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Keep Chip in your toasts, and prayers!


Blackheart

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There's no telling what's happening to Chip. He's a leader in the industry and a valuable friend to us all.

Fingers crossed that this works itself out to his satisfaction.

http://whiskyadvocate.com/whisky/2014/09/11/the-balcones-controversy/?utm_source=SilverpopMailing&utm_medium=email&utm_campaign=ShankenNewsDaily9-15-14%20(1)

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The same thing happened to us almost. We were approached by a Venture Capital firm.

A few of our larger investors were actually interested at first and entertained negotiations with them. However we had several minority investors dead set against the idea and raised all of the red flags. Luckily these minority investors within our company made a great case for not doing any deal with the Venture Capital firm.

During the meetings, the people from the VC firm flat out said that minority investors typically get screwed eventually, either through dilution or convertible debt or a buyout at less than favorable terms for minority shareholders. The VC firm basically shot themselves in the foot by confirming exactly what our minority shareholders were warning about.

Red Flags to be aware of:

1) If they offer to provide debt financing, be very nervous. Often this is a strategy to gain 100% control by having repayment terms that you are likely to fail to meet at some point in the future. Then they will leverage that into much worse. For example, they will later offer to convert their debt to shares at a VERY heavy dilution ratio (really low share price).

2) No matter what, be nervous if anyone outside wants to buy anywhere above 30% voting in your company. That is a dangerous amount to have from any outside potentially hostile group. We have informally set a maximum of 10% for any new shareholder to acquire within our company.

3) Avoid any sort of "drag along" provisions for the VC. If they insist on a "drag along" provision in the shareholder agreement, that means that when they sell their shares to another company (private equity, major spirits company, etc) then all of the minority shareholders also have to accept whatever the VC negotiates.

4) Quite often VC's will have provisions in their purchase agreement that force the sale of the company in a certain time frame. Many VC funds operate on a 5 year or 10 year time frame. Then they return capital to their fund shareholders. That forces them to liquidate all of their portfolio companies (including your distillery) regardless of whether it is really a good time to do so.

5) If the company is sold at a loss or less than a certain profit for the VC, often they have provisions in the agreement where the VC gets paid first. I have read stories where the VC is guaranteed a 100% return on their investment minimum and no other shareholders get anything unless the VC gets their money first.

Moral of the story.... don't take VC money if there is any way you can avoid it. They are sharks and mostly interested in financial engineering. They are not necessarily interested in building a long term company and they certainly are not concerned about your future plans.

From reading the article, it sounds like Chip Tate and his original investor group allowed a new investor, Greg Allen, to acquire majority voting control. So when they agreed to that deal, Chip Tate lost the right to keep calling the shots. He who has the gold makes the rules.

If Chip Tate wanted to remain in control, he should have done one of the follow:

1) slow down expansion so that they don't need as much money

2) use debt from a bank instead of equity

3) convert the founder's shares to a different class of Super Voting stock with 10 votes for every 1 share. That way you can maintain voting control even if you have less than 50%. That must be done BEFORE you bring on the new investors. Example: Mark Zuckerberg controls over 50% of Facebook voting stock and only owns around 22% of the shares. He has a different class of shares.

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5) If the company is sold at a loss or less than a certain profit for the VC, often they have provisions in the agreement where the VC gets paid first. I have read stories where the VC is guaranteed a 100% return on their investment minimum and no other shareholders get anything unless the VC gets their money first.

This is called "participating preferred" and it's often more than a 100% guarantee. For example, "3x participating preferred" means that the VC gets 3x their original investment; and they get paid before anyone else ("preferred") in the event of a sale. So, let's say the VC puts in $5M, and the company sells for $16M. The VC gets $15M and everyone else splits $1M.

Why do they put in such an apparently unfair provision? It's because they are investing with the intent to get a 10X or 100X return on investment. A 3X return is viewed as basically a wash, not as a success. If you take VC money, they want you to go big.

For anyone who is curious about how these kinds of deals work, I recommend the book "Venture Deals" (Feld, Mendelson) as a good overview of deal structures, terminology, and pitfalls.

