Highland Response

HIGHLAND CAPITALMANAGEMENT, L.P., ANDCORNERSTONE HEALTHCAREGROUP HOLDING, INC.

Plaintiffs,

v.

PATRICK DAUGHERTY,

Defendailt and Counter-Plaintiff,

v.

SIERRA VERDE; LLC, HIGHLANDEMPLOYEE RETENTION ASSETSLLC, JAMES DONDERO, PATRICKBOYCE, AND WILLIAM L. BRITAIN,

Third-Party Defendants.

§§§§§§§§§§§§§§§§§§§§§

,I

DALLAS COUNTY, TEXAS

68th JUDICIAL DISTRICT

FILED UNDER SEAL

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVE DEFENSESOF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE, LLC, JAMES

DONDERO, PATRICI(BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM 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

68th JUDICIAL DISTRICT

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVE DEFENSESOF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE, LLC, JAMES

DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM 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 AFFIRMATIVEDEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE,LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM 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 amanager primarily because of me ... [on the other hand] Jim is one of the most focusedand driven people I have ever met. He has no ego ... He was raised to pick up pemliesand because of that, treats our LPs money as if it were his own. But many people don'tknow he is one of the most generous and charitable people on the planet. He'd be veryannoyed with me for saying this, but Jim truly cares about the little guy who is willing towork hard to increase his lot in life. The fact is, Highland's culture is a manifestation ofhis desire to provide opportunity and advancement on merit, not on connection orpedigree."

Daugherty then says of himself:

"[I]n the case of dealing with you and your colleague, I was an ass. . . I do not give youthese 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 thebusiness. These truly are great people who work together and believe in the firm'smission 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.

2Exhibit 1.See Exhibits 2 and 3.

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVEDEFENSES 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 - 3

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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

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVEDEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE,LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM 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 29th, had on share prices of comparable companies, it was decided that a second valuation as

of a more recent date (August 15th) 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 8th 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.


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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


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


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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 ofDistribution and potentially an additional $10 lnillion in value should aggregate distributions of $1.7 billion notbe made to Crusader investors by the 43 rd month following the adoption of the plan. In addition, Highlandcontributed $3 million in connection of the Credit Strat plan of distribution, with an additional $6 million dueon the third anniversary of such approval, with such payments guaranteed by Dondero and Okada.


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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 proposedtransaction.


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 threat~ned, 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


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 smallischemic strokes. That is, in TIAs, as in ischemic strokes, brain cells die.

Research indicates the consequences of strokes such as those experienced by Daugherty includethe following:

[M]ay have a lingering feeling that something odd has happened to [theirbodies].8 These symptoms may include emotional changes. 9 In addition, if bloodsupply to a particular area is blocked for several minutes, the nerve cell of thatarea of the brain dies. 10 This causes permanent neurologic deficit commonlyrefened to as a "dead SpOt."ll When a TIA occurs, problem-solving ability can beaffected,12 This is due, in part, to the patients being impulsive and havingdecreased awareness of their deficits. They tend to be impulsive and fail to thinkbefore they act, which reflects an inability to think through a situation rationally, 13The emotional reaction of a person who has experienced a stroke may beunexpected, confusing and difficult to know how to deal with. 14 Many peoplefollowing a stroke find that they burst into tears very easily.15 Medical staff oftenrefer to uncontrollable crying or laughter as 'emotional liability' and believe this tobe directly related to damage to the brain, caused by the stroke. 16 Some people doevidence this emotional liability most with explosive tempers,I7 Conmmnicationdeficits may include decreased attention, distractibility, and the inability to inhibitinappropriate 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-andcure/what-is-transient-ischemic-attack.htm1) ;http://www.drgarysmultip1esclerosiscure.org/B1og/spina1-corddemye1ination.htm1http://www.n1m.nih.gov/medlinep1us/ency/article/000730.htmhttp://www.healthscout.com/ency/1/136/main.htmlhttp://stanmed.stanford.edu/2005faWstroke.htmlSee, 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=EFFECTStroke 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)

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVEDEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L,P., SIERRA VERDE,LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY - Page - 26

DAL:835555.1

memory related area of behavior called quality control. 19 This refers to how wellindividuals 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.sh·oke.org.nz/resources/SF2116EmoBehavLR.pdf);American Stroke Association (http:// http://www.strokeassociation.org/sh·okeorgl)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 EXCEPTIONS22

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 HighlandEmployee Retention Assets, LLC ("HERA"). Texas law dictates that any claims involving a foreign entity'sinternal 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 andSierra Verde are Delaware limited liability companies. Counterclaim. at '1'1 4-5. In addition, both the HERAand Sierra Verde Agreements contain Delaware choice-of-law provisions.

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, Al~D AFFIRMATIVEDEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L.P., SIERRA VERDE,LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY - Page - 29

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


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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


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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


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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


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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 ofDaugherty'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.


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. KatzState Bar No. 00791002James M. StantonState Bar No. 24037542William J. MooreState Bar No. 24051075Isabel Andrade CrosbyState Bar No. 24050226

1717 Main Street, Suite 3700Dallas, Texas 75201Telephone: 214-659-4400Facsimile: 214-659-4401

ATTORNEYS FOR HIGHLAND CAPITALMANAGEMENT, L.P., JAMES DONDEROAND SIERRA VERDE, LLC.


