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Ocean Tomo, LLC v. PatentRatings, LLC

United States District Court, N.D. Illinois, Eastern Division

June 14, 2017

Ocean Tomo, LLC, Plaintiff,
v.
PatentRatings, LLC; Jonathan Barney, Defendants.

          MEMORANDUM OPINION AND ORDER

          THOMAS M. DURKIN, UNITED STATES DISTRICT JUDGE

         Jonathan Barney, through his company PatentRatings, LLC, created, patented, and developed software for analyzing and evaluating patents. Ocean Tomo, LLC, provides financial services related to intellectual property, including patent analytics. In 2004, the parties reached an agreement that provided for (1) licensing PatentRatings's software to Ocean Tomo; (2) giving Ocean Tomo an ownership interest in PatentRatings; and (3) giving Barney an ownership interest in, and a management position with, Ocean Tomo. The relationship among the parties soured, giving rise to amendments to the agreements in 2007, and eventually this litigation in 2012.

         PatentRatings and Barney have made counterclaims against Ocean Tomo alleging breaches of various contracts governing the parties' business relationship (Counts I-III); tortious interference with prospective economic advantage (Count IV); violation of the Computer Fraud and Abuse Act, 18 U.S.C. § 1030 (Count V); fraud (Count VI); and seeking various declaratory judgments regarding the contracts governing the parties' relationship (Count VII). R. 175. Ocean Tomo has filed a motion seeking summary judgment on Count I for breach of the “Operating Agreement”; Count VI for fraud; and Count III for breach of contract of the “License Agreement.” R. 238. For the following reasons, the motion is denied in part and granted in part.

         Legal Standard

         Summary judgment is appropriate “if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(a); see also Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). The Court considers the entire evidentiary record and must view all of the evidence and draw all reasonable inferences from that evidence in the light most favorable to the nonmovant. Ball v. Kotter, 723 F.3d 813, 821 (7th Cir. 2013). To defeat summary judgment, a nonmovant must produce more than “a mere scintilla of evidence” and come forward with “specific facts showing that there is a genuine issue for trial.” Harris N.A. v. Hershey, 711 F.3d 794, 798 (7th Cir. 2013). Ultimately, summary judgment is warranted only if a reasonable jury could not return a verdict for the nonmovant. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).

         Analysis

         I. Count I - Breach of the Operating Agreement

         As a member of Ocean Tomo, Barney is a party to Ocean Tomo's Operating Agreement. Under the Operating Agreement, the Ocean Tomo Board of Managers has discretion to determine whether profits from a transaction are “Net Profits from Operations” or “Other Net Profits.” R. 241-5 at 7. The full relevant provision of the Operating Agreement provides the following:

“Net Profits from Operations” and “Net Losses from Operations” shall mean, for each Fiscal Year or other period, such portion of the Company's Net Profits (or Net Losses) attributable to the ordinary course operation of the Company's business for such period; provided that, (1) such amount shall exclude any Net Profits or Net Losses resulting from the sale of all or substantially all of the Company's assets, and (2) such amount shall be subject to any other modification (including any modification that would otherwise be inconsistent with the definition set forth in this paragraph) as determined by the Board of Managers (but shall not in any event include profits from the sale of all or substantially all of the Company's assets). The portion of the Company's Net Profits (or Net Losses) constituting Net Profits from Operation (or Net Losses from Operations) shall be determined by the Board of Managers in its sole discretion and such determination shall be conclusive on the Members.

Id. The determination of whether profits from a transaction constitute “Net Profits from Operations” or “Other Net Profits” is important because different types of profits are allocated to Ocean Tomo's members in different ways. “Other Net Profits” are “allocated among the Members for each Fiscal Year in accordance with their respective Percentage Interest.” Id. at 20. The Operating Agreement does not appear to directly state how “Net Profits from Operations” should be allocated. But according to Barney's allegations, “75% of ‘Net Profits from Operations' shall be allocated among the members as determined by the Board of Managers, and the remaining 25% of ‘Net Profits from Operations' shall be allocated among the members in accordance with their respective percentage interest.” R. 175 ¶ 13. At least for purposes of this motion, Ocean Tomo does not appear to dispute this characterization of the process for allocation of “Net Profits from Operations.”

         A. Performance Under the Operating Agreement

         Barney alleges that Ocean Tomo's Board of Managers improperly determined that the revenue from two particular transactions-the sales of Ocean Tomo subsidiaries ICAP and IPXI-were “Net Profits from Operations” rather than “Other Net Profits, ” thereby depriving Barney of income. R. 175 ¶ 72. Barney also argues that the Board of Managers exercised its discretion to make these decisions in violation of the covenant of good faith and fair dealing. R. 254 at 15-16. Ocean Tomo argues that summary judgment is appropriate because the Operating Agreement provides that allocation of profits is within the Board of Managers' discretion. R. 239 at 7-8.

         1. Interpretation of the Contractual Language Providing the Board of Managers' Discretion

         Barney argues that even though the provision of the Operating Agreement defining “Net Profits from Operations” grants the Board of Managers' discretion to classify profits, the definition also limits that discretion, in that

to the extent that the Board of Managers have discretion to modify, the modification can only be to “such amount, ” which refers to the amount in the preceding clause-i.e., “such portion of the Company's Net Profits . . . attributable to the ordinary course operation of the Company's business . . . .” Thus, the Board of Managers does not have discretion to modify the classification of any other portion of Ocean Tomo's Net Profits.

