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EFiled: Aug 6 2004 12:26PM EDT Filing ID 4008369

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE IN AND FOR NEW CASTLE COUNTY

LAZARD DEBT RECOVERY GP, LLC, individually, and on behalf of the LAZARD DEBT RECOVERY FUND, L.P., and LAZARD DEBT RECOVERY MANAGEMENT LLC, Plaintiffs, v. MICHAEL A. WEINSTOCK and ANDREW J. HERENSTEIN, Defendants.

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C.A. No. 19503

OPINION Date Submitted: July 19, 2004 Date Decided: August 6, 2004 Anne C. Foster, Esquire, Catherine G. Dearlove, Esquire, Evan O. Williford, Esquire; RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Rowan D. Wilson, Esquire, Thomas G. Rafferty, Esquire, Kenneth E. Lee, Esquire, CRAVATH, SWAINE & MOORE, New York, New York, Attorneys for Plaintiffs. Kenneth J. Nachbar, Esquire, MORRIS, NICHOLS, ARSHT & TUNNELL, Wilmington, Delaware; Jonathan Rosenberg, Esquire, Daniel L. Cantor, Esquire, John T. Hammer, Esquire, O'MELVENY & MYERS, LLP, New York, New York; Attorneys for Defendant Michael A. Weinstock. Norman M. Monhait, Esquire, ROSENTHAL, MONHAIT, GROSS & GODDESS, P.A., Wilmington, Delaware; Kenneth A. Zitter, Esquire, LAW OFFICES OF KENNETH A. ZITTER, New York, New York; Attorneys for Defendant Andrew J. Herenstein STRINE, Vice Chancellor

Lazard Freres & Co. started a fund focused on investing in the securities of distressed companies. To that end, it created controlled subsidiaries to act as the fund's general partner and investment manager, and the general partner invested startup capital to get the fund going. Two Lazard partners, Michael Weinstock and Andrew Herenstein, were employed by the investment manager and the fund and were the key humans who actually invested the capital that Lazard and outside investors placed in the fund. After the fund was operating, Weinstock and Herenstein began considering leaving the fund to start a similar fund at Quadrangle, a firm started by four former Lazard partners. In the period they were contemplating their possible departure, Weinstock and Herenstein continued to function on behalf of the Lazard-sponsored fund and did not disclose that they were thinking about leaving. Instead, they made general statements to investors about the high quality of Lazard as an employer and that they enjoyed their jobs. Allegedly, during this period new investments came into the fund. When Weinstock and Herenstein eventually decided to leave Lazard and go to Quadrangle, they came into work one day and resigned effective noon that same day. According to the complaint, which was filed by the Lazard-sponsored fund, general partner, and investment manager, the departure of Weinstock and Herenstein forced Lazard to wind up the fund. Lacking the ability to replace Weinstock and Herenstein in a sufficiently timely manner to responsibly manage the fund, Lazard's only option other than a wind-up was to accede to Weinstock and Herenstein's offer to "lift-out" the fund to Quadrangle. Lazard refused to accept this offer. In the complaint, the plaintiffs allege that Weinstock and Herenstein intended that their departure would leave Lazard with no

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option other than transferring the fund to Quadrangle and planned their departure to maximize the chances that would occur. The conduct of Weinstock and Herenstein is further alleged to have violated fiduciary and contractual duties they owed the plaintiffs, and their failure to disclose their consideration of their possible departure is alleged to have been fraudulent. In this opinion, I address and grant Weinstock and Herenstein's motion to dismiss the complaint, in all but one narrow respect. The reasons for that decision are articulated in full later in this opinion. Pervading the reasoning of the opinion is an important economic reality. Weinstock and Herenstein had no fiduciary duty to remain as employees of the plaintiffs or of Lazard and the complaint fails to allege that they owed any contractual duty to give prior notice of their plans to leave. Any harm that befell the plaintiffs because of Weinstock and Herenstein's departure was a foreseeable one, the risk of which the plaintiffs and investors in the fund were fully informed and which could have been minimized by common contractual techniques. Any damages suffered by the plaintiffs or Lazard flowed not from unlawful conduct of Weinstock and Herenstein but from the failure of Lazard and its affiliates to plan for the contingency that their key human capital might exercise its right to depart. The various theories pled in the complaint are generally designed to shift the cost of that economic risk from the entities that bore it to the employees who exercised the economic freedom left to them by their employer. By contrast, I conclude that the complaint does (weakly but sufficiently) state a claim that Weinstock and Herenstein misused confidential information, in violation of