DAL:835555.!

GRUBER HURST JOHANSEN HAILSHANK,LLP

M-JL 1Iw'.i- If I!i? «~Ii' fP'MMichael K. HurstState BarNo. [email protected]. Shonn BrownState Bar No. [email protected] CochraneState Bar No. [email protected]

1445 Ross Avenue, Suite 2500Dallas, Texas 75202Telephone: 214-855-6800Facsimile: 214-855-6808

ATTORNEYS FOR PATRICK BOYCE ANDWILLIAM 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 theforegoing document has been served on counsel of record via hand delivery as follows:

James W. RibmanRuth AIm DanielsLooper Reed & McGraw P.c.1601 Elm Street, Suite 4600Dallas, Texas 75201(214) 954-4135(214) 953-1332 (Fax)

Marc D. Katz

ORIGINAL ANSWERS, SPECIAL EXCEPTIONS, AND AFFIRMATIVEDEFENSES OF HIGHLAND CAPITAL MANAGEMENT, L.P.,SIERRA VERDE,LLC, JAMES DONDERO, PATRICK BOYCE, AND WILLIAM L. BRITAIN TOCOUNTERCLAIM AND THIRD-PARTY PETITION OF PATRICK DAUGHERTY - Page - 48

DAL:835555.\

From:Sent:

SubJe-ct:

Ross,

Pat DaughertyFridaY, 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 thenews that you are not interested in moving forv1ard with Highland as a manager primarily be(:<:luse of me. I accept yourdecision and apologize for any unintended offense I may have conveyed in our discussions. Frankly, I do have atendency to be grllff at times and I can understand how it Cal1 be off··putting. I just wanted to let you know that I neverintended to offend you and I very much appreciate the time that you spent evaluating us in the first place. ! do regret that Ihave undone the. hard work of so many people at Highland who reaily wanted to earn your business, Highland is indeed atough culture but it isa good group of people are committed to each other and their clients. To the extent you areinterested, 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 daysover the last 10 years wr1ere thought it wasn't right for .rne. That said, Highland has provided enormousopportunity for people to excel beyond their Wildest dreams and be rewarded for performance on a pure meritbasis. That was particularly meaningfUl for someone like me, because as a yOLlng man I felt like I couldaccomplish great things if someone would just give me a chance. Jim Qqve me that chance and many others whohave 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 comfortablebeing anonymous ina crowd that having th8< brig ht fights cast upon 111m. He was raised to pick up pennies andbecause of that, treats our LPs money as if it were his own,< But many people ,~on't know he is one of the mostgenerous and charitablepeople on the planet He'd bevery annoyed with me for saying this, but Jim truly caresabout the little guy Who is willing to work hard to increase his. lot in!ife. The fact is, Highland's culture is amanifestation of his desire to provide opportunity and advanc(3ment on merit, not on connection or pedigree. Idon'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 asdistressed investing is a VERY ugly business; with management teams \Nho try to loot the Companies, agentswhO try to s.elMeal, out-of-the-rnoney subord!natedinvestor.s who try to hold the estate for ransom andlawyersfprofessionals who try to feed off of the carcass. Also, distressed brings out the worst in people because itboils down toa fight for survival. It is often a zero sum game. I don't remember what issue! was dealing beforeour call but I have been very bl)Sy evaluating one distressed crisis after the other and I see that trend continuingfor the next few years. This is not an excuse. I'm just trying to give you some context for what I was working thruprior to our call. The down side is that I am not always able to quickly shift into client service mode and in thecase 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 orworse, 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 areforgivable so long as they are not repeated. I have lost very few people on my team over the last 10 ~ years. Allof my employees know that I will give them a fair chance to succeed. I have developed and promoted severalmembers of my team to areas of leadership in the firm. They <;!Iso know that I might be tough on them at timesbut irs because I beUeve in them and j INant them to fUifiiJ their potential. I do not aHow them to shOrt-changethemselves 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 amanager.

'" As you know, John Honis and I co-manage our private equity effort John is one of my best friends, but wemuch have a brotherly relationship (that includes the good and the bad). We have gone {i'!r:! f!'!)!!'T"!>!:!!'!"!;!"'.:!!!!;