R. 254 at 15. In other words, Barney argues that the Board does not have discretion to classify profits as “Net Profits from Operations, ” because the contract already sets forth that definition as “Net Profits . . . attributable to the ordinary course operation of the Company's business.” Barney argues that the Board's discretion does not apply to this initial classification as “Net Profits from Operations, ” but only to a subsequent “modification” of this already determined “amount.”

         This interpretation flies in the face of the plain language of the provision. There is no dispute that “Net Profits from Operations” are defined as “Net Profits . . . attributable to the ordinary course operation of the Company's business.” Barney's argument ignores three important phrases. First, the phrase “provided that” appears immediately after the definition of “Net Profits from Operations.” This shows that the clause giving the Board the right to “modify” the “amount” is not an additional modification on the initial classification of “Net Profits from Operations, ” but is the process of classifying “Net Profits from Operations” in the first place.

         This interpretation is further confirmed by the second phrase Barney's argument ignores, namely that the “modifications” the Board is permitted to make are permitted to be “inconsistent with the definition set forth in this paragraph.” In other words, even if the clause does provide for a two-step process for determining “Net Profits from Operations”-i.e., (1) the initial classification according to the definition set forth in the contract, and (2) any “modification” by the Board-the Board also has the power to “modify” the initial classification definition. This power moots the limitation Barney's interpretation would place on the Board's discretion.

         And third, the last clause of the provision states, “The portion of the Company's Net Profits . . . constituting Net Profits from Operations . . . shall be determined by the Board of Managers in its sole discretion and such determination shall be conclusive on the Members.” To the extent Barney has identified any ambiguity in the preceding clauses (of which there is none), this clause removes it. The Operating Agreement unambiguously grants the Board of Managers “sole discretion” to classify Net Profits from Operations, and Barney's interpretation of the contract's language does not serve to defeat Ocean Tomo's motion.

         2. Good Faith and Fair Dealing

         However, “[w]hen one party to a contract is vested with contractual discretion, ” as the Board of Managers is here, “it must exercise that discretion reasonably and with proper motive, and may not do so arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties.” Interim Health Care of N. Ill., Inc. v. Interim Health Care, Inc., 225 F.3d 876, 884 (7th Cir. 2000). Yet, the duty of good faith and fair dealing “cannot override an express term of a contract.” Cromeens, Holloman, Sibert, Inc. v. AB Volvo, 349 F.3d 376, 396 (7th Cir. 2003). It “is not an independent source of duties for the parties to a contract, ” but rather is “used as a construction aid in determining parties' intent” with respect to the duties or obligations imposed by the contract's terms. Wilson v. Career Educ. Corp., 729 F.3d 665, 687 (7th Cir. 2013); see also Cromeens, 349 F.3d at 395 (“Illinois courts use the covenant to determine the intent of the parties where a contract is susceptible to two conflicting constructions.”); VC Mgmt., LLC v. Reliastar Life Ins. Co., 195 F.Supp.3d 974, 995 (N.D.Ill. 2016) (“an independent duty of good faith and fair dealing does not appear to exist under Illinois law”).

         Here, as discussed, the provision granting “sole discretion” to the Board of Managers to determine whether certain profits constitute “Net Profits from Operations” is unambiguous. The covenant of good faith and fair dealing does not serve to impose a limitation on the discretion granted by this provision in and of itself.

         But Barney points out that the Operating Agreement provides, with respect to “return of Capital Contributions or as to Net Profits, Net Losses or distributions, ” that “no Member shall have priority over any other Member.” R. 241-5 at 16 (§ 6.05). This provision could reasonably be understood to impose a limitation on the Board of Managers' discretion with respect to classifying profits, to the extent that profits cannot be classified in a manner that gives one member “priority over” another. “Priority, ” however, is not defined in the Operating Agreement, leaving the intent of the parties with respect to the meaning of the term, and the provision's relation to the contract as a whole, “susceptible to conflicting constructions.” The Seventh Circuit has applied the covenant of good faith and fair dealing in similar circumstances. See Wilson, 729 F.3d at 676 (“[E]ven though the termination clause also says [the defendant] has the right to terminate the Plan for any reason, the fact that the parties anticipated that [the defendant] might have to terminate the Plan ‘for regulatory compliance purposes' implies that the parties had a reasonable expectation about how [the defendant] would exercise its discretion in this very situation.”); Interim Health, 225 F.3d at 884 (applying the covenant of good faith and fair dealing where the contract provided one party the right to “withhold some account leads, but the contract is vague about which leads it may withhold, and what justifies withholding”). The ambiguity present when the section concerning “priority of members” is applied to the Board's discretion to classify “Net Profits from Operations, ” is similar to that in Wilson and Interim Health, and so opens a space for the covenant of good faith and fair dealing to play a role.

         In that regard, Barney points to the following email between Ocean Tomo's majority owners as evidence that the Ocean Tomo Board of Managers did not exercise its discretion with respect to determining Net Profits from Operation in good faith:

There is one other way to do it: treat the sale like an operating item instead of a sale item. An argument could be made for that too. If we did that I'd bet we get a number close to the above because you own so much of the firm and because our ET value generation is not far off of our ownership percentages. If anything, you'll gain at JB's expense.

R. 254-9 at 2. Ocean Tomo does not address this email in its brief. With its references to “treating a sale like an operating item instead of a sale item, ” “ownership percentages, ” and “gaining at JB's expense, ” this email could be evidence that the Ocean Tomo Board of Managers exercised its discretion to prioritize the majority owners' interests over Barney's with respect to classifying profits. On the basis of this evidence, a reasonable jury could find that Ocean Tomo did not exercise its discretion in good faith. Therefore, Ocean Tomo's ...


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