Highland Response

HIGHLAND CAPITAL
MANAGEMENT, L.P., AND

CORNERSTONE HEALTHCARE
GROUP HOLDING, INC.
Plaintiffs,
v.
PATRICK DAUGHERTY,
Defendailt and Counter-Plaintiff,
v.
SIERRA VERDE; LLC, HIGHLAND
EMPLOYEE RETENTION ASSETS
LLC, JAMES DONDERO, PATRICK
BOYCE, AND WILLIAM L. BRITAIN,
Third-Party Defendants.
,I
DALLAS COUNTY, TEXAS
68
th
JUDICIAL DISTRICT
FILED UNDERSEAL
ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVE DEFENSES
OF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE, LLC, JAMES
DONDERO, PATRICI(BOYCE, AND WILLIAM L. BRITAIN TO
COUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY
DAT .,RViSS?.l
CAUSE NO. 12-04005
HIGHLAND CAPITAL
MANAGEMENT, L.P., AND
CORNERSTONE HEALTHCARE
GROUP HOLDING, INC.
Plaintiffs,
v.
PATRICK DAUGHERTY,
Defendant and Counter-Plaintiff,
v.
SIERRA VERDE, LLC, HIGHLAND

EMPLOYEE RETENTION ASSETS
LLC, JAMES DONDERO, PATRICK
BOYCE, AND WILLIAM L. BRITAIN,
Third-Party Defendants.
IN THE DISTRICT COURT OF
DALLAS COUNTY, TEXAS
68
th
JUDICIAL DISTRICT
ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVE DEFENSES
OF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE, LLC, JAMES
DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TO
COUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY
On May 22, 2012, Defendant/Counter-Plaintiff Patrick Daugherty ("Daugheliy") filed an
Original Answer, along with a 50+ page Counterclaim and Third-Pariy Petition ("Counterclaim")
alleging valious bad acts and a limited number of claims against a number of individuals and
entities, including, Highland Capital Management, L.P. ("Highland"), Sierra Verde, LLC
("Sierra Verde"), James Dondero ("Dondero"), Patrick Boyce ("Boyce") and William L. Britain
("Blitain") (Highland, Sierra Verde, Dondero, Boyce and Britain may be collectively referred to
herein as the "Defendants"). The Counterclaim is legally and factually insufficient, contains
numerous specious, false, in-elevant, and otherwise improper allegations, and is defective in form
ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVE
DEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE,
LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TO
COUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY - Page - 1
DAL:835555.1
and substance. It does not provide fair notice of DaugheIiy's claims adequate to allow the
Defendants to detennine the nature and basic Issues of the controversy in question. The
Counterclaim also contains causes of action that are not recognized under applicable law.
Therefore, the Defendants each file their Original Answer, Special Exceptions, and Affinnative
Defenses, as follows:
I.
ANSWER
A. General Denial
Pursuant to Texas Rule of Civil Procedure 92, Highland, Sierra Verde, Dondero, Boyce
and Britain deny each and every, all and singular, material allegations of fact contained in
Daugherty's Counterclaim, together with each amendment or supplement thereto, in whole or in
part, and demand strict proofthereofby a preponderance ofthe evidence.
B. Daugherty's Specious Allegations
Daughertv's Malicious Intentions
1. Daugherty's Counterclaim reveals that his claims are nothing more than a dispute
over compensation, yet his pleading is littered with falsehoods and misstatements having nothing
to do with his actual claim. It is apparent that the allegations of the Counterclaim stem from (i)
Daugherty's desire for revenge against Highland, for unwinding Sierra Verde and having sued
him for his misappropriation of confidential infonnation and his interference in Highland's
business, and (ii) Daugherty's egregiously mistaken assumption that his outrageous allegations
will induce Highland to pay him to go away.
2. In telling contrast to the diatribes Daugheliy litters throughout his Counterclaim,
during the period of misconduct Daugherty alleges of Defendants, DaugheIiy sent a lengthy
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email to a key prospective investor who refused to invest in Highland's flagship private equity
fund because of Daugheliy's reputation and conduct. Daugherty's email provides in pertinent
part:
"I hear the news that you are not interested in moving forward with Highland as a
manager primarily because of me ... [on the other hand] Jim is one of the most focused
and driven people I have ever met. He has no ego ... He was raised to pick up pemlies
and because of that, treats our LPs money as if it were his own. But many people don't
know he is one of the most generous and charitable people on the planet. He'd be very
annoyed with me for saying this, but Jim truly cares about the little guy who is willing to
work hard to increase his lot in life. The fact is, Highland's culture is a manifestation of
his desire to provide opportunity and advancement on merit, not on connection or
pedigree. "
Daugherty then says of himself:
"[I]n the case of dealing with you and your colleague, I was an ass. . . I do not give you
these details to absolve my conduct. You were right to be offended and I do apologize."
Daugherty's closing paragraph includes the following:
"[Highland's] people work exceptionally hard at making the best money manager in the
business. These truly are great people who work together and believe in the firm's
mission to maximize value to its investors."]
3. Subsequently, when Daugherty resigned in 2011, he was very complimentar"y of
Highland and Dondero, and, although he submitted a resignation letter at that time, in neither that
letter nor a prior letter he sent in 2008 threatening resignation did he mention any of the
purpOlied concerns or allegations he is now raising in his Counterclaim.
2
However, despite all of
these positive sentiments, in the days following Daugherty's 2011 resignation from Highland,
when Daugherty was infornled that his Siena Verde vehicle had to be telminated, Daugherty
declared that he would "destroy" the car"eers of those responsible.
2
Exhibit 1.
See Exhibits 2 and 3.
DAL:835555.1
4. After Daugherty's receipt of Highland's second "cease and desist" letter, which
was necessitated by Daugherty's continued tortious conduct against Highland following his
departure, yet ignored by Daugherty, Daugherty boasted to a third party that the law provided
him an absolute privilege against defamation with respect to any allegations he made in a legal
pleading. For this reason, he threatened that if Highland sued him he would attempt to cmsh
Highland by providing a response crammed with falsehoods and inflammatory allegations
against Highland and Dondero for which, he taunted, he could not be held accountable. The
profound number of falsehoods and misstatements in Daugherty's Counterclaim show that
Daugherty is making good on his threat.
5. Daugherty further stated that on at least one occasion, he was contacted by a
reporter from the Wall Street Journal whom Daugherty believed was going to publish a negative
piece on Daugherty, and Daugherty felt it was essential to set the stage prior to the miicle's
release by portraying Dondero and Highland as the wrongdoers. It is apparent that Daugherty's
Counterclaim was intended to serve this purpose as well.
6. Unfortunately for Daugherty, in filing his Answer and Counterclaim, Daugherty
disregarded applicable law and his duties of honesty and candor to the Court as a licensed
attomey, and his duties to maintain privilege and confidentiality as both a fonner employee of
Highland and as its former General Counsel. The specious allegations in Daugherty's
Counterclaim serve no purpose whatsoever other than to defame and interfere with the business
of his former employer and colleagues, and have no bearing on what Daugherty alleges is a
dispute over compensation.
7. The fundamental lack of tmthfulness of Daugherty's Counterclaim, and the
damaging impression it leaves, has left Highland with no choice but to directly address the
DAL:835555.1
multitude of misstatements so that it is not prejudiced in precisely the manner Daugheliy
intended. It is clear that Daugheliy has misused privileged and other confidential information in
order to present a false picture of the Defendants. The Defendants are presenting this factual
background for the purpose of mitigating the damages of Daugherty's actions, and nothing in
here is intended to be, or should be, construed as a waiver of any privilege or confidentiality
rights to the extent any such information is deemed to be disclosed.
Daugherty's Misrepresentations Regarding Sierra Verde
8. Sierra Verde was an employee compensation vehicle conceived by Daugherty
primarily for the benefit of Daugherty and certain members of his private equity team as
compensation for direct services provided to certain Highland pOlifolio companies. Daugherty
worked behind the scenes on this project without consultation with Highland's legal and
compliance team, other than a single brief initial meeting in early February 2010. Daugherty
never discussed Sierra Verde with Highland's legal and compliance team between February and
Deceniber 2010, when Daugherty was trying to launch Sierra Verde.
9. The approval process for this transaction was orchestrated entirely and only by
Daugheliy. This process involved approval of concept from independent boards, formulating
plan documents with external counsel, setting timing/pricing and allocation of grants and
obtaining final approval of the independent board. An ongoing review of thousands of emails
and correspondence to date has not revealed anything to demonstrate that Daugheliy ever
infonned anyone in Highland's legal and compliance team, Dondero or any other member of
senior management about the pricing issues and conflicts discussed more fully below.
10. Daugherty failed to provide Highland's legal and compliance team with the full
detail of Sierra Verde, and he did not inform Dondero or any other member of Highland senior
DAL:835555.1
management that Daugheliy "cherry picked" the ultimate strike price for these equity grants.
The strike price Daugherty chose for Cornerstone Healthcare Group Holding, Inc., a Highland
portfolio holding company and its subsidiaries (collectively, "Cornerstone") was set based on the
share price of the company over two years prior ($640/share) rather than the current market
value of the company ($2,041/share) on the date of grant;3 in the case of Trussway, however,
Daugherty selected the market value of the shares on the date of grant ($27.67/share) but not the
value on the date over two years prior (as used in Cornerstone) ($89.76/share).
11. Further highlighting the inconsistency in the option pricing determined by
Daugherty, Highland subsequently discovered that Daugherty, as portfolio manager of another
Highland advised account, caused the account to make an equity investment in one of the Sierra
Verde holdings at more than triple the valuation at which he had issued the equity to Sierra
Verde the preceding day. The value at which the Highland account invested was appropriately
the then current market value and was supported by an independent valuation opinion.
Daugherty never disclosed any potential conflict to anyone in Highland senior management or its
legal and compliance team. To add insult to injury, and just prior to his most recent resignation,
Daugherty proposed an additional issuance of shares to Sierra Verde for his own benefit to
counter the dilution caused by this investment. Fortunately, this proposed additional issuance
was disclosed by a Daugherty team member and prevented.
12. Immediately following DaughertY's departure, the Sierra Verde transactions were
terminated after a careful review of the structure, pricing, timing, and non-disclosures by
Daugheliy. As a result, these transactions were terminated without cost, impact, or harm to any
Highland accounts or portfolio companies (including Cornerstone), and the related equity grants
$2,041 value was calculated as of December 17, 2010.
DAL:835555.1
were cancelled. Once the issues were discovered, every member of Sierra Verde voted to
telminate the agreement, except for Daugherty. Shockingly, despite being informed in detail of
the issues with this transaction and despite being informed that its termination was necessary due
to the discoveries, Daugherty still insisted that he receive his Sierra Verde interest following his
departure, and when Highland refused, Daugherty set out on his current path. Daugherty feigns
disbelief over how Sierra Verde could be an "improper transaction," all the while knowing full
well what he had done and why Sierra Verde was unwound.
Daughertv's Misrepresentations Regarding Tunstall
13. In early 2010, two Highland portfolio companies sought to invest excess cash. As
a result, Daugherty proposed the creation of a new investment adviser called Tunstall Capital
Management ("TCM") and a new hedge fund then called the Tunstall Distressed Opportunities
Fund (the "Tunstall Fund"). He further proposed it have a typical hedge fund 2% management
and 20% performance fee structure with a substantial portion of these fees inuring to his personal
benefit under the terms he proposed for TCM's internal partnership agreement.
