a suit for dissolution, breach of contract, or breach of fiduciary duty. The Court addressed similar arguments when ruling on Krohn Racing’s motion to dismiss certain counts of Lola’s first complaint.[248] There is no ground either to conclude that Lola breached the Operating Agreement by suing for dissolution or other relief before it attempted to terminate the Operating Agreement under § 10.1, or to impose liability upon Lola because it sought judicial dissolution instead of first invoking the contractual disentanglement option of § 10.2.

5. Bad Faith and Fee Shifting

As its final claim, Krohn Racing argues that Lola “knowingly advanced frivolous claims and defenses and engaged in a pervasive pattern of needlessly antagonistic litigation behavior”;[249]
thus, according to Krohn Racing, Lola should pay Krohn Racing’s litigation costs under the bad faith exception to the American Rule.[250] In support of its request, Krohn Racing contends that several of Lola’s

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claims were baseless — specifically those involving the contested expenses that were agreed to by Manwaring, the allegedly missing inventory, Hazell’s decision to seek an exemption from Grand Am’s revised roll hoop regulation, and Hazell’s purportedly disloyal sales strategy. Krohn Racing also challenges Lola’s conduct during discovery and trial, basically arguing that several aspects of Lola’s litigation strategy were annoying or obnoxious.[251]

The Court once again is not persuaded by Krohn Racing’s contentions. There was nothing about Lola’s conduct before or during trial that smacks of the bad faith that would justify fee shifting.[252] Of course, many of Lola’s claims were flimsy, but all had some basis, even if minimal, in fact. There was no doubt something to be litigated. Indeed, Lola prevailed on some of its more minor claims; and the issues that it focused on originally — the monies owed it from Krohn Racing and the inventory problems — were genuinely troubling to it. Finally, Lola could have raised fewer procedural hurdles, but such is litigation. For these reasons, Krohn Racing’s request for fee shifting is denied.

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D. Judicial Dissolution
Finally, the Court turns to judicial dissolution. Section 18-802 of Delaware’s Limited Liability Company Act provides that upon “application by or for a member or manager the Court of Chancery may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.”[253] This is a high standard.[254] And, as the statute makes clear, even if the standard of “not reasonably practicable” is met, the decision to enter a decree of dissolution nonetheless rests with the discretion of the Court.[255] The Court’s discretion has been guided by, among other considerations: 1) whether there is deadlock between the members at the board level; 2) whether the operating agreement gives a means of navigating around the deadlock; and 3) whether, due to the company’s financial position, there is still a business to operate.[256] Of course, “[t]hese factual circumstances are not individually dispositive; nor must they all exist for a court to find it no longer reasonably practicable for a business to continue operating.”[257]

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The factors set forth above, although not strictly applicable here, are helpful nonetheless. For starters, there is no deadlock between the Member Parties as that word is commonly used.[258]
Although representation on Proto-Auto’s board is split evenly between the Member Parties, management of Proto-Auto’s daily affairs is vested in Hazell as its chief executive. He cannot be removed unilaterally. The business may therefore continue even if the Member Parties have disagreements about its management because they agreed at the outset that Hazell would be responsible for Proto-Auto’s operations. There is thus no disagreement, as revealed in the trial record, between the Member Parties that precludes Proto-Auto from functioning in conformity with the Operating Agreement.[259]

Proto-Auto, on the other hand, is a joint venture.[260] It requires cooperation between the Member Parties to thrive: as stated previously, Lola’s design efforts are to enhance vehicle performance, as demonstrated by Krohn Racing’s success on the track. These combined efforts are to lead to sales, with that effort spearheaded by Hazell. Proto-Auto’s business model additionally requires trust

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between the Member Parties: they are located on different continents, and the Member Party responsible for housing and managing Proto-Auto is also its sole customer. Although the Member Parties’ conflict may technically not amount to member deadlock, deep concern is warranted as to whether they are any longer capable of working together cooperatively to attain the prolonged success envisioned in the Operating Agreement.[261]

Thus, the Member Parties’ frustration with one another informs whether there is still a business to operate. Concern over Proto-Auto’s future and viability, however, is tempered by the fact that the Operating Agreement contains a means by which the Member Parties may work around their difficulties: the deadlock procedure.[262] This provision may not provide a precise or ideal remedy for Lola’s discontent with Hazell and Krohn Racing, but it likely provides a path for Lola to exit the business if it so chooses.[263]

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There is an additional concern that may overshadow other considerations: that the difficult state of relations between the Member Parties was brought about in large part by Lola — the party seeking dissolution.[264] Although Lola had some reason to be concerned about the imbalance and the accounting uncertainties when Birrane first raised those issues with Hazell in August 2008, Hazell shortly thereafter undertook good faith efforts to remedy both problems; indeed, as stated before, the imbalance was repaid by December 2008.