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Jedd Haas made an excellent point. The VCs are looking for home runs and more than 10X return on investment. They will want you to grow grow grow and fast fast fast. Even to the point of being high risk and unhealthy. For every 10 companies in their portfolio, the VC fully expects that 7-8 will implode and be liquidated. That is part of their business model and they are fine with that.

But are you fine with your company imploding under that high risk strategy? You only have that one shot at a startup. For you to begin again from scratch is a major setback for you. For the VC it is just a line item on their list of companies that didn't make it. No big deal to them. It comes with the territory.

When we were talking with the VC firm that wanted 51% of our distillery, they said their strategy was to grow as fast as possible to $20 million in annual sales, then sell it off to a Private Equity firm for a huge profit. Really.... that was their proposal to us and they thought we would be fine with it. They insisted on voting control to move forward with the deal. We told them no thanks. After spending 3 months talking with them, we realized it was just a distraction and a waste of time. We have decided to not even entertain proposals any longer from VCs. We just tell them no thanks right away.

There are plenty of investors that are interested in only a small stake and remaining passive minority owners. We are more comfortable with that type of investor. It takes a bit longer to accumulate $500,000 in fresh capital doing it that way, but it is far safer in terms of the founders keeping control.

I suspect Chip Tate wanted to grow faster and took the risk of one big investor that could quickly write a large check. That is a very seductive situation because it is quick and easy. But the risk is having one large and potentially hostile shareholder to deal with.

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I am waiting with baited breath to hear Chip's side of the story (when the gag order is lifted). Stories like this make me reflect how lucky we all are, everyone wants a piece of the pie- and on the rare occasion that there are crumbs left we might have a few for ourselves. We could all use some toasts and prayers....

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The most likely outcome is that they resolve their differences and everyone tries to pretend this never happened.

Even if the worst happens and Chip is kicked out, the company will likely try to buy his silence with a severance package that will include Chip not saying anything negative about the company.

The only way we will hear Chip Tate's side is if he flips everyone the middle finger, leaves and starts a new distillery and then rakes his former company over the coals.

Chip likely has enough connections where he could start over with a new distillery and negotiate better terms for himself with new investors. Based on his recent experience, Chip likely knows what not to do now.

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It looks like Chip Tate has responded. This article is new today. If this is accurate, this is exactly how the vultures operate. Once they had voting control, the new investors started trying to do financial engineering with $15 million in debt (likely convertible to shares) in very favorable terms. The new investors would likely have purchased the sweetheart debt deal themselves, thereby also becoming the creditor of the distillery.

http://whisky-file.com/2014/09/16/chip-tate-says-balcones-board-tried-to-force-him-out-in-court-filing-denying-allegations-against-him/

Balcones founder Chip Tate denied the charges pitted against him by the board of his company and alleged that the investors tried to orchestrate a hostile takeover of his share of the company, according to a court filing submitted Friday and posted Tuesday to the web by Whisky Cast.

In the filing, Tate denies saying he would shoot Balcones board Chairman Greg Allen or burn the distillery down, as alleged in the civil lawsuit filed earlier this month by the board. Instead, Tate says the owners tried to wrench away his share of the company through actions taken at meetings held without him. If true, those actions would violate the company’s bylaws, which require Tate’s presence for a quorum.

“This is not an employee dispute,” the filing reads. “Quite the contrary this is an attempt to purloin the plump ripe peach that is Balcones from the founder Chip, who built it with his own two hands from scratch. This is a private equity group trying to unjustifiably take advantage of a craft distiller and take his ownership in Balcones.”

The filing says that the board authorized an internal offering, which Tate opposed, of $15 million in debt that would have diluted Tate’s ownership of the company from 27 percent to less than 10 percent. Taking such action without Tate’s consent violated the company agreement, according to the filing.