14. Contrary to Daugherty's assertion that he "learned" of Tunstall's approval in
September 2010, Daugherty presided over the respective Board meetings as Chainnan of each of
the portfolio companies in January 2010, which minutes include in pertinent part: ''''Mr.
Daugherty described the rationales behind the proposed investment in Tunstall ... [and]
suggested that the Tunstall investment could provide a return on investment in excess of the
current return received." Following this presentation by Daugherty, and only Daugherty, each of
these portfolio companies made an investment in the Tunstall Fund. All allocations were
approved by independent board members of the portfolio companies and were approved by the
independent investment committee of the funds then holding the equity in these companies.. The
COUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY - Page -7
DAL:835555.1
terms of this investment, including fund fees, were negotiated by independent legal counsel on
behalf of these companies in Febmary 2010. Both of these companies earned significant returns
on their investments. The first company earned an 8.8% annualized net return, and 20.1 %
cumulative net on an approximately $40 million investment, and the second company earned a
10.8% annualized net return, and 21.8% cumulative net on approximately $25 million
investment.
15. Despite his allegation to the contrary, Daugherty did in fact sign the incumbency
certificate as an executive officer of TCM, and his sole objection with respect to these entities
related to his unsatisfied demands regarding additional concessions in the manager's internal
partnership agreement, including demands for significant increases in ownership thereof and the
ability to keep his ownership interest should he resign. The failure to reach resolution in these
disputes over economics is what resulted in Daugherty not signing TCM's internal partnership
agreement.
16. The total fees paid to TCM were approximately $1.2 million, significantly less
than industry standards. Any and all required rebates of these fees were made to respective
funds under their respective governing documents. Following his departure and after discussions
with investors, TCM elected to wind down the fund given one of the two investors sought
liquidity for its investment.
Daugherty's Misrepresentations Regarding Cornerstone
17. In June 2011, the Highland Credit Strategies Fund ("Credit Strat") was in formal
wind down and, therefore, seeking liquidity for its assets. In an effort to accommodate a request
from the Credit Strat Redeemer Committee, it was proposed that Cornerstone, a Highland
portfolio company, purchase certain of its equity and debt positions held by Credit Strat. In
DAL:835555.1
connection with a series of offers, Cornerstone provided the fund with then-current third party
valuations, which were immaterially lower than the then-current Highland marks. Based on the
independent valuation performed by the third-party valuation service selected by Cornerstone
(Dondero and Boyce had no involvement in selecting the firm), Cornerstone independently
determined the offer price, which was materially lower than the independent valuations for
specific concerns facing the industry that were disclosed to the Redeemer Committee with the
offer price. Cornerstone's desire to obtain a private market discount was appropriate given the
high value it placed on liquidity and financial flexibility, as well as other alternative investments
it could make in the industry.
18. Daugherty confuses the valuation, which at all times was accurate and properly
disclosed, with the offer which was presented to the fund's committee to accept or reject at their
discretion. The fund's committee did not accept any of the offers, and the transaction was never
consummated. The remainder of Cornerstone equity is owned almost entirely by Crusader and
another Highland advised account, with Highland owning a 2.3% interest of the overall company
that it acquired in 2007. Any benefits from using corporate cash to buyout Credit Strat would
inure to the other equity holders, not to Highland as alleged (except as to Highland's 2.3%
stake).
19. Volatility in the healthcare industry surfaced during the late July and August 2011
timeframe, and as a result of expected reimbursement changes, such volatility caused comparable
healthcare companies to trade off then current recent values by as much as fifty percent (50%).
Daugherty's allegations that "Dondero was not pleased with the new valuation because it was
'not low enough'" and the allegations of subsequent actions taken by David Smith ("Smith"), a
then current employee of Daugherty's team, and Boyce to "further reduce the third-party
DAL:835555.!
valuation" are entirely false and could only have been contrived and intended to sully the
character and professional reputations of Dondero, Smith and Boyce. The original valuation was
dated June 30, 2011. Noting the date and the impact of recent events in the industry, specifically
July 29
th
, had on share prices of comparable companies, it was decided that a second valuation as
of a more recent date (August 15
th
) was necessary so that acurrent fair value could be presented
to the Credit Strat Redeemer Committee. Boyce's involvement was to direct the flow of
additional information to the third party valuation expert because Smith and Daugherty were
unavailable to respond due to their participation in a meeting of the Board of Directors of
Cornerstone on the 8
th
floor of the Highland offices when the valuation was received. Although
Daugherty claims he was in Montana during this process, he was actually in Highland's Dallas
offices for three days arguing for increased compensation. Daugherty was copied on the
communications regarding this effort and was infonned of the final result, which was only 6.9%
lower than the most recent mark provided by members of his team. Daugherty did not object to
the second valuation or the justification for it.
20. Separately, Cornerstone was in a difficult situation after the departure of members
of its senior management team. While the search was ongoing for a permanent executive team,
Highland employees performed executive functions for the company on interim basis for no
additional compensation. This is standard operating procedure for Highland's operationally-
oriented private equity team. Cognizant of the compensation package of the former CEO and
desirous of the perks frequently associated with being a CEO, Daugherty proposed to Dondero
that he assume the CEO role and be compensated for it. This proposal was reviewed in detail
and was dropped, and neither Daugherty nor Dondero received any compensation in the co-CEO
capacity.
DAL:835555.1
Daughertv's J\iIisrepresentations Regarding Safetv Kleen
21. Safety Kleen ("SK") is a portfolio company in which an investment is held by
various Highland advised accounts. The Highland accounts own approximately 39% of SK's
equity and hold a minority position (2 of 8) on its board of directors. In January 2012, SK's
Board unanimously approved a share repurchase plan open to all investors. The Board
determined the price range, which was below the third party mark utilized by Highland to value
the position in the various funds. This offer was presented by SK to all the equity owners of SK
including all Highland accounts that owned any SK equity. Highland recommended against
tendering and all such accounts rejected the offer.
22. SK was successful in repurchasing $5 million of shares at the price range from
non-Highland accounts. Highland always believed a sale of the company was preferable to an
IPa because a sale would provide immediate liquidity for the full position rather than some
liquidity and a public security burdened by a lock up and trading restrictions. Contrary to
Daugherty's allegations that served no purpose other than to defame certain of his former
colleagues, at no time did any Highland employees attempt to acquire any of these securities in
their personal accounts, nor have they ever owned any in their personal accounts.
Daugherty's Misrepresentations Regarding Crusader
23. The Highland Crusader Fund ("Crusader") was one of Highland's flagship hedge
funds prior to the market collapse of 2008-2009. Up until this time, Crusader had consistent
market-leading performance and had been nominated for several awards, including Creditflux
manager of the year. Prior to the market collapse in 2008, this fund was consistently a
perfoD11ance leader in the industry and experienced average annual performance of 21.2%.
DAL:835555.1
Highland had, and continues to have, significant exposure to Crusader. Daugherty, in his
Counterclaim, alleges that Highland threatened to reduce its exposure to the fund if the fund
could not achieve the returns that Dondero expected. What Daugherty fails to understand is that
the vast majority of Highland's exposure to Crusader was through a derivative arrangement that
was linked across numerous Highland managed accounts, as well as through earned but unpaid
deferred performance fees. In 2008, Highland contributed approximately $120 million in
support of these derivative arrangements and never contemplated not supporting the fund,
contrary to Daugherty's claims. Highland made these contributions to support its exposure to its
funds through the derivative, which derivative, at the time, involved aggregate exposure to
Highland funds of approximately $582 million. These financings did not provide any effective
means for Highland to materially reduce its exposure to the fund because, in the case of the
derivative, the fund exposure could not be reduced without unwinding the entire arrangement,
and, in the case of the deferred fees, no attempt was ever proposed to reduce its exposure, and
withdrawing those fees would have resulted in adverse tax consequences. Accordingly,
Highland did not and could not, nor did it ever threaten to, reduce its exposure. In addition,
Dondero and Okada contributed an additional $30 million to various Highland funds to bolster
liquidity during the financial crisis. The portrait of Dondero painted by Daugherty conflicts with
the reality of a man who invested a significant amount of his own capital to save his investors.
Ultimately, Dondero lost hundreds of millions of dollars in Highland's funds as he sbived to
support them. Daugherty, on the other hand, in the best of times and worst of times, never once
invested one dollar of his money in Crusader.
24. Furthermore, as a diverse multi-strategy hedge fund, the governing documents of
Crusader, including its private offering memorandum disclosures to investors, always
DAL:835555.1
contemplated that the fund would engage in a diverse range of investments, often with
significant leverage and significant illiquidity. Highland and Dondero never traded the positions
in the funds to intentionally render them illiquid nor to harm investors. Rather, every investment
made was believed to be consistent with disclosures in the fund's governing documents,
Highland's fiduciary duties as a registered investment adviser, and the best interest of the funds.
25. The diminishing liquidity level of Crusader was by no means unique to Crusader,
and was largely due to the unprecedented market factors including asset illiquidity, numerous
margin calls and settlement difficulties. It was a routine and disclosed practice consistent with
the governing documents of the fund for Highland to build key and/or control positions across
the Highland platform to the extent investments were suitable for the applicable accounts. No
Highland employee intentionally stated any intent to make the funds illiquid or to "punish"
investors. Notably, Highland's economic and reputational interests were at all times aligned
with the interests of investors in the fund since Highland was one of the largest beneficial interest
holders in the fund.
26. Daugherty alleges that he objected to certain investments in asset classes such as
real estate, yet Daugherty personally sourced for Crusader undeveloped residential real estate
investments through his personal network. To suggest that Highland invested in "seed"
initiatives beyond its expertise and skill defames the contributions of many highly experienced
investment professionals and joint venture partners. Highland employed experienced portfolio
managers for each asset class in which it invested. Daugherty resented and rebelled against any
Crusader investments that were sourced by other investment personnel, despite approval of
Highland's Investment Committee. He irrationally believed that all fund capital should be
COUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICKDAUGHERTY - Page - 13
DAL:835555.1
directed solely to his investment ideas. When other investments were made, Daugherty launched
into attacks directed at Dondero and other key investment professionals at Highland.
27. Daugherty's allegations of "robotrading" via excessive leverage and inappropriate
asset classes are baseless and reflect his lack of understanding of hedging and investments
outside of credit. In addition, certain asset classes, such as treasuries, subprime, equity indices,
and foreign exchange, were utilized as cost efficient hedges given the overall macroeconomic
uncertainty and the increasing illiquidity of existing credit investments. In addition to these
macroeconomic hedges, Highland also made various investments in Financial Industry related
securities and derivatives (of which Lehman Brothers was a very small portion representing $21
million in losses) to further offset the impact on the funds of the Credit Crisis. In conjunction
with the macroeconomic hedges, these efforts produced profits of approximately $277 million
for Crusader investors during 2008. Financial industry related hedging activity during 2008
yielded approximately $210 million in profits for Crusader inclusive of the losses on Lehman.
28. Unfortunately, the markets continued to trend downward. Redemptions in the
funds increased. The decision not to elect to satisfy redemptions with a "payment in kind" in
Crusader was not "shocking," as alleged by Daugherty in his Counterclaim. Initially, the fund's
illiquid holdback provisions were triggered under the governing documents of the fund.