1

CONFIDENTIAL

togetherIt 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 getemotionaL However, I have 0hormous respect fOf ,Jor'ln and! know he \//illstand up for what he believes in, as will1. I think this creates a healthy check and balance \;vithin the organization and ultimately our investors benefit fromthe 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 andHighi.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 untouchableafter that stunt but .. asked Jim iJ he vI''OLlld give a kid who made a stuoid mistake another chance todear his name. Jim agreed to hire. idespite the risk to the firm becauseof the ,very negative doud thatfolto\lved / I think fhat speaks volumes about the good hearts of Jim . (was a challenge tomanage. I inherited after another Team Leader . . had determined that hecouldn't work with him. The thouqrlt was that my tough love style of management might be better suited toworking with a personality like That fact is, he was probably the smartest kid 1had in my group, but hewas very lazy, prone to misreoresent facts and sometimes failed to follow commands. That notWithstandinG Itried 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 inliquidation or are in sever Financial duress to this day. In December of 2007, the Team Leader's voted to assignthe ,'effort to another Portfolio Manager and was reassigned back to my team. Theperformance for his portfolio caused him to be ranked at the bottom of his peer group which meant Waspassed over for promotion to Team Leader for the second year in a row. was not happy with his ranking orhis compensation package. One 8gain, ,Jim tried to do the right thing by allowing to receive certain mid-year 2.008 incremental bonuses if he cou~d deliver on the recovery assumptions he represented to the valuaHoncommittee That never happened and about two months into 2008, resiflned and joined the former founderof

I do not give you these details to absolve iTly conduct. You were right to be offended and! do apologize. I'm not askingand I do not expect YClu to change your mind, I just don't want my conductand the comments of a disgruntled formeremployee to leave yOll with a bad impression of a firm that some 260 people work exceptionally hard at making the bestmoney manager in the business. These truly are great people who work together and believe in the firm's mission tomaxin"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 aredifferentiated such that I could at least be of assistance in helping you evaluate other managers. I think we will have ourflr.5t fund invested by the eild of next year and who l~nows. maybe over time I can prove my sincerity and that ofHighland'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 veryappreciative of the opportunities and experiences that you and the firm have afforded meover the last 10 Y:z years. I do view you as a great leader and friend, but also as a goodman. However, I've come to a point in my life where it is necessary for me to makesome changes. As I told you in Febmary during compensation review, I think theHighland compensation plan no longer works for me given my age, contributions andexperience. In addition, I feel that it is time, and that I have earned the right to diversifysome 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 revisedcompensation plan that would be mutually agreeable to us both. The reality is that therehas been no dialogue with me on the subject other than to say things will get better nextyear. That's fine and I am truly not offended but its time for the issue to be addressednow 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 thefirst half of the year. Now that things have stabilized, I think it is appropriate that wedeal with these issues. Importantly, I have no offer away and indeed, I have neverinterviewed during my entire 10 Y:z year career in Highland. I have had several inquirieslately but I've not engaged them for fear 0 f setting off rumors on the street that coulddamage Highland. In fact, I am only copying Kevin Latimer on this Resignation becauseI fear there are too many other people that might leak the infollnation before you areready to address it. In that regard, I am willing to maintain an affiliation with Highlandpast my 30 day Resignation period so that you can address the matter in whateverstrategic manner you choose. Obviously, we would need to agree to modify the terms ofthe current Plan and LTIP treatments in return for that transition period. Importantly, Iam not negotiable on the 30 day payout of my STIP (Option-it) interest post my effectiveresignation date.

Perhaps most impOliantly, I am willing to stay assuming we come to written agreementon my compensation terms within the Resignation notice period (next 30 days). Mycritical needs include:

I) A significant cash payment as partial monetization of either my LTIP or STIPinterests

2) A significant increase in my partnership stake which will carry similar rightsas Founder shares as opposed to my Clm-ent Non-founder shares (obviouslywith 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 Timekeeperbut will be able to count ALL hours worked away from Highland offices withthe 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 amlogged out of Timekeeper.

5) A clear understanding that I will work for you and no one else for as long as Iwork at the finn.

6) Clear description ofmy role, responsibilities that can't be changed withoutseeking my agreement or giving me cause to tenninate my employmentwithout penalty.

I really don't think I'm taking you to the woodshed on these requests. It's simplecommon sense and it's fair. I fully acknowledge and agree that there can only be oneperson to decide what is best for the finn and that person is you. There is no one I'drather follow than you. That said, I need to take some of my money out of the equationin order to feel comfortable with decisions that I may not agree with out of risk appetitedifferences or otherwise. Frankly, I owe that to my family. I can put up with the Jackand Okada clown act or anything else so long as I have a safe nest egg and adequateupside.

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 justifywhat 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 thatis just nonsense. You have very good young people and it's just a matter of making themstep up. Lane, Winston, Martinson, Winston, Lee, Dave, Tom, Ledderer and Clay are alldoing great things. Ultimately, it boils down to cost versus benefit and you are in the bestposition to make that call.

I guess I'm telling you that at age 41, I'm not willing to follow the same paradigm thatworked for me at 31. I have kids, a family, responsibilities and the wear and tear of lifethat cause me to view Highland and what I want out of life differently. I will always beappreciative for the opportunity and confidence you bestowed upon me. I assure you thatI will reward your faith with loyalty and respect even after I have no economic incentiveto do so.

Sincerely,

Patrick H. Daugherty

CONFIDENTIAL

Date: 9/28/11To: Jim Dondero

I very much appreciate the opportunity to have worked with you and at Highland for thelast 13 Yz years. After careful and deliberate consideration, I have decided to move on tothe next chapter in my life and am giving my 30 notice of resignation effective today. Iwish 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

2011Highland 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%Over/(Under) Performance 11.01%

DAL:835543.1

CONFIDENTIAL

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