The document says that Tate was not suspended, as alleged by the board, but rather terminated after talks between Tate and Allen over buying each other out of the company broke down. According to the filing, Allen “barged, unannounced and without warning, into a meeting (literally throwing open the door and stopping the meeting) Chip was having with a corn supplier at Balcones on August 5, 2014. As Chip tried to diffuse the situation created by Allen, it was revealed to Chip that two sheriff’s deputies were waiting outside with instructions to remove Chip from the Balcones premises.”

Following that, the document says, Tate received a letter of suspension and was then served with a lawsuit.

“It is absurd to call this anything other than a termination,” the filing says.

The document denies that the board has the power to suspend Tate because Tate’s presence is needed for a quorum and he did not attend the meeting at which the board voted to suspend him.

A hearing in the case is scheduled for Thursday.

The full court response by Chip Tate is VERY entertaining. It reads like a novel. Very easy to read even for non-lawyers.

http://whiskycast.com/files/BalconesLawsuit_TateResponse.pdf

Based on what has been written in the original filing by Greg Allen's group and the response by Chip Tate, I have difficulty seeing how both sides get back together and work successfully. Someone is going to likely have to buyout the other side.

Maybe Chip can find a white knight investor that will offer to buyout the Greg Allen group. That seems like the best scenario.

I don't think it makes sense for Greg Allen and his investors to buyout Chip Tate. This has already gone too public for them to pretend that this is a friendly parting. If Chip is kicked out, it will be a scorched earth separation and it will likely cause a lot of damage to the brand. Just my opinion.

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It is very sad to hear about this happening to someone like Chip. I have only had the chance to meet him in passing and to attend a taste/nosing class he ran in Louisville a couple of years ago. He has a great head for producing top notch spirits. I hope he finds a way out that keeps him in the business.

That being said, I had big plans to build a destination distillery in Minnesota and I have worked for two years to get to a place where I could do it. I have tried to go on loans with small investments from trusted friends/family and no one else. I have had my dream cut back in size twice after being told no one would lend me what I was asking for as a start up with no sales record. I'm down to a 1200sq/ft renovated existing pole shed and a system which can produce two barrels a week. I'm going to be working alone with one person doing some marketing and outreach for us. But after waiting and watching others in Minnesota get on the shelves first, my distillery is finally getting going. We are building out next month and ordering equipment soon. I have often heard the words Venture Capital from people I talk with and friends who say I could make it all happen pretty fast.

This story simply supports the answer I have always given them on why I will wait or build it from scratch. "I don't want anyone telling me what to do or how to do it, even worse trying to take it from me." While making a living is a big concern, My first concern is making a great whiskey people talk about, enjoy and share. Venture Capital doesn't give a crap about what people like me, who are makers at heart, want from this business.

My best to Chip Tate, I hope you find a way out that keeps your name and brands in tact, or if you have to start from ground up, know we are all pulling for you.

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It is very sad to hear about this happening to someone like Chip. I have only had the chance to meet him in passing and to attend a taste/nosing class he ran in Louisville a couple of years ago. He has a great head for producing top notch spirits. I hope he finds a way out that keeps him in the business.

That being said, I had big plans to build a destination distillery in Minnesota and I have worked for two years to get to a place where I could do it. I have tried to go on loans with small investments from trusted friends/family and no one else. I have had my dream cut back in size twice after being told no one would lend me what I was asking for as a start up with no sales record. I'm down to a 1200sq/ft renovated existing pole shed and a system which can produce two barrels a week. I'm going to be working alone with one person doing some marketing and outreach for us. But after waiting and watching others in Minnesota get on the shelves first, my distillery is finally getting going. We are building out next month and ordering equipment soon. I have often heard the words Venture Capital from people I talk with and friends who say I could make it all happen pretty fast.

This story simply supports the answer I have always given them on why I will wait or build it from scratch. "I don't want anyone telling me what to do or how to do it, even worse trying to take it from me." While making a living is a big concern, My first concern is making a great whiskey people talk about, enjoy and share. Venture Capital doesn't give a crap about what people like me, who are makers at heart, want from this business.

My best to Chip Tate, I hope you find a way out that keeps your name and brands in tact, or if you have to start from ground up, know we are all pulling for you.