Daugherty, who was aware of, did not object to, and even explained the validity of the hold back
to a major financial counterparty. Notably, on August 4, 2008, Daugherty sent an email to a
representative at Lehman Brothers in which he states "We actually have the right to pay
redeemers in kind or hold back payment completely." Furthermore, in stark contrast to
Daugherty's allegation that he recommended selling assets to raise cash, Daugherty closed this
email by stating: "[W]e are not looking to sell any large block of assets."
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29. At the time, Highland believed liquidity concerns were temporary and thus
continued to manage the fund as a going concern. Therefore, Highland managed redemptions for
the benefit of the fund as a whole in accordance with the fund's governing documents. Given
that prices had begun to decline in the market, the sale of assets at depressed prices threatened to
lock in losses that could never be recouped. It was not readily apparent at the time that price
decreases were not a temporary dislocation, but rather represented a more significant event
changing the overall price point of the market. However, with respect to redemptions payable at
the end of September 2008, distributing assets in kind in satisfaction for those redemption claims
was considered in detail and reviewed with investors. Due to the further significant deterioration
in the market before details could be finalized with the specific investors, Crusader entered into
wind-down on October 15, 2008.
30. Prior to market collapse in 2008, this fund was consistently a performance leader
in the industry and experienced average annual performance of 21.2%. While Crusader was
materially impacted by the market collapse of 2008, it has significantly rebounded as result of
Highland's efforts since the wind-down, having achieved performance of +25.6% from the wind-
down date through April 30,2012, and +85.9% since the market's bottom in March 2009, which
compares favorably to the Dow Jones Event Driven Distressed Hedge Fund Index, which has
returned 35.4% for the period from March 2009 through April 30, 2012.
31. Contrary to Daugherty's allegation that Dondero sought to buy multiple investor
interest in Crusader at a discount, there was only one instance where a Highland account
purchased an investor's interest in Crusader. This single purchase was done at an investor's
request for immediate liquidity on its investment in the fund, which was otherwise non-
transferable and completely illiquid in connection with the fund wind-down. The date of this
DAL:835555.1
purchase was in May 2010, which was over 18 months following the election to wind down the
fund but prior to the adoption of the fund's plan of distribution and was concurrently disclosed to
the Redeemer Committee.
32. A formal plan of distribution was entered into August 2011 with the approval of a
super-majOlity of both the prior redeemers and compulsory redeemers each voting as a separate
class. As is customary in the resolution of any dispute, releases were provided under the plan,
but it was the resolution of the dispute itself that was a condition to making the distributions.
Furthermore, it did not make sense to liquidate assets at depressed values when the proceeds
would have been held in cash or cash equivalents generating de minimus returns pending
resolution of the dispute and the prospect of future returns was critical to the class of compulsory
redeemers in the dispute. As a matter of fact, Highland provided substantial additional
consideration from its own capital for the plan.
4
Over the nine months since the plan was
approved, Cmsader has distributed over $512 million to its investors and is continuing the
orderly liquidation of the fund as directed by the plan.
33. Daugherty has attempted to negatively sensationalize the press release regarding
the adoption of the consensual plan for Credit Strat and Cmsader. Reaching a consensual
resolution of the outstanding dispute and achieving a consensual plan of distribution ratified by
over 85% of investors was clearly viewed by all constituencies involved as a favorable event. '
This was especially tme in the context of the overall hedge fund market, where a substantial
portion of funds that had either gated or suspended redemptions were embroiled in litigation
4
Highland contributed approximately $6 million in connection with the approval of the Crusader Plan of
Distribution and potentially an additional $10 lnillion in value should aggregate distributions of $1.7 billion not
be made to Crusader investors by the 43
rd
month following the adoption of the plan. In addition, Highland
contributed $3 million in connection of the Credit Strat plan of distribution, with an additional $6 million due
on the third anniversary of such approval, with such payments guaranteed by Dondero and Okada.
DAL:835555.!
and/or liquidated at pennies on the dollar. In fact, Highland is unaware of any other gated funds
in Bermuda that successfully negotiated a consensual plan and is rightfully proud of the Credit
Strat and Crusader plans that were approved by over 85% of their investors.
34. The allegation that Dondero manufactured the prior/compulsory redeemer dispute
rs another complete fabrication. Given that there were a significant amount of effective
redemptions ("prior" redemptions) and the market was in a state of collapse, compulsorily
redeeming the remaining investors was the only meaningful path to lock in value for the
significant number of remaining investors in the fund rather than allow the widespread value
destruction that would have occurred in a formal insolvency proceeding. As a result, the
compulsory/prior dispute resulted from the operation of the redemption provisions in the fund's
governing documents that, as drafted, locked in redemption values on the respective redemption
effective dates. In order to minimize the possibility of the investors claiming the distributions
were improperly made, there was no practical way to distribute fund proceeds until the redeemer
dispute was resolved in the plan of distribution. Both the prior and compulsory redeemers were
represented by renowned national law finns, and the negotiations took place over hundreds of
hours of negotiation and formal mediation. Daugherty's allegation is completely disproven by
Daugherty's own admission in an email Daugherty sent on October 16, 2008 (the day following
the wind down announcement on October 15, 2008), in which Daugherty, when referencing the
election to wind down the fund and redeem all remaining investors, says: "better to treat all
investors the same (including me)," which is interesting, given that Daugherty in the best of
times and the worst of times never once invested one dollar of his money in Crusader.
35. The notion that Highland contrived the May 2012 Crusader restructuring proposal
to "steal" from investors is preposterous. Certain Crusader investors asked Highland to provide
DAL:835555.!
immediate liquidity for their investment in Crusader, which would otherwise be liquidated over a
number of years under the current wind-down plan. These investors absolutely understood that
any altemative providing immediate liquidity (with respect to an otherwise completely illiquid
asset) would be at a discount to current net asset value (NAV). Highland committed significant
time and resources at its own expense working toward achieving this goal for investors via a
series of voluntary altematives. It was also disclosed and understood that Highland was not able
to fund the overall offering without seeking extemal investors or financing. While working to
arrange financing to complete the process, the investors reconsidered their position, but Highland
continued to explore liquidity options for other investors.
5
Daugherty's Misrepresentations Regarding Highland Credit Agreement
36. Highland made no misrepresentations to its lenders. In contrast to Daugherty's
allegation that Dondero and Okada "siphoned" cash from Highland, Dondero and Okada
collectively made payments to Highland of approximately $30 million in 2008. Furthermore,
any transfers that occurred under Highland's intemal credit agreement with its lenders were
disclosed to such lenders in connection with amendments to Highland's credit facility (the
"Credit Facility"). Highland has paid down the Credit Facility from $150 million to $23 million.
As further evidence of their level of commitment to the firm, Dondero and Okada have
personally guaranteed a substantial portion of the outstanding obligation under the Credit
Facility. Dondero and Okada did whatever they could to support Highland, including agreeing
to, as part of the amendment to the Credit Facility, severe restrictions to their respective
compensation levels, which capped their overall compensation at only their base salaries
Conh'ary to Daugherty's assertions, neither Okada nor Boyce had any involvement with this proposed
transaction.
DAL:835555.1
beginning in July 2009. At all times the Credit Facility negotiations and amendments occurred
during the nonnal course of business and Highland never missed an interest payment.
37. Highland Employee Retention Assets, LLC ("HERA"), which Daugherty refers to
as the "Employee Compensation Reserve" or the "Vessel" in his Counterclaim, was established
to hold a pool of assets for the benefit of a small number of then current Highland employees,
and is controlled by its board of directors and not Dondero, as Daugherty alleges. HERA was
established at Dondero's request in the context of the 2009 renegotiation of the facility in order
to ensure retention of certain key employees. Dondero and Okada are neither officers nor
directors of HERA, nor do they have an economic interest therein. The allocation of assets to
this vehicle was approved by Highland's lenders.
Daugherty's Misrepresentations Regarding HFP
38. Highland Financial Partners ("HFP") is a Highland advised account that was
intended to be the principal holding vehicle for Highland's CLOs and certain other investments.
The HFP transaction involved the issuance by HFP of senior secured notes in exchange for
certain assets held by other Highland accounts. This transaction was completed in two tranches:
the first on September 26, 2008, and the latter on October 10, 2008. The HFP transaction was
disclosed to and approved by the independent members of the HFP board, as well as the
independent investment committee of the other Highland accounts involved. Highland believed
that the HFP Note transaction would be beneficial to the other Highland accounts because: (1)
the interest in the HFP Note would add diversity to the Highland accounts as it represented an
interest in an entity that held interests in many CLOs, not just a few; (2) the HFP Note would
have a shorter average life than the assets that the Highland accounts sold to HFP; (3) the HFP
Note would be more marketable than the assets sold by the Highland accounts to HFP in
DAL:835555.1
exchange for the note, given the illiquidity of CLO assets and restrictions on holders; and (4) it
relieved ceriain of the Highland accounts from future funding obligations related to the
transferred life settlement assets. Contrary to Daugherty's assertions, Britain did not take control
of Daugheriy's team and had no involvement with the trades, nor was Boyce responsible for
executing or settling the trades and had no involvement with the trades. As further evidence of
Highland's belief and support of this transaction, Highland invested approximately $22 million
of own capital in these notes.
39. Unexpectedly, the market for CLOs steeply declined in late 2008 and the first
quarter of 2009, as unprecedented and unforeseeable downgrades occurred, affecting thousands
of tranches totaling approximately $100 billion from 760 CLOs, and defaults increased in the
underlying loan assets. As a result, CLO cash flows significantly declined and HFP, as an entity,
became unviable. Consequently, Highland determined that the HFP note holders should seek to
unwind the HFP Note transaction because HFP would not be able to continue to service the
Notes. Each of the note holders entered into an agreement dated March 20, 2009, with HFP
pursuant to which the note holders received the assets that they had originally sold as of January
1, 2009 (or securities of roughly equivalent value to the extent such securities were seized by
financial counterparties during the interval period), in exchange for the HFP Note, such that all
note holders were put in the same economic position they would have been had the HFP
transaction never occurred, and all parties to the agreement were released of any additional
claims. In order to facilitate the unwind and without holdout investors, Highland agreed to
accept de minimus value for the $22 million of notes it held. This transaction has previously
been discussed with, and disclosed in detail to, the investors in Crusader and Credit Strat and
released.
DAL:835555.1
Daughertv's Misrepresentations Regarding NexBank
40. The 2010 and 2011 NexBank offeIings were arms-length, fairly structured
offerings of shares of common stock of NexBank Capital the documentations in respect of which
were prepared by extema1 counsel and, contrary to Daugherty's assertion, the 2011 offeIing was
suppOlied by an independent faimess opinion. These offerings were necessary to provide needed
capitalization, and all existing investors had an equal oppOliunity to pmiicipate. The overall
faimess of the transaction was evidenced by the broad participation in each of the offerings. In
the first offeIing, 29 of 34 investors pmiicipated; in the second, 22 of 44 participated. The
ownership of the pIincipal shareholders, Dondero and Okada, barely changed in percentage
terms. There was no targeted or broad-based dilution.
Daughertv's Misrepresentations Regarding Tax Distributions and Highland 2.0
41. For partners who are in compliance with all applicable obligations to the
partnership, Highland is obligated to make tax distributions to its partners to fund their respective
tax obligations on Highland income. Conversely, as is customary practice in partnerships with
required tax distributions, any tax refunds generated in respect of such income are deemed the
property of the partnership, and thus the decision to allow partners to keep these refunds was
treated as compensation to the partners. This is standard industry practice, and Daugherty's
inference of impropriety shows his lack of understanding of basic partnership accounting. Since
Highland compensation statements are released in February, they would have been calculated
based on estimated tax information, and the actual tax refunds may have differed immaterially
from such estimated amounts. In any event, the cash refunds the parhlers received that year
would have exceeded the compensation the pminers otherwise would have received since such
DAL:835555.1
refunds were paid in one installment, as opposed to the CUlTent Highland compensation structure
that bifurcates bonuses into multiple installments.