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their fiduciary and contractual duties. I therefore deny their motion to dismiss this aspect of the complaint. I. Factual Background These are the pertinent facts, as drawn from the amended complaint and the documents it incorporates. This case centers on the demise of a venture of the investment bank of Lazard Freres & Co. or "Lazard." The plaintiffs are all entities directly or indirectly controlled and/or owned by Lazard. Lazard itself has chosen not to participate directly as a plaintiff although it is commercial injury to Lazard that is the implicit, but clearly discernible, motivation for this lawsuit. In 2001, Lazard closed its High Yield/Distressed Debt Department and sought to make money from that area of the investing field through another method. That method involved the formation of plaintiff Lazard Debt Recovery Fund, L.P. (the "Fund") and related Lazard-controlled entities that would manage and control the Fund. The Fund was the entity that would hold investments in the securities of distressed companies. Lazard was not the only investor in the Fund. Rather, the goal of Lazard was to locate outside investors who would invest in the Fund. To manage the Fund, Lazard formed two other entities that are also plaintiffs in this action. Lazard Debt Recovery GP, LLC (the "General Partner") was the general partner of the Fund. Lazard is the managing member of the General Partner. Lazard Debt Recovery Management LLC (the "Investment Manager") was responsible for the investment of the Fund's capital, subject to control by the General Partner.

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Of course, behind these entities, Lazard had to have human beings who could actually deploy their expertise in marketing and investing in order for the Fund to succeed. To satisfy this need, Lazard employed two employees from its former High Yield/Distressed Debt Department, defendant Michael A. Weinstock and defendant Andrew J. Herenstein. Weinstock was a Managing Director of Lazard. Herenstein was a Director of Lazard. According to the complaint, Weinstock and Herenstein were given several titles connected with the Fund, the General Partner, and the Investment Manager. They were allegedly Co-Managers of the Fund; Principals, Co-Portfolio Managers, Co-Managers and Directors of the Investment Manager; and members of the General Partner. The complaint does not specify exactly what these titles meant or how some of these titles comport with the authority invested in the General Partner and the Investment Manager -- as entities -- with relation to the Fund pursuant to the "Investment Management Agreement" among the Fund, General Partner, and the Investment Manager.1 The complaint also alleges that Weinstock and Herenstein personally invested in the Fund. In connection with making those investments, Weinstock and Herenstein allegedly signed agreements binding them to certain obligations under the "Limited Partnership Agreement" governing the Fund.2 The extent of those obligations is a subject of dispute that is addressed later in this opinion.

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Nachbar Aff. Ex. B (the "Investment Management Agreement"). Nachbar Aff. Ex. C (the "Limited Partnership Agreement").

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To start up the Fund, the General Partner allegedly expended $8 million that went to create necessary infrastructure, set up the necessary entities, and fund employees. As noted, an Investment Management Agreement was executed among the Fund, the General Partner, and the Investment Manager. Weinstock signed that Agreement on behalf of each Lazard-controlled entity. In the Investment Management Agreement, the Investment Manager agreed to be bound by the same standard of care applicable to the General Partner under the Limited Partnership Agreement, which "at a minimum," allegedly required the General Partner to "act in good faith and to keep confidential any information relating to the Fund."3 The complaint contends that the investing strategy of the Fund involved a great deal of risk and complexity. In its own words, the complaint states: 25. Investment in distressed debt is a risky, complicated and potentially lucrative business, in which the Fund's investment team must identify distressed debt opportunities by leveraging off the extensive relationships that have been established with investors, brokers, banks and other advisory professionals. Having identified distressed debt opportunities, the investment team, in this case managed by Weinstock and Herenstein, must then perform rigorous credit analyses and make assessments about intrinsic values and the probability and timing of key events that drive the market recognition of values. Given the volatility and relative instability of distressed debt companies, investments must be monitored daily, with numerous trades being executed each day. As part of their duties as CoManagers on behalf of the Fund's Partners, Weinstock and Herenstein were engaged in dozens of complex positions requiring sophisticated trading strategies and daily personal attention.4

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Compl.

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