You said it Rick.

It can be discouraging to see others start with more--but the pride of figuring it out how to do it all yourself and the reward of not having big loans or investors is worth it. Be proud you are starting with less because you are on the right path to living the American dream (vs living an VCs dream).

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My favorite part of his filed response-

"Its a neat trick not uncommon among bullies- assert a bunch of false and unfounded accusations to obtain injunctive relief that would arguably rob Chip of his Constitutional right to deny the allegations made public by the filing of the lawsuit. Somewhere, Vladimir Putin is smiling."

I will remember that line for some time.

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My favorite part of his filed response-

"Its a neat trick not uncommon among bullies- assert a bunch of false and unfounded accusations to obtain injunctive relief that would arguably rob Chip of his Constitutional right to deny the allegations made public by the filing of the lawsuit. Somewhere, Vladimir Putin is smiling."

I will remember that line for some time.

It is also quite common to abuse the legal system in the manner that Chip Tate has described. If Chip lacks the resources to respond in court, then Greg Allen's version of events would be accepted and enforced by court order. Hopefully Chip has the resources to defend himself in this situation.

I found Chip's response very credible. If the current employees, that were there that day, back up Chip's version of events, then I suspect Chip will ultimately win.

What I really find confusing is the ultimate strategy of Greg Allen and his investors. By adopting this scorched earth strategy, they are destroying the brand they invested in.

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If you are reading this Chip, all the best, I hope this has a good ending for you.

This thread is quite timely for me,

I just received an email yesterday with what appears to be a possible offer of mentoring assistance and finance.

Has anyone had dealings with www.distillventures.com

I have agreed to a phone conversation on Monday but would appreciate some feedback from anyone who has had dealings with them.

I suspect I am too small for them but I would like to see what they have to say.

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PeteB,

I would be extremely hesitant to do any deal with large venture money. That is what Distill Ventures seems to be. It looks like a Venture Capital group with heavy experience from Diageo, probably with Diageo money backing them.

Anyone who thinks they are going to go into negotiations with VCs and come out on top on the other end, well.... you are not. They have far more experience in negotiating and writing terms of any deal.

  • They will ask for preferred stock with special shareholder rights.
  • They will offer convertible debt that converts into shares at a crazy low price per share (massive dilution to your ownership percentage).
  • They will show you a plan where they expect you to grow at a crazy fast rate or implode trying.
  • They will be regularly involving themselves in your business. If you take their money, you will have to play by their rules.
  • They will want a significant ownership stake. 30% to 51% is common. Are you ready to lose control like Chip did?

They are fine with you failing. It is just another portfolio company to them. In fact, their model is for 80% of their companies to fail. Then they hit home runs with 10% to 20% of their companies.

Frankly, there are plenty of smaller investors willing to invest without wanting to takeover your business. It takes longer to raise money that way, but in the end it keeps all of the other investors in the single digit percentage ownership range. I would rather have 15 small investors each owning 2% rather than one large potentially hostile block of 30%.

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Thanks for the reply James.

After reading this thread I will certainly tread very cautiously. I have always worked for myself or in the family business and I am doubtful that I would accept an investment from a small investor, and even less likely from a big player.

I think it will be an interesting interview but I am more than 99% sure of my answer.

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  • 2 weeks later...

It looks like Chip removed his personal info from his company phone before returning it, so they found him in contempt of court. Frankly, I would have done the same thing Chip did. Your phone typically has a mix of personal and business email accounts and phone contacts. No way would I give that to them.

http://www.wacotrib.com/news/business/judge-rules-balcones-distilling-founder-in-contempt-of-court/article_5ff51a06-a2ce-5bfa-be91-6075e5eb6da8.html

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Yea, James, I agree that's pretty natural / justified, but god forbid if you're ever in a similar situation, don't do it!