42. Highland 2.0 was an intemal telTl1 refelTing to a broad measure intended to revise
a number of different business practices and decision making processes across Highland. Any
suggestion that it was focused on compensation is inaccurate.
Daugherty's Turbulent Historv at Highland and Cornerstone
43. Over the years, Daugherty repeatedly used aggressive, extortion-like tactics,
including multiple attempted, and staged resignations, invariably at delicate
moments, to increase his compensation when he felt he had leverage against the filTl1, such as
during bank facility negotiations, hedge fund wind downs, key man events, and the like.
44. Specifically, Daugherty alleges that he resigned on September 10, 2008, because
he was "out of patience with Dondero's reckless and self-serving actions." Daugheliy's
resignation letter, however, makes no reference whatsoever to any such allegations, but instead
reflects Daugherty's demands for additional compensation as a condition precedent to his
retum.
6
45. Other examples of Daugherty's egregious attempts to take advantage of Dondero
and Highland during moments of extreme uncertainty includes Daugherty's demand on October
15, 2008, the day the Crusader and Credit Strat commenced wind-down, that he receive an
immediate bonus of $500,000, or he would resign. Dondero acquiesced and satisfied
Daugherty's request by agreeing to a payment of $500,000 to Daugherty in the fOlTl1 of a loan
that was later forgiven. Also, two days following Daugheliy's September 2008 resignation
See Exhibit 2.
DAL:835555.1
letter, he assures an investor that Daugherty will be around for a Highland follow on fund, once
again showing that Daugherty's resignations were a ploy for additional compensation.
46. Daugherty proclaims that he managed Highland's portfolio back to health in 2009
and 2010 and that he was consistently ranked as the top perfonner during this period. However,
in 2009 and 2010, Daugherty's team had the worst investment perfonnance (overall return) of
any of the credit research teams. Yet, notwithstanding his smaller contributions relative to the
broader team, Daugherty routinely demanded greater compensation that was unjustified by his
overall contributions to the finn.
47. Ironically, in making his demands he would incessantly tout his level of
responsibility, but Daugherty's allegations in his Counterclaim suggest that he falsely portrays
himself as having little to no responsibility with respect to the funds and initiatives on which he
worked and managed.
48. Upon Daugherty's final resignation, and after a full summer of hardball tactics to
gain increased compensation, he became emaged and emotionally disturbed because Dondero
actually allowed him to resign.
49. His 2011 threat to reSIgn was met with his biggest demands to date for
compensation and vacation. This was during the launch of a new fund in progress towards the
first close, which he believed gave him maximum leverage. It included demands for 25-35% or
more of the revenue of the funds under his management, pieces of other partners' funds, and a
significant piece of new funds that did not involve Daugherty's experience or participation.
50. As evidence of his dwindling effort and devotion, and based on his flawed
assumption that his absence would create issues for Highland and therefore increase his
compensation leverage, Daugherty elected to "work" from his vacation home in Montana during
LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAML. BRITAIN TO
DAL:835555.1
the entire summer of 2011. While he was available for certain marketing meetings and board
calls, the extended absence of any employee from the offices for non bona-fide health or
personal reasons was unheard of at Highland. It was a highly unusual absence, and the team
around Daugherty noted the absence with concern. However, the dramatic improvement in the
Dallas team's morale and productivity during his extended absence quickly fostered the notion
that Highland would be better served by Daugherty's permanent separation from the firm.
51. Daugherty's human interaction skills and leadership capabilities were poor and
had declined over the years. After the financial crisis was over and done, Dondero was forward-
looking and seeking to grow the firm to the next level with capable partners who could nm
business units on their own. This required both strong people leadership skills as well as good
investment skills. Dondero was willing to let Daugherty leave because Daugherty was sorely
lacking in leadership and human interaction capability.
52. Daugherty voluntarily resigned in September 2011 in a written resignation letter
to Highland.
7
On the day Daugheliy resigned from Highland, he called an impromptu meeting
with the team, at which he announced his resignation. Daugheliy shared that he was thankful to
Dondero, his opportunities at Highland, and for teaching him everything he knows about
distressed investing and restructurings. Daugheliy told Highland employees at that meeting that
he was leaving because of compensation, and that he and Dondero were unable to come to an
agreement despite much effort over the summer. He told the team that Highland was known to
be an aggressive investor but that the firm had always stayed on the right side of any and all legal
or regulatory boundaries. He said that Highland was on strong footing for the future and that the
team was well-positioned to succeed. During the meeting, Daugherty told the team that things
Exhibit 3.
DAL:835555.1
could get ugly, and if they did, not to take it personally because "it's just business" - a clear
indication that Daugheliy was already bitter over his departure.
53. Based on Daugherty's institutional knowledge of Cornerstone's business and on-
going litigation, which potentially represented significant value to Cornerstone, and the need to
have an orderly transition of this infonnation, Cornerstone, with the approval of its independent
Board, offered to enter into a consulting agreement with Daugherty following his departure,
pursuant to which Daugherty would receive an aggregate compensation of $600,000, payable
over time, which the Board deemed to be moderate and worthwhile.
54. In his attempts to maintain good relations with a semor fonner employee,
Dondero tried to help smooth Daugherty's transition from Highland with calls and two dinners
without success, as it became clear Daugherty was increasingly volatile and unstable.
Unbeknownst to Dondero, Daugherty had already stalied a campaign of talking to investors, both
current and prospective, in efforts to smear Highland's reputation and hamper its ability to raise
money. Daugherty apparently seized this opportunity to speak with investors to create a conflict
between Highland and certain Crusader investors, presumably with the intention of having
Highland removed as manager of Crusader and replaced by Daugherty or his new employer
following his departure. Additionally, he set to work on a similar campaign with portfolio
company board members and C-Ievel executives, with efforts focused on inciting distrust of
Highland as a business partner and investor.
Daughertv's Transient Ischemic Attacks (TIAs) / Strokes
55. While Daugherty makes allegations that Highland, in the lawsuit it filed against
him, falsely accused him of having strokes, he is apparently confused about the allegations
contained in the lawsuit. The only mention in that pleading is the absolutely true statement that
DAL:835555.!
Daugherty made about a reason he was not fulfilling the duties of his job in a diligent,
trustworthy or business-like manner. Fmiher, Daugherty falsely denies experiencing strokes and
makes a point to characterize his events as TIAs. However, TIAs are in fact "strokes," and they
do cause death of brain tissue. The Merck Manual provides in pertinent part:
Experts used to think that ...TIAs did not cause any permanent brain damage.
That is, no brain cells died. However, most experts now think that TIAs are small
ischemic strokes. That is, in TIAs, as in ischemic strokes, brain cells die.
Research indicates the consequences of strokes such as those experienced by Daugherty include
the following:
[M]ay have a lingering feeling that something odd has happened to [their
bodies].
8
These symptoms may include emotional changes.
9
In addition, if blood
supply to a particular area is blocked for several minutes, the nerve cell of that
area of the brain dies.
10
This causes permanent neurologic deficit commonly
refened to as a "dead SpOt."ll When a TIA occurs, problem-solving ability can be
affected,12 This is due, in part, to the patients being impulsive and having
decreased awareness of their deficits. They tend to be impulsive and fail to think
before they act, which reflects an inability to think through a situation rationally, 13
The emotional reaction of a person who has experienced a stroke may be
unexpected, confusing and difficult to know how to deal with.
14
Many people
following a stroke find that they burst into tears very easily.15 Medical staff often
refer to uncontrollable crying or laughter as 'emotional liability' and believe this to
be directly related to damage to the brain, caused by the stroke.
16
Some people do
evidence this emotional liability most with explosive tempers,I7 Conmmnication
deficits may include decreased attention, distractibility, and the inability to inhibit
inappropriate behavior.
l8
Even minor brain damage from a stroke affects a
10
II
12
l3
14
15
16
17
18
Dr. Mark Monteiro, What is Transient Ischemic Attack (http://www.findmedica1advice.com/diseases-and-
cure/what-is-transient-ischemic-attack.htm1) ;http://www.drgarysmultip1esclerosiscure.org/B1og/spina1-cord-
demye1ination.htm1
http://www.n1m.nih.gov/medlinep1us/ency/article/000730.htm
http://www.healthscout.com/ency/1/136/main.html
http://stanmed. stanford. edu/2005faWstroke.html
See, e.g., Jacques Courseault, M.D., What are the After Effects of a TIA Stroke (March 30, 2011)
(http://www.livestrong.com/article/ 186131-what-are-the-after-effects-of-a-tia-stroke);
http://www.livestrong.com/article/47662-light-cerebral-stroke-symptoms/
http://www.stroke.org/site/PageServer?pagename=EFFECT
Stroke SA, Stroke Fact Sheet 4: Emotional Issues Following Stroke (http://stroke.org.au/pdf/Stroke4.pdf)
Id.
Id.
http://www.wisegeek.com/what-is-emotional-lability.htm
Stroke Connection Magazine, Behavior Changes After Stroke (January/February 2005)
DEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L,P., SIERRA VERDE,
DAL:835555.1
memory related area of behavior called quality control.
19
This refers to how well
individuals check and control their own behavior and do the 'light thing' at the
'right' time in social situations.
20
56. Accordingly, despite Daugherty's allegation that his statement regarding
"strokes" and "dead spots" on his brain are a complete fabrication, the neurological event is a
plausible explanation for the level of vindictiveness, irrationality, behavior without objective,
temper outbursts and crying fits experienced while he was employed at Highland, and in fact, in
addition to the numerous witnesses of the occurrence, Highland has a photograph that was taken
while Daugherty was unconscious on the floor beside his desk and being attended to by an EMS
professional as a result of the neurological event while at the office.
Daugherty's False and Outrageous Personal Allegations
57. Regarding Daugherty's appearance at the Dondero divorce hearing, Daugherty
was not a reluctant witness. It appears from his testimony that Daugherty was cooperating with
Dondero's wife, and on multiple occasions provided irrelevant testimony that was not solicited,
and in fact, on at least one occasion, the Court had to stlike Daugherty's testimony. Highland
believes that Daugherty coordinated the planting of two reporters in the courtroom, testified
falsely by stating Dondero was manipulating his net worth, and then repeatedly and aggressively
attempted to insert financial testimony that was never asked by any attorney during questioning.
58. As Daugherty exited the courtroom, he turned to Dondero and Dondero's
attorney, smirked and sarcastically gloated, "Good luck, boys."
59. Moreover, although it is wholly unclear how the dinners between Dondero and
Daugherty at Nicolas are in any way relevant to Daugherty's compensation claim, his allegations
19
20
Stroke Foundation of New Zealand Inc. (http://www.shoke.org.nz/resources/SF2116EmoBehavLR.pdf);
American Stroke Association (http:// http://www.strokeassociation.org/shokeorgl)
Id.