Despite Hazell’s efforts, Lola amplified — and then raised grievances that went well beyond — the two original issues. The record demonstrates that, by the fall of 2008, Lola was growing increasingly uneasy with the size of its investment in Proto-Auto and the venture’s profitability.[265] Birrane brought these

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issues to Hazell’s attention in late October 2008 — he criticized Hazell’s performance, complained of outstanding invoices from Krohn Racing, and demanded that Hazell take steps to make the venture more profitable.[266] It was at this moment that the Member Parties’ relationship began to decline. In his response to Birrane, Hazell was clearly agitated — his tone became more combative and he blamed Lola for several of Proto-Auto’s early problems.[267]

Matters worsened. Dawson began to raise more serious concerns regarding the Member Parties’ relationship, expectations, and strategic direction.[268] Lola was, however, by and large powerless to assert greater control over the venture given the division of responsibilities established by the Operating Agreement. Perhaps realizing this, Dawson questioned Proto-Auto’s continued viability in a down economy and then suggested, for the first time, the possibility of dissolution or buy-out.[269] When that proposition failed to attract much interest, Lola ratcheted up its earlier complaints while much more seriously questioning Hazell’s competency, loyalty, and character.[270] Birrane brought Lola’s allegations to Krohn’s attention and proposed — quite strongly — that Hazell be removed as Proto-Auto’s chief executive and replaced with a Lola employee.[271] The breadth of

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Lola’s grievances and the vigor with which they were pursued further strained the Member Parties’ already-deteriorating relationship.

These allegations formed the core of Lola’s lawsuit. Critically, Lola failed to prove its claims at trial.[272] Lola’s most troubling allegation — that parts were lost or stolen due to Hazell’s gross negligence — foundered on the rocks of Phillips’ review, which confirmed that the accounting problems were related to discrepancies between the different recording systems, and had little to do with the improper movement of physical parts. Several of Lola’s less serious complaints, like those allegations regarding the roll hoop and parts trailer, involved decisions previously approved of by Manwaring, [273] while others pertained to aspects of the business that were contemplated by the Member Parties when they established Proto-Auto — most notably the works team issue and Hazell’s position as Proto-Auto’s sales authority.[274]

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If Lola had proven at least some of those claims, judicial dissolution might very well be appropriate.[275] But without such success, Lola’s frustration amounts to little more than disappointment with how Proto-Auto is structured and managed and how Proto-Auto is attempting to expand its market presence.[276]
Unfortunately for Lola, it agreed to this arrangement when it partnered with Krohn Racing. Given its overzealous role in escalating this dispute, the Court will leave it to Lola to assess whether to exercise the deadlock procedure contained within the Operating Agreement — a provision that provides a no less reasonable means by which the Member Parties may disentangle themselves than dissolution.[277]

The Court concludes by emphasizing that a party to a limited liability company agreement may not seek judicial dissolution simply as a means of freeing

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itself from what it considers a bad deal.[278] This is so even if the Member Parties’ relationship has — as here, due largely to pressure applied by Lola both within and without the litigation context — been badly damaged. Endorsing such a rule would allow for one party — unfairly — to defeat the reasonable expectations of its counterparty.[279] Moreover, the Member Parties in their private ordering effort embraced a provision within the Operating Agreement that allows for disentanglement. Lola may not be in an enviable position.[280] Perhaps it should never have agreed to place Proto-Auto in Georgia and to allow Krohn Racing to select the venture’s chief executive. Regardless, it is not for the Court to terminate, or rewrite, the Operating Agreement. Lola’s request for dissolution is denied.[281]

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V. CONCLUSION
The Court finds that Krohn Racing owes Lola interest on the historic loan imbalance; there is also a trade debt owed Lola from Proto-Auto for design work related to the Porsche engine. Lola will be directed to withdraw its request that Chassis 8 remain at Multimatic’s facility in Canada and to release all of Proto-Auto’s intellectual property. Otherwise, all other requests for relief are denied.

Counsel are requested to confer and to submit an implementing form of order.

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