Here is a good rule to live by: if you anticipate litigation, don't delete anything; doing so is "spoliation of evidence". This is an area where technology has left the law in the dust, and as a result a lot of people are doing things that are entirely reasonable to most of us, but seriously frowned on by the courts. For example, none of us would think twice about deleting family texts off our company phone before returning it. A fair minded person would have no problem concluding that personal texts from your spouse are not relevant. But the law doesn't trust you to do that ad hoc with possible litigation on the horizon.

Discovery used to be so much simpler when everything was on paper and in file cabinets. You knew you were doing something bad if you shredded those company records in the filing cabinet as a result of something going sideways. We don't feel the same way about every text message because invariably all those digital records don't have the same weight as our old paper files. All the time now across the country people are getting subpoenaed, being asked to turn over their entire laptop as part of a lawsuit - yikes!

Rule #1: write every text message and email in such a way that you would be comfortable with it being read back to you by opposing counsel in a courtroom. When that's not doable, call the person.

Rule #2: as soon as viable (it'll seem like a waste of money), get a dedicated company phone and computer. Then #1 starts to become doable; mind you #1 is still a good rule to live by for your personal phone and computer as well (just ask Governor McDonnell and his wife).

Rule #3: adopt an official Company Records Management policy, especially if you can't help yourself with Rule #1. The ABA website gives an example here. Basically what this policy does is apply some order to saving and deleting of files. So, for example, if can't bring yourself to give up forwarding chain letters or writing personal notes from the company computer/phone, then you should at least have a policy where those types of "records" get deleted on a scheduled basis. E.g., once or twice a year on pre-arranged dates you go through your inbox and sort things out that need to be saved and delete the rest. If it's done on an approved company schedule, courts are sympathetic - with the giant, huge caveat that if you sense litigation is on the horizon, you absolutely must stop deleting.

Anyway, best wishes for Chip, hang in there sir.

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Chip could also upgrade to iOS8, which is fully encrypted, prior to handing his phone in. Even the FBI is complaining that it is causing them problems.

Or you could just drop it in the toilet on accident. Then hand your phone in to technically meet the requirements of the court order.

After that, buy a new phone with your personal money. Once you restore a backup from iCloud (or whatever Android uses) it is now your personal phone 100%.

Having been involved in court cases personally, I can assure you that these things happen all the time.

I think Chip is going about this the wrong way. The court cannot silence him in this manner. If I were in his position, I would be appealing the judge's order. I would also file a counterclaim and seek to get an injunction halting the illegal decisions that the board of directors are making without Chip in the meetings. If Chip's info is correct, the board cannot take action without a quorum being present. Chip not attending denies them a quorum.

Chip needs to go on offense, not just sit back and take the bullets coming his direction. But that all depends on his personal resources. If Chip doesn't have the money to fight this legal battle, then he is likely going to get skinned alive in this process.

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James, encryption is great for protecting against unwanted intruders, but not against court subpoenas. If you hand it over encrypted, they'll just tell you to unlock it and take off the password. Refusing to cooperate in discovery or otherwise obstructing (by handing in a damaged device) is not a good choice. A court instruction directing a jury to make adverse inferences against you because you were responsible for missing records = you lose. There are serious fines and sanctions for spoilage.

If you have really embarrassing personal records on the device being subpoenaed that you really don't want the other party to see and aren't relevant to the litigation, you can petition the court to have a neutral third party vendor comb through your phone/computer to ensure only relevant docs are handed over. But that could be a lot more expensive for you than the initial investment of having a company-only device.

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James, encryption is great for protecting against unwanted intruders, but not against court subpoenas. If you hand it over encrypted, they'll just tell you to unlock it and take off the password. Refusing to cooperate in discovery or otherwise obstructing (by handing in a damaged device) is not a good choice. A court instruction directing a jury to make adverse inferences against you because you were responsible for missing records = you lose. There are serious fines and sanctions for spoilage.

If you have really embarrassing personal records on the device being subpoenaed that you really don't want the other party to see and aren't relevant to the litigation, you can petition the court to have a neutral third party vendor comb through your phone/computer to ensure only relevant docs are handed over. But that could be a lot more expensive for you than the initial investment of having a company-only device.