DAL:835555.1
of what transpired during his meetings at Nicolas are inaccurate, and should be clarified in order
to correct his malicious misstatements. Contrary to Daugherty's allegations, any emails of
Becky Dondero in Dondero's possession were obtained legally. Moreover, Dondero never
assured Daugherty that Daugherty's wife had remained faithful. At dinner, and noted by
restaurant staff, Daugherty cried uncontrollably, inconsolably, for at least 20 minutes. Dondero
never used the word "whore" to describe his wife.
Daugherty's Misrepresentations Regarding Highland's Performance
60. Highland's investment performance continues to outperform applicable indices.
Its investment approach consists of in-depth fundamental research focused on specific sectors
performed by highly trained staff individually covering fewer than half the number of credits
than the industry average. This focus, unique among its competitors, has allowed Highland to
generate tremendous returns over the last 20 years. More recently, Highland delivered index-
beating performance across virtually all of its funds. Over the past 2Yz years, the bank loan
assets held by Highland's institutional funds and CLOs have generated a cumulative return of
18.4%, which exceeds the Credit Suisse Leveraged Loan Index return of 16.1%.
61. In 2010, Highland successfully returned the capital invested in two managed
accounts to our investors after earning exceptional returns for investors in those accounts. In
addition, Highland and its affiliates added approximately $1.1 billion of new assets to the firm
during 2011. In 2011, Highland's actively managed credit and equity hedge funds beat their
respective benchmarks by an average of 6.8% and 10.7%, respectively.21
62. Highland is honored that many world-class financial institutions continue to trust
Highland to manage their assets and Highland rewards their trust with market-leading returns. It
21
See Exhibit 4.
DAL:835555.1
has been honored with several recent awards for investment performance from the final press,
including receiving the Creditflux 2012 award for most improved CLO perfOlmance and
Highland's Diversified Credit Fund was a finalist for Creditflux's Best High Yield Hedge Fund
during 2011.
II.
SPECIAL EXCEPTIONS
22
A. Special Exception Standard
63. The purpose of pleadings is to give an opposing party fair notice of the claims
asserted. Tex. R. Civ. P. 47. A pleading provides fair notice only ifit "gives the opposing party
information sufficient to enable him to prepare defense." Horizon/CMS Healthcare Corp. v.
Auld, 34 S.W.3d 887,897 (Tex. 1999); see also Low v. Henry, 221 S.W.3d 609,612 (Tex. 2007).
Special exceptions are designed to compel clarification of pleadings when such pleadings are not
sufficiently clear or sufficiently specific or fail to plead a cause of action. See Tex. R. Civ. P. 91;
Baylor Univ. v. Sonnichsen, 221 S.W.3d 631, 635 (Tex.. 2007) (holding that purpose of special
exceptions is to compel clarification of pleadings when pleadings are not clear or sufficiently
specific or fail to plead cause of action). The purpose of the special exceptions rule is to give the
opposing pmiy infonnation sufficient to enable it to prepare a defense. See Horizon/CMS
Healthcare, 34 S.W.3d at 897.
22
As a preliminary matter, Delaware law applies to Daugherty's claims relating to Siena Verde and Highland
Employee Retention Assets, LLC ("HERA"). Texas law dictates that any claims involving a foreign entity's
internal affairs will be governed by the state in which the entity as incorporated. Tex. Bus. Org. Code 1.102;
see also State Farm Mut. Auto. Ins. CO. V. Lopez, 156 S.W.3d 550, 557 n.7 (Tex. 2004). Both HERA and
Sierra Verde are Delaware limited liability companies. Counterclaim. at '1'1 4-5. In addition, both the HERA
and Sierra Verde Agreements contain Delaware choice-of-law provisions.
ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, A l ~ D AFFIRMATIVE
DAL:835555.!
64. A trial court has broad discretion to sustain special exceptions, and may dismiss a
cause of action on the pleadings when the allegations cannot constitute a cause of action as a
matter of law. See Baylor Univ., 221 S.W.3d at 635 (holding trial court did not abuse its
discretion in sustaining special exception and dismissing breach claim when pleader could not
have corrected defect by re-pleading). While courts generally give pleaders an opportunity to
amend, such latitude is unnecessary if a defect cannot be cured by amendment. See id.; Tex. A &
M Univ. Sys. v. Koseoglu, 233 S.W.3d 835, 840 (Tex. 2007) (analogizing plea to jurisdiction to
special exceptions and holding "a pleader must be given an opporttmity to amend ... only if it is
possible to cure the defect") (emphasis added); Marts v. Transp. Ins. Co., 111 S.W.3d 699, 706
(Tex. App.-Fort Worth 2003, pet. denied) (holding trial court did not err in sustaining special
exceptions and striking claims that could not have been cured by re-pleading).
B. Dondero's Special Exceptions
Pursuant to Texas Rule of Civil Procedure 91, Dondero files the following Special
Exceptions to the Counterclaim and requests a hearing on same:
65. Dondero specially excepts to paragraphs 115 through 116 of Daugherty's
Counterclaim on the grounds that Daugherty failed to plead all the elements of a defamation
claim. Specifically, Daugheliy fails to allege any statement of fact that Dondero purpOliedly
made. For a statement to actionable in defamation, it must expressly or impliedly assert facts
that are objectively verifiable. Bentley v. Bunton, 94 S.W.3d 561, 579 (Tex. 2002). In addition,
Daugherty fails to give notice of what pecuniary injury he purportedly suffered. Dondero further
specially excepts to Daugherty's use of the phrase "among other things" in paragraph 115. A
defamation plaintiff must include the precise language of the allegedly defamatory statement
DAL:835555.!
upon which the suit IS based. See, e.g., Nlurray v. Harris, 112 S.W.2d 1091, 1094
(Tex.Civ.App.--Amarillo 1938, writ dism'd).
66. Dondero specially excepts to Daugherty's incurably deficient pleading of a claim
for breach of contract in paragraphs 118 and 123 of his Counterclaim because Daugheliy fails to
provide fair notice of his claim. Daugherty fails identify any valid, enforceable contract to which
Dondero was allegedly a party. Assuming Daugherty contends that Dondero is a party to the
Limited Liability Company Agreement of Sierra Verde ("Sierra Verde Agreement") discussed in
relation to his claim, Daugherty fails to identify any provision thereof that Dondero allegedly
breached, or any act that would constitute a breach, both of which are required to state a breach
of contract claim. See Spencer v. City of Seagoville, 700 S.W.2d 953, 957 (Tex. App.--Dallas
1985, no writ). As Daugherty concedes, the plain language of the Sierra Verde Agreement gave
Dondero, as Manager, the "sole right, power and authority to manage, direct and control all of
the business and affairs" of Sierra Verde. See Counterclaim at '1 118. Daugherty's allegations
only state that Dondero acted in accordance with this mandate.
67. Dondero specially excepts to Daugherty's claim for minority shareholder
oppression set forth in paragraphs 124 through 126 of his Counterclaim because Sierra Verde is a
Delaware limited liability company, meaning Delaware law applies, and "shareholder
oppression" is not a valid cause of action under Delaware law. See, e.g., Nixon v. Blackwell, 626
A.2d 1366 (Del. 1993). Further, even if Delaware did recognize such a cause of action,
Daugherty fails to allege any "oppressive" conduct, merely reciting the conduct alleged in his
breach of contract claims. See Redmon v. Griffith, 202 S.W.3d 225 (Tex.App.--Tyler 2006, no
pet.). Dondero further specially excepts to the extent Daugherty is attempting to assert a claim
for breach of fiduciary duties owed to him individually as a member because these contractual
DAL:835555.!
rights are separate from his rights as an alleged member. See Riblet Products Corp. v. Nagy, 683
A.2d 37, 40 (Del. 1996) (finding fiduciary duties are not implicated when the issue involves
rights of a minority stockholder under its employment contract).
68. Dondero specially excepts to Daugherty's claim for breach of fiduciary duty
purportedly brought on behalf of Sierra Verde set forth in paragraphs 127 through 131 of his
Counterclaim because Daugherty fails to plead all of the required elements. Specifically,
Daugherty fails to identify any haIm to Sierra Verde, merely repeating the injuries he allegedly
suffered as an individual that were offered in support of his breach of contract claims.
Regardless of the foregoing, Daugherty lacks standing to bring a derivative action because he
was not a member of Sierra Verde (which has been dissolved) at the time he commenced the
derivative action on behalf of Sierra Verde, as required under Sections 18-1001 and 18-1002 of
the Delaware LLC Act. Kelly v. Blum, 2010 WL 629850, at *9 (Del. Ch. Feb. 24, 2010); Lewis
v. Ward, 852 S.2d 896, 900-01 (Del. 2004); see also CML V, LLC v. Bax, 6 A.3d 238 (Del.Ch.
2010) (creditors of dissolved LLC lack standing because they are neither members or assigns of
an interest in the LLC). And, even if he were, he has not even attempted to present evidence to
overcome the business judgment rule, as required to challenge the actions of Sierra Verde's
manager.
69. Dondero specially excepts to paragraphs 132, which is labeled "Improper
Withholding of Corporate Books and Records." Daugherty alleges violations of the Texas
Business Corporations Act, which has been superseded by the Texas Business Organizations
Code, and which is no longer the law in the State of Texas. However, even ifnot superseded, the
cause of action is vague as written, and Daugherty fails to allege when and how his purported
"demand to inspect Sien-a Verde's books and records" was made, and he further fails to establish
DAL:835555.1
that he has standing to bring the claim. Regardless, Delaware law would apply because Siena
Verde is a Delaware limited liability company. Tex. Bus. Org. Code 1.102. Furthermore,
Dondero is not a member of Sierra Verde, and only members have rights to the company's books
and records.
70. Dondero specially excepts to paragraphs 133 through 135 of the Counterclaim
relating to Daugherty's claim for conversion. The elements of a cause of action for conversion
are: (a) the plaintiff owned, possessed, or had the right to immediate possession of personal
property; (b) the propeliy was personal property; (c) the defendant wrongfully exercised
dominion or control over the property; and (d) the plaintiff suffered injury. See Green Int'l v.
Solis, 951 S.W.2d 384, 391 (Tex. 1994); United Mobile Networks, L.P. V. Deaton, 939 S.W.2d
146, 147 (Tex. 1997); Khorshid, Inc. V. Christian, 257 S.W.3d 748, 758 (Tex.App.--Dallas 2008,
no pet.). In his Counterclaim, Daugherty does not identify any personal property that was
allegedly converted by Dondero. See Cage Bros. V. Whiteman, 163 S.W.2d 638, 640-41 (Tex.
1942); Khorshid, Inc., 257 S.W.3d at 758-59. Daugherty also fails to allege facts sufficient for
Dondero to determine how any such property was "wrongfully" taken; instead, he simply refers
to actions that were taken in accordance with the Sierra Verde Agreement.
71. Dondero further specially excepts to paragraph 133 through 134 of the
Counterclaim because the claim is an improper recasting or fracturing of his claim for breach of
contract. Under the Texas economic loss rule, if a plaintiff only seeks to recover for the loss or
damage to products, goods, or services which are the subject matter of a contract, he cannot
maintain a tOli action against a defendant. Sterling Chemicals, Inc. v. Texaco, Inc., 259 S.W.3d
793, 796 (Tex. App.--Houston [1st Dist.] 2007, pet. denied). "Simply stated, under the economic
loss rule, a duty in tort does not lie when the injury claimed is one for economic damages
DAL:835555.!
recoverable under a breach of contract claim." Id.; see also Formosa Plastics Corp., USA v.