They are not in discovery. This was merely a court order as part of a TRO to return his phone and computer. There is no order for him to provide passwords or to provide access to the device. I would also enable the option where the device automatically wipes itself after 10 failed passcode attempts. Then you can just blame the other side that they did it themselves. The court will likely never be able to figure it out. And people forget their old passwords all of the time.

If it were me, for all intents the device would be useless for discovery if the case gets that far. Objecting to discovery every step of the way would be my strategy. I would go on offense against Greg Allen, I wouldn't be sitting back on defense all of the time.

This is all theoretical in terms of the root issue. Greg Allen and his investors are destroying the value of their investment with this strategy. They cannot keep Chip Tate silent forever without a settlement out of court and an agreement for non-disparagement.

There is no scenario where Chip just walks away quietly without any payoff. Chip has first amendment rights and will eventually be able to share his story with the media. When Chip does start talking, the value of the Balcones brand will crater. If Greg Allen and co want to salvage any part of their investment and preserve any value in the Balcones brand, then they need to figure out a graceful way to bring this back from the edge of the cliff they are on.

The scorched earth strategy on Chip Tate will just destroy the value of their brand. I am surprised they are moving ahead with the $15 million expansion with this cloud hanging over everything.

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My previous posts weren't aimed at Chip's current situation, just best practices for people running businesses. And yea, if you believe you have a legitimate cause to object to a discovery demand or order, definitely make it, or you'll lose your opportunity. If you bring it up later, the court will be less sympathetic.

There's no role for encryption-as-protection against civil litigation. If you're seen to be obstructing the litigation, you're putting yourself at a disadvantage. By all means vigorously protest discovery demands, but don't destroy records. And encrypting them won't get help you if the other party has a legitimate reason to see the records:

ENARGY POWER CO. LTD. et al. v. XIAOLONG WANG

However, to order Wang to disclose the password for those files encrypted on Enargy’s server allows both parties to continue to work on the projects while the parties litigate the ownership of the trade secrets. In other words, as the purpose of a preliminary injunction is to preserve the status quo, the most appropriate way to do so in this case is to allow both parties to have access to the project files during the pendency of the litigation. CMM Cable Rep., Inc. v. Ocean Coast Properties, Inc., 48 F.3d 618, 620 (1st Cir. 1995) (noting that “[t]he purpose of a preliminary injunction is to preserve the status quo, freezing an existing situation so as to permit the trial court, upon full adjudication of the case's merits, more effectively to remedy discerned wrongs”). In light of significant evidence in the record at least of joint ownership of these files, D. 8-1 ¶¶ 6-7; D. 17 ¶ 23 (demonstrating collaboration between Wang and Enargy), the Court cannot say that the harm Wang faces by disclosing the password is outweighed by Enargy’s legitimate interest in unfettered access to its server and the ability to compete with Wang during the pendency of the dispute.

http://www.gpo.gov/fdsys/pkg/USCOURTS-mad-1_13-cv-11348/pdf/USCOURTS-mad-1_13-cv-11348-0.pdf

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  • 2 weeks later...
  • 4 weeks later...

It looks like Chip Tate is winning in court. The judge ruled that Chip Tate is correct.

The new board of directors is not authorized to take the actions that have been occurring because there is not a quorum unless Chip Tate attends the meetings.

http://www.wacotrib.com/news/business/judge-sides-with-founder-in-ongoing-balcones-distilling-dispute/article_45a53799-90f2-589d-b04a-41aa2b7b3b90.html

“The most immediate effect of the judge’s ruling means that all the board actions that have taken place in August, September and October are all invalid because Chip didn’t participate in any of them,” Clouston said. “The long-term effect is we are still trying to figure this all out because, at the end of the day, it is becoming clear that one of these people (Tate or Allen) has to go.”

Tate last attended a board meeting in July, which was one of the complaints the board had with him.

According to the judge’s ruling, the board violated its own bylaws by suspending Tate, filing the lawsuit against him and in deciding the funding mechanism for the $15 million expansion.

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