PresidioEng'rs & Contractors, Inc., 960 S.W.2d 41,45-47 (Tex. 1998).
72. Similarly, Dondero specially excepts to paragraphs 136 through 137 of the
Counterclaimbecause Daugherty's unjust enrichment claim is an improper recasting of his claim
for breach of contract barred by the Texas economic loss rule. Daugherty must identify a harm
suffered separate and apart from the damages alleged in support of his breach of contract claim.
73. Dondero specially excepts to Daugherty's claim for breach of fiduciary duty set
forth in paragraphs 138 through 139 because Daugherty fails to plead all of the elements of a
breach of fiduciary claim. Specifically, Daugherty fails to identify the existence of a fiduciary
relationship between Daugherty and Dondero. The Sierra Verde Agreement expressly states:
"no Manager shall be liable for mistakes of judgment, for any act or omission suffered or taken
by it, or for losses due to any such mistakes, action or inaction." Sierra Verde Agmt. ~ 8.1(a).
Under the Delaware Limited Liability Company Act, members are free to eliminate, as between
themselves, any and all potentia1liabi1ity of the LLC's manager, and they will not be subj ect to
any non-contractual fiduciary duties. 10 Del. Code Ann. tit. 18-1101, et. seq.; see also Allen v.
Devon Energy Holdings, L.L.c., No. 01-09-00643-CV, 2012 Tex.App. LEXIS 2110, *97
(Tex.App.--Houston [1st Dist.] March 9, 2012) (declining to recognize a fiduciary duty between
members of an LLC). Furthermore, Dondero's allegations based on the "wrongful conduct
described above" in his breach of contract claim do not implicate any fiduciary duties. See
Riblet Products, 683 A.2d at 40 (finding fiduciary duties are not implicated when the issue
involves rights of a minority stockholder under its employment contract).
74. Dondero specially excepts to Daugherty's claim for minority shareholder
oppression set forth in paragraphs 143 through 144 of his Counterclaim because Daugherty fails
COUNTERCLAIM AND THIRD-PARTYPETITION OF PATRICK DAUGHERTY - Page - 34
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to allege any facts that would support such a claim. As previously discussed, "shareholder
oppression" is not a valid cause of action under Delaware law. Nixon, 626 A.2d 1366. In
addition, Daugherty fails to allege any "oppressive" conduct beyond the conduct alleged in his
breach of contract claims. Instead, Daugherty refers to HERA's board of directors "unilaterally
amending the Agreement" (see the Counterclaim at ~ 143), but does not allege facts sufficient for
Dondero to determine how the amendment of the relevant Agreement was wrongful (e.g., not in
compliance with amendment requirements of the HERA Agreement or other corporate
govemance documents or policies), particularly on the part of Dondero.
75. Dondero specially excepts to Daugherty's claim for breach of fiduciary duty
purportedly brought on behalf of HERA set forth in paragraphs 145 through 149 of his
Counterclaim because Daugherty fails to plead all of the elements of a breach of fiduciary claim.
Specifically, Daugherty fails to identify any harm to HERA. Whether a claim is derivative or
direct under Delaware law tums "on the following questions: (1) who suffered the alleged harm
(the corporation or the suing stockholders, individually); and (2) who would receive the benefits
of any recovery or other remedy (the corporation or the stockholders, individually)?" Tooley v.
Donaldson, Luj7dn, & Jenrette, Inc., 845 A.2d 1031, 1033 (Del. 2004). Despite the conclusory
allegations in paragraph 149, it is clear that the alleged misconduct - "amending the Agreement
to suspend distributions for any holder of units [doing certain acts] making it impossible for
anyone to enforce collections through the reward program" - describes a potential injury to the
individual members, not HERA, and any remedy would go to HERA's members, not the LLC
itself. Furthermore, Daugherty lacks standing to bring a derivative claim because Daugherty
failed to make a demand on HERA's managers and has failed to allege particularized facts to
excuse the demand requirement. Lewis v. Anderson, 477 A.2d 1040 (Del. 1984); cf Lola Cars
DAL:835555.1
Int'l Ltd. v. Krohn Racing, LLC, 2009 WL 4052681 (Del. Ch. Nov. 12,2009) (finding corporate
demand requirements apply to LLCs); see also In re Schmitz, 285 S.W.3d 451,455 (Tex. 2009)
(issuing mandamus to correct trial court's failure to dismiss suit based on shareholders' failure to
comply with Texas' strict pre-suit demand requirements under Tex. Bus. Org. Code Ann.
21.553).
76. Dondero further specially excepts to paragraphs 150 through 151 of the
Counterclaim because Daugherty fails to identify how or why Highland's and HERA's alleged
breach of contract should simultaneously be considered a conversion tort on the part of Dondero.
It is well-settled Texas law that a complainant cannot maintain a tort action against an individual
when his damages are only for economic losses caused by the failure to perform a contract.
Coffey V. Fort Wayne Pools, Inc., 24 F. Supp. 2d 671, 687 (N.D. Tex. 1998). When a
complainant asserts a tort claim arising from a business relationship, the court must look to the
substance of the cause of action, not the manner in which it was plead, to determine the type of
action that is brought. See Formosa Plastics Corp., 960 S.W.2d at 45; Tarrant Cty. Hosp. Dist.
v. GE Automation Servs., Inc., 156 S.W.3d 885, 895 (Tex. App.-Fort WOlih 2005, no pet.).
When the injury is only for economic loss resulting from an alleged breach of the contract itself,
the action sounds in contract alone. Id.; see also Fed. Land Bank Ass 'n v. Sloane, 825 S.W.2d
439, 442-43 (Tex. 1991) (adopting independent injury requirement). In this case, the same
alleged' conduct forms the basis of Daugherty's breach of contract claim and his conversion
claim and establishes no injury or damages independent of his breach of contract claim.
77. Finally, Dondero specially excepts to the prayer in Daugherty's Counterclaim,
which does not provide Dondero with adequate or fair notice of the maximum amount of
DAL:835555.!
damages claimed by Daugherty. Pursuant to Rule 47 of the Texas Rules of Civil Procedure,
Dondero requests that Daugherty state the maximum amount of Daugherty's alleged damages.
c. Highland's Special Exceptions
Pursuant to Texas Rule of Civil Procedure 91, Highland files the following Special
78. Highland specially excepts to paragraphs 115 through 116 of Daugheliy's
Counterclaim on the grounds that Daugherty failed to plead all the elements of a defamation
claim. Specifically, Daugherty's claim is only based on Highland's alleged statements that
Daugherty "was 'burned out' and had left for 'lifestyle' reasons," which are not statements of
fact. For a statement to actionable in defamation, it must expressly or impliedly assert facts that
are objectively verifiable. Bentley, 94 S.W.3d at 579. In addition, Daugherty fails to give notice
of what pecuniary injury he purportedly suffered. Highland further specially excepts to
Daugherty's use of the phrase "among other things" in paragraph 115. A defamation plaintiff
must include the precise language of the allegedly defamatory statement upon which the suit is
based. See, e.g., Murray, 112 S.W.2d at 1094.
79. Highland specially excepts to paragraph 132 of the Counterclaim, which is
labeled "Improper Withholding of Corporate Books and Records." This paragraph is vague as
drafted, as it is unclear i'om the pleadings whether Daugherty alleges violations of the Texas
Business Corporations Act against anyone other than Dondero. To the extent such claims are
raised against Highland, Highland specially excepts to this paragraph for the additional following
reasons: the Texas Business Corporations Act is no longer the law in the State of Texas;
Delaware law applies to this claim; Daugherty fails to allege when and how his purported
"demand to inspect Sierra Verde's books and records" was made; he fails to establish that he has
DAL:835555.1
standing to bring the claim; and he does not demonstrate how Highland would be responsible for
providing access to Sierra Verde's books and records.
80. Highland specially excepts to the breach of contract cause of action identified in
paragraphs 141 and 142 of the Counterclaim. Daugherty fails to identify the provision or
provisions of the Limited Liability Company Agreement of HERA ("HERA LLC Agreement"),
which he alleges were breached by the Limited Liability Company's decision to amend the tenns
of the HERA LLC Agreement, or how that act would constitute a breach. By omitting such key
facts, Daugherty fails to identify an essential element for a breach of contract claim. See
Spencer, 700 S.W.2d at 957.
81. Highland further specially excepts to paragraphs 150 through 151 of the
Counterclaim because Daugherty fails to identify any facts supporting a claim for conversion
apart from those alleged in support of his claim for breach of contract. "It is well-settled Texas
law that a plaintiff cannot maintain a tort action against a defendant when his damages are only
for economic losses caused by the failure to perfonn a contract." Coffey, 24 F. Supp. 2d at 687.
When a plaintiff asserts a tort claim arising from a business relationship, the court must look to
the substance of the cause of action, not the manner in which it was plead, to detelmine the type
of action that is brought. Tarrant Cty. Hasp. Dist., 156 S.W.3d at 895. When the injury is only
for economic loss resulting from an alleged breach of the contract itself, as appears to be the case
herein, the action sounds in contract alone. Id.
82. Highland specially excepts to Daugherty's breach of contract claim in paragraphs
153 through 154 because it is impennissibly vague and provides inadequate pleading notice to
Highland. Daugherty fails to identify any contract that was allegedly breached in connection
with the "LTIP". Daugherty also fails to identify how he perfofiled or tendered perfonnance
DAL:835555.!
under the alleged agreement and the specific provision(s) of the agreement Highland allegedly
breached, both of which are required for a breach of contract claim.
83. Highland specially excepts to Daugherty's claims of conversion in paragraphs 155
through 156 of his Counterclaim because Daugherty fails to allege any facts that would support
such a claim. Specifically, Daugherty fails to identify any personal property that was allegedly
converted and which is made the basis for his claim. See Cage Bros., 163 S.W.2d at 640-41;
Khorshid, 257 S.W.3d at 758. Highland further specially excepts to paragraphs 155 through 156
to the extent the alleged damages are only for economic losses caused by Highland's purported
breach of contract. Coffey, 24 F. Supp. 2d at 687.
84. Finally, Highland specially excepts to the prayer in the Counterclaim, which does
not provide it with adequate or fair notice of the maximum amount of damages claimed by
Daugherty. Pursuant to Rule 47 of the Texas Rules of Civil Procedure, Highland requests that
Daugherty state the maximum amount of Daugherty's purported damages.
D. Sierra Verde's Special Exceptions
Pursuant to Texas Rule of Civil Procedure 91, Siena Verde files the following Special
85. Siena Verde specially excepts to paragraphs 124 through 126 of the
Counterclaim, which purpOlis to bring a claim for "oppression of a minority shareholder" against
Sierra Verde. First off, Daugherty is not a shareholder in Sierra Verde. In fact, he is not even a
member. However, even assuming arguendo that Daugherty were a member and had standing to
bling this claim, Siena Verde is a Delaware limited liability company governed by Delaware
law, which does not recognize a claim for shareholder oppression. See, e.g., Nixon, 626 A.2d
1366. And, even jurisdictions that recognize such a cause of action do not pelmit the claim to be
DAL:835555.1
made against the limited liability company itself; rather only against "directors or those in
control" of the company. Ritchie v. Rupe, 339 S.W.3d 275, 290 (Tex.App.--Dallas 2011, pet.
denied).
86. Sierra Verde specially excepts to Daugherty's claim of conversion in paragraphs
133 through 135 of his Counterclaim because Daugherty fails to identify any personal property
that was allegedly converted and which is made the basis for his claim. See Cage Bros., 163
S.W.2d at 640-41; Khorshid, Inc., 257 S.W.3d at 758-59. Daugherty also fails to allege facts
sufficient for Sierra Verde to determine how any such property was "wrongfully" taken.
87. Sierra Verde specially except to Daugherty's incurably deficient pleading of a
claim of unjust enrichment in paragraphs 136 through 137 of its Counterclaim. Daugherty has
not alleged, and cannot allege, the kinds of facts that are required to state a claim for unjust
enrichment, even if an independent cause of action for unjust enrichment exists under Texas law.
Specifically, Daugherty has not alleged that Daugherty conferred any benefit on the Sierra Verde
that the Sierra Verde is obligated to refund. Moreover, unjust enrichment is not available when a
plaintiff has adequate legal remedies, i.e., to bring a claim for breach of contract. The same
alleged conduct forms the basis of Daugherty's breach of contract and his unjust enrichment
claim, and he establishes no injury or damages independent of his breach of contract claim.
When the injury is only for economic loss resulting from an alleged breach of the contract itself,
the action sounds in contract alone. Sloane, 825 S.W.2d at 442-43.
E. Boyce's Special Exceptions
Pursuant to Texas Rule of Civil Procedure 91, Boyce files the following Special
DAL:835555.1
88. Boyce specially excepts to Daugherty's claim for minority shareholder oppression
set forth in paragraphs 143 through 144 of his Counterclaim because Daugherty fails to allege
any facts that would support such a claim. "Shareholder oppression" is not a valid cause of
action under Delaware law. Nixon, 626 A.2d 1366. In addition, Daugherty fails to allege any
"oppressive" conduct beyond the conduct alleged in his breach of contract claims. Instead,
Daugherty refers to HERA's board of directors "unilaterally amending the Agreement" (see the
Counterclaim at ~ 143), but does not allege facts sufficient for Boyce to detelmine how the
amendment of the relevant Agreement was wrongful (e.g., not in compliance with amendment
requirements of the HERA Agreement or other corporate governance documents or policies),
particularly on the part of Boyce.
89. Boyce further specially excepts to paragraph 150 through 151 of the Counterclaim
because Daugherty fails to identify how or why Highland's and HERA's alleged breach of
contract should simultaneously be considered a conversion tort on the part of Britain. It is well-
settled Texas law that a complainant cannot maintain a tort action against an individual when his
damages are only for economic losses caused by the failure to perform a contract. Coffey, 24 F.
Supp. 2d at 687. When a complainant asserts a tort claim arising from a business relationship,
the court must look to the substance of the cause of action, not the manner in which it was plead,
to determine the type of action that is brought. See Formosa Plastics Corp., 960 S.W.2d at 45;
Tarrant Cty. Hosp. Dist. v. GE Automation Servs., Inc., 156 S.W.3d 885, 895 (Tex. App.-Fort
Worth 2005, no pet.). When the injury is only for economic loss resulting from an alleged
breach of the contract itself, the action sounds in contract alone. Id.; see also Fed. Land Bank
Ass 'n v. Sloane, 825 S.W.2d 439,442-43 (Tex. 1991) (adopting independent injury requirement).
In this case, the same alleged conduct forms the basis of Daugheliy' s breach of contract claim
DAL:835555.1
and his conversion claim and establishes no injury or damages independent of his breach of
contract claim.
90. Finally, Boyce specially excepts to the prayer in Daugheliy's Counterclaim,
which does not provide Britain with adequate or fair notice ofthe maximum amount of damages
claimed by Daugherty. Pursuant to Rule 47 of the Texas Rules of Civil Procedure, Britain
requests that Boyce state the maximum amount of Daugherty's alleged damages.
F. Britain's Special Exceptions
Pursuant to Texas Rule of Civil Procedure 91, Britain files the following Special
91. Britain specially excepts to Daugherty's claim for minority shareholder
oppression set forth in paragraphs 143 through 144 of his Counterclaim because Daugherty fails
to allege any facts that would support such a claim. "Shareholder oppression" is not a valid
cause of action under Delaware law. Nixon, 626 A.2d 1366. In addition, Daugherty fails to
allege any "oppressive" conduct beyond the conduct alleged in his breach of contract claims.
Instead, Daugherty refers to HERA's board of directors "unilaterally amending the Agreement"
(see the Counterclaim at '1143), but does not allege facts sufficient for Britain to determine how
the amendment of the relevant Agreement was wrongful (e.g., not in compliance with
amendment requirements of the HERA Agreement or other corporate govemance documents or
policies), particularly on the part of Britain.
92. Britain further specially excepts to paragraph 150 through 151 of the
Counterclaim because Daugheliy fails to identify how or why Highland's and HERA's alleged
breach of contract should simultaneously be considered a conversion tort on the pati of Britain.
It is well-settled Texas law that a complainant cannot maintain a tort action against an individual
DAL:835555.!
when his damages are only for economic losses caused by the failure to perform a contract.
Coffey, 24 F. Supp. 2d at 687. When a complainant asselis a tort claim arising from a business
relationship, the comi must look to the substance of the cause of action, not the manner in which
it was plead, to determine the type of action that is brought. See Formosa Plastics Corp., 960
S.W.2d at 45; Tarrant Cty. Hasp. Dist, 156 S.W.3d at 895. When the injury is only for economic
loss resulting from an alleged breach of the contract itself, the action sounds in contract alone.
Id.; see also Fed. Land Bank Ass 'n, 825 S.W.2d at 442-43 (adopting independent injury
requirement). In this case, the same alleged conduct forms the basis of Daugherty's breach of
contract claim and his conversion claim and establishes no injury or damages independent of his
breach of contract claim.
93. Finally, Britain specially excepts to the prayer in Daugherty's Counterclaim,
which does not provide Britain with adequate or fair notice of the maximum amount of damages
claimed by Daugherty. Pursuant to Rule 47 of the Texas Rules of Civil Procedure, Blitain
requests that Britain state the maximum amount of Daugherty's alleged damages.
III.
AFFIRMATIVE DEFENSES
For fmiher answer, should same be necessary, the Defendants asseli the following
affirmative defenses pursuant to Texas Rule of Civil Procedure 94, subject to their Special
Exceptions:
94. Daugheliy's claims are barred, in whole or in pati, for failure to state a claim
upon which relief may be granted.
95. Daugheliy's claims are barred, in whole or in part, by repudiation and/or material
breach.
DAL:835555.1
96. Daugherty's claims are balTed, in whole or in part, by the doctrine of justification.
97. Daugheliy's claims are balTed, in whole or in part, because his own acts or
omissions caused or contributed to his alleged damages and/or injuries, which alleged damages
and/or injuries Highland, Siena Verde, Dondero, Boyce and Britain each vigorously deny.
98. Daugherty's claims are subject to offset.
99. Daugherty's claims are balTed, in whole or in part, to the extent Daugherty has
failed to mitigate any alleged damages.
100. Daugherty's claims are baned, in whole or in part, by ratification, acquiescence,
estoppel, and/or waiver.
101. Daugherty's claims are balTed in whole or in part by the doctrine of unclean
hands.
102. Daugherty's claims for defamation are balTed, m whole or m part, because
statements made were true and/or were a matter of opinion.
103. Daugherty's derivative claims for breach of fiduciary duty are baned, in whole or
in part, by the equitable doctrine of laches.
104. Daugherty's claims are baned, in whole or in part, by the exculpatory provisions
in the Siena Verde and HERA Agreements.
105. Daugherty's claims are baned, in whole or in part, because Daugherty lacks
standing to bring them.
106. Daugherty's derivative claims are baned because Daugherty failed to make a
demand on the Board of Directors of either Siena Verde and HERA, and failed to meet the other
procedural and substantive requirements for a derivative action.
107. Daugherty's claims are baned, in whole or in pali, by the business judgment rule.
COUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY- Page - 44
DAL:835555.!
108. Daugheliy's claims are baned, in whole or in part, by the economic loss rule.
109. Each of the Defendants assert their rights to recover any and all attorneys' fees
and costs to the fullest extent available under applicable law.
By pleading the foregoing defenses, none of the Defendants assume the burden of proof
on any matter. Also, additional facts may be revealed by discovery that support additional
affiunative defenses presently available to, but unknown to, any of the Defendants. Therefore,
each of the Defendants reserves the right to assert additional defenses in the event that discovery
and investigation indicate that additional defenses would be appropliate.
IV.
PRAYER
WHEREFORE, PREMISES CONSIDERED, Highland, Siena Verde, Dondero, Boyce
and Britain each respectfully request:
(i) that their special exceptions be sustained and that Daugheliy be required
to replead his allegations in accordance therewith;
(ii) if Daugherty fails to or refuses to replead, those portions of Daugherty's
Counterclaim be stricken and/or the conesponding purported causes of action be
dismissed;
(iii) that Daugheliy take nothing, that all claims in the Counterclaim be
dismissed with prejudice, and that the Defendants recover all damages, costs of litigation,
including attomeys' fees, costs and expenses, pre-judgment and post-judgment interest;
and
(iv) that each of the Defendants be granted all such other and fmiher relief,
both at law and in equity, to which hefit may be justly entitled.
DAL:835555.!
Respectfully submitted,
ANDREWS KURTH LLP
-..:::;:::
Marc D. Katz
State Bar No. 00791002
James M. Stanton
William J. Moore
Isabel Andrade Crosby
1717 Main Street, Suite 3700
Dallas, Texas 75201
Telephone: 214-659-4400
Facsimile: 214-659-4401
ATTORNEYS FOR HIGHLAND CAPITAL
MANAGEMENT, L.P., JAMES DONDERO
AND SIERRA VERDE, LLC.
DAL:835555.!
GRUBER HURST JOHANSEN HAIL
SHANK,LLP
M-JL 1Iw'.i- If I!i? ~ I i ' fP'M
Michael K. Hurst
State BarNo. 10316310
mhurst@gbjh1aw.com
A. Shonn Brown
sbrown@gbjh1aw.com
Diana Cochrane
dcochrane@ghjh1aw.com
1445 Ross Avenue, Suite 2500
Dallas, Texas 75202
Telephone: 214-855-6800
Facsimile: 214-855-6808
ATTORNEYS FOR PATRICK BOYCE AND
WILLIAM L. BRITAIN
DAL:835555.!
CERTIFICATE OF SERVICE
I hereby certify that on this the 18th day of June, 2012, a true and correct copy of the
foregoing document has been served on counsel of record via hand delivery as follows:
James W. Ribman
Ruth AIm Daniels
Looper Reed & McGraw P.c.
1601 Elm Street, Suite 4600
Dallas, Texas 75201
(214) 954-4135
(214) 953-1332 (Fax)
Marc D. Katz
DEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L.P.,SIERRA VERDE,
DAL:835555.\
From:
Sent:
SubJe-ct:
Ross,
Pat Daugherty
FridaY, September '12, 20084:34 PM
Letter of apo!OfJY
Importantly, no one at Highland has asked me to write this email and no Ohe even kno\,vs that I'm \A/riting it. i heard the
news that you are not interested in moving forv1ard with Highland as a manager primarily be(:<:luse of me. I accept your
decision and apologize for any unintended offense I may have conveyed in our discussions. Frankly, I do have a
tendency to be grllff at times and I can understand how it Cal1 be offputting. I just wanted to let you know that I never
intended to offend you and I very much appreciate the time that you spent evaluating us in the first place. ! do regret that I
have undone the. hard work of so many people at Highland who reaily wanted to earn your business, Highland is indeed a
tough culture but it isa good group of people are committed to each other and their clients. To the extent you are
interested, I did vvant to address some of your points In the only vlay I know how, with complete honesty:.
~ The Highland culture is very unique and challenging. it is definitely not for everyone and I myself have had days
over the last 10 years wr1ere thought it wasn't right for .rne. That said, Highland has provided enormous
opportunity for people to excel beyond their Wildest dreams and be rewarded for performance on a pure merit
basis. That was particularly meaningfUl for someone like me, because as a yOLlng man I felt like I could
accomplish great things if someone would just give me a chance. Jim Qqve me that chance and many others who
have stayed loyal to him to this day.
" Jirnis one of the most focused and driven people I have ever met. . He has no ego and is much more comfortable
being anonymous ina crowd that having th8< bright fights cast upon 111m. He was raised to pick up pennies and
because of that, treats our LPs money as if it were his own,< But many people , ~ o n ' t know he is one of the most
generous and charitablepeople on the planet He'd bevery annoyed with me for saying this, but Jim truly cares
about the little guy Who is willing to work hardto increase his. lot in!ife. The fact is, Highland's culture is a
manifestation of his desire to provide opportunity and advanc(3ment on merit, not on connection or pedigree. I
don't like some afthe elements of our quirky culture (IH(eTimekeeper our d.eferred camp and our travel policies)
but I focus on the big picture which is to provide opportunity and to lead with sincerity on behalf of our investors.
" There is no doubt that I Il$ve a very hard charging ,md tough personality. In some ways it is a necessary asset as
distressed investing is a VERY ugly business; with management teams \Nho try to loot the Companies, agents
whO try to s.elMeal, out-of-the-rnoney subord!natedinvestor.s who try to hold the estate for ransom and
lawyersfprofessionals who try to feed off of the carcass. Also, distressed brings out the worst in people because it
boils down toa fight for survival. It is often a zero sum game. I don't remember what issue! was dealing before
our call but I have been very bl)Sy evaluating one distressed crisis after the other and I see that trend continuing
for the next few years. This is not an excuse. I'm just trying to give you some context for what I was working thru
prior to our call. The down side is that I am not always able to quickly shift into client service mode and in the
case of dealing with you and your colleague, I was an ass.
o My management personality is one of tough/lol/B. I grew up playing football vvith tough coaches and for better or
worse, this is hOIN I learned to get the most out of people. When someone does something well, I tell them and!
make sure seliior management recognizes the accomplishment. Whet\ someone performs poorly, I tell them so,
and then I try to coach them on how to perform better next time. Everyone on my team knows that mistakes are
forgivable so long as they are not repeated. I have lost very few people on my team over the last 10 ~ years. All
of my employees know that I will give them a fair chance to succeed. I have developed and promoted several
members of my team to areas of leadership in the firm. They <;!Iso know that I might be tough on them at times
but irs because I beUeve in them and j INant them to fUifiiJ their potential. I do not aHow them to shOrt-change
themselves orour investors by taking shortcuts. I view my role as an evaiuator of talent and I think it is critical
that a good manager must have the courage to identify and train his replacement. This is my mission as a
manager.
'" As you know, John Honis and I co-manage our private equity effort John is one of my best friends, but we
much have a brotherly relationship (that includes the good and the bad). We have gone {i'!r:! f!'!)!!'T"!>!:!!'!"!;!"'.:!!!!;
1
CONFIDENTIAL
together
It is true that John and I have had tension in our history VVe
don't always agree and when we reject one another's deals, or disagree on allocation of resources, we can get
emotionaL However, I have 0hormous respect fOf ,Jor'ln and! know he \//illstand up for what he believes in, as will
1. I think this creates a healthy check and balance \;vithin the organization and ultimately our investors benefit from
the inteflectual honesty.
" Which brings me to my last point, I think I know who the former 8mplyyee is that gave you the color on me and
Highi.and. If it Is .. I would !ike to say a few things. .isthe same That was fired from
for writing that sophomoric letter to his colleagues regarding his exp10its ... . was untouchable
after that stunt but .. asked Jim iJ he vI''OLlld give a kid who made a stuoid mistake another chance to
dear his name. Jim agreed to hire. idespite the risk to the firm becauseof the ,very negative doud that
folto\lved / I think fhat speaks volumes about the good hearts of Jim . (was a challenge to
manage. I inherited after another Team Leader . . had determined that he
couldn't work with him. The thouqrlt was that my tough love style of management might be better suited to
working with a personality like That fact is, he was probably the smartest kid 1had in my group, but he
was very lazy, prone to misreoresent facts and sometimes failed to follow commands. That notWithstandinG I
tried to create a path for 'to advance by having him initially assist me and then lead our
Unfortunately, the project fa,iled and many of the investments that 11lade are in
liquidation or are in sever Financial duress to this day. In December of 2007, the Team Leader's voted to assign
the ,'effort to another Portfolio Manager and was reassigned back to my team. The
performance for his portfolio caused him to be ranked at the bottom of his peer group which meant Was
passed over for promotion to Team Leader for the second year in a row. was not happy with his ranking or
his compensation package. One 8gain, ,Jim tried to do the right thing by allowing to receive certain mid-
year 2.008 incremental bonuses if he deliver on the recovery assumptions he represented to the valuaHon
committee That never happened and about two months into 2008, resiflned and joined the former founder
of
I do not give you these details to absolve iTly conduct. You were right to be offended and! do apologize. I'm not asking
and I do not expect YClu to change your mind, I just don't want my conductand the comments of a disgruntled former
employee to leave yOll with a bad impression of a firm that some 260 people work exceptionally hard at making the best
money manager in the business. These truly are great people who work together and believe in the firm's mission to
maxin"Iize value to its investors. I feel so bad about what I've done that I would like to offer my thoughts on any matters of
"distressed" investing tt1at could help you make decisions about other managers. I know who is good and how they are
differentiated such that I could at least be of assistance in helping you evaluate other managers. I think we will have our
flr.5t fund invested by the eild of next year and who maybe over time I can prove my sincerity and that of
Highland's so that you would consider us on our second fund.
Sincerely,
2
CONFIDENTIAL
30 Day Notice of Resignation
September 10, 2008
It is with great regret that I submit my fonnal notice of resignation. I am very
appreciative of the opportunities and experiences that you and the firm have afforded me
over the last 10 Y:z years. I do view you as a great leader and friend, but also as a good
man. However, I've come to a point in my life where it is necessary for me to make
some changes. As I told you in Febmary during compensation review, I think the
Highland compensation plan no longer works for me given my age, contributions and
experience. In addition, I feel that it is time, and that I have earned the right to diversify
some of my net worth away from Highland and away from the financial sector in general.
That said, I told you I was open to discussions that would result in a revised
compensation plan that would be mutually agreeable to us both. The reality is that there
has been no dialogue with me on the subject other than to say things will get better next
year. That's fine and I am truly not offended but its time for the issue to be addressed
now or you and I need to move on.
I wanted to resign earlier this year but I felt that I needed to help you tlml the chaos of the
first half of the year. Now that things have stabilized, I think it is appropriate that we
deal with these issues. Importantly, I have no offer away and indeed, I have never
interviewed during my entire 10 Y:z year career in Highland. I have had several inquiries
lately but I've not engaged them for fear 0 f setting off rumors on the street that could
damage Highland. In fact, I am only copying Kevin Latimer on this Resignation because
I fear there are too many other people that might leak the infollnation before you are
ready to address it. In that regard, I am willing to maintain an affiliation with Highland
past my 30 day Resignation period so that you can address the matter in whatever
strategic manner you choose. Obviously, we would need to agree to modify the terms of
the current Plan and LTIP treatments in return for that transition period. Importantly, I
am not negotiable on the 30 day payout of my STIP (Option-it) interest post my effective
resignation date.
Perhaps most impOliantly, I am willing to stay assuming we come to written agreement
on my compensation terms within the Resignation notice period (next 30 days). My
critical needs include:
I) A significant cash payment as partial monetization of either my LTIP or STIP
interests
2) A significant increase in my partnership stake which will carry similar rights
as Founder shares as opposed to my Clm-ent Non-founder shares (obviously
with the exception that I would have no veto rights on how you run the finn)
3) A clear understanding that I will work 60 hour minimums under Timekeeper
but will be able to count ALL hours worked away from Highland offices with
the understanding that I must be available 24/7 in person or by phone
(basically what I thought was our deal for the last 10 Y:z years,).
CONFIDENTIAL
4) The ability to work out 3 days a week around lunch time so long as I am
logged out of Timekeeper.
5) A clear understanding that I will work for you and no one else for as long as I
work at the finn.
6) Clear description ofmy role, responsibilities that can't be changed without
seeking my agreement or giving me cause to tenninate my employment
without penalty.
I really don't think I'm taking you to the woodshed on these requests. It's simple
common sense and it's fair. I fully acknowledge and agree that there can only be one
person to decide what is best for the finn and that person is you. There is no one I'd
rather follow than you. That said, I need to take some of my money out of the equation
in order to feel comfortable with decisions that I may not agree with out of risk appetite
differences or otherwise. Frankly, I owe that to my family. I can put up with the Jack
and Okada clown act or anything else so long as I have a safe nest egg and adequate
upside.
Importantly, you have some very good people around here that can do much of what I do.
You also have several people around here who don't generate enough value to justify
what you are paying them (that is up and down the organization, not just investments).
Of course we all like to think that we are not replaceable and I am no exception. But that
is just nonsense. You have very good young people and it's just a matter of making them
step up. Lane, Winston, Martinson, Winston, Lee, Dave, Tom, Ledderer and Clay are all
doing great things. Ultimately, it boils down to cost versus benefit and you are in the best
position to make that call.
I guess I'm telling you that at age 41, I'm not willing to follow the same paradigm that
worked for me at 31. I have kids, a family, responsibilities and the wear and tear of life
that cause me to view Highland and what I want out of life differently. I will always be
appreciative for the opportunity and confidence you bestowed upon me. I assure you that
I will reward your faith with loyalty and respect even after I have no economic incentive
to do so.
Sincerely,
Patrick H. Daugherty
CONFIDENTIAL
Date: 9/28/11
To: Jim Dondero
I very much appreciate the opportunity to have worked with you and at Highland for the
last 13 Yz years. After careful and deliberate consideration, I have decided to move on to
the next chapter in my life and am giving my 30 notice of resignation effective today. I
wish you and the firm all the best and am available to assist in an appropriate transition.
Sincerely,
Patrick H. Daugherty
cc Patrick Boyce
CONFIDENTIAL
Exhibit 4
2011
Highland Bank Loan Composite 7.97%
Benchmark CS Loan Index 1.67%
Over/(Under) Performance 6.30%
Highland Diversified Credit Hedge Fund 8.31%
Benchmark HFRI Fixed Income Index 0.85%
Select Hedge Fund 6.82%
Benchmark S&P 500 2.12%
Healthcare Hedge Fund 18.39%
Benchmark S&P 500 2.12%
Secondary CLO Portfolio 12.68%
Benchmark CS Loan Index 1.67%
DAL:835543.1
CONFIDENTIAL

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HIGHLAND CAPITAL

MANAGEMENT, L.P., AND

Defendant and Counter-Plaintiff,

SIERRA VERDE, LLC, HIGHLAND

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