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John Cumming v. Wesley R. Edens, et al., C.A. No. 13007-VCS (Del. Ch. Feb. 20, 2018) (Slights, V.C.)

February 20, 2018

In this memorandum opinion, the Court of Chancery denied Defendants’ motion to dismiss derivative Plaintiff John Cumming’s (“Plaintiff”) derivative complaint for breach of fiduciary duty, finding that Plaintiff met the test for demand futility and had stated a viable claim for breach of fiduciary duty under the applicable entire fairness standard of review. 

Plaintiff was a stockholder in Nominal Defendant New Senior Investment Group, Inc. (“New Senior”).  New Senior is a publicly traded real estate investment trust that owns a portfolio of senior housing complexes.  The challenged transaction at issue consisted of three separate parts, each of which Plaintiff alleged was detrimental to New Senior.  First, the overarching transaction was New Senior’s acquisition of a portfolio of properties (the “Holiday Portfolio”) from Defendant Holiday Acquisition Holdings LLC (“Holiday”) at an allegedly unfair price (the “Acquisition”). Second, New Senior financed the Acquisition (in part) through an equity offering that allegedly favored Defendant Fortress Investment Group, LLC (“Fortress”), which owned Holiday, to the detriment of New Senior.  And third, New Senior entered into a property management agreement with Holiday to manage the Holiday Portfolio at allegedly higher-than-market rates (collectively the “Challenged Transactions”).  Plaintiff filed a derivative complaint on behalf of New Senior, and Defendants moved to dismiss for failure to adequately plead demand futility and for failure to state a claim (the “Motion to Dismiss”).  The Court denied the Motion to Dismiss in its entirety.

The Court first analyzed whether Plaintiff had adequately alleged demand futility.  The Court found that Plaintiff had met both of the prongs of the test for demand futility set forth in Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984).  But because only one prong need be satisfied, the Court limited its analysis to the first prong in the Aronson test:  namely that the complaint must raise a reasonable doubt that a majority of the directors could have independently evaluated a demand.  The Court found that only one of New Senior’s seven person board was independent with respect to the Challenged Transactions.  The six board members the Court found lacked independence consisted of the founder of Fortress, a Fortress employee who acted as New Senior’s lead negotiator with Fortress on the Acquisition, an employee of the bank that was financing the Acquisition, and two close, personal friends of the Fortress CEO, one of whom worked for a non-profit partially funded by the CEO (collectively, the “Board Defendants”).

Having determined that Plaintiff had demonstrated demand futility, the Court then analyzed whether Plaintiff had stated a viable claim for breach of fiduciary duty.  Plaintiff alleged that the Board Defendants caused New Senior to pay Fortress more than was reasonable for the Holiday Portfolio at the expense of New Senior and its stockholders.  The Court found that these allegations were sufficient to state a claim for breach of the duty of loyalty.  Next, the Court analyzed the applicable standard of review.  Defendants first argued that the business judgement rule should apply because the Challenged Transactions fit within the safe harbor provision codified in 8 Del. C. § 144(a)(1).  The Court found that compliance with Section 144(a)(1) does not necessarily invoke business judgment review of an interested transaction because common law principles requiring a majority of disinterested directors approve the transaction must still be considered.  Under a common-law analysis, the Court found that a majority of the Board was interested in the Challenged Transactions or otherwise not independent sufficient to justify business judgement review.  The Court explained that the test for director independence in analyzing a loyalty breach is generally the same as the test under the first prong of Aronson, which the Court already determined Plaintiff had satisfied.  Accordingly, those same allegations were found by the Court to state a claim for breach of the duty of loyalty.  As a result, the entire fairness standard of review applied.  Lastly, the Court determined that the Company’s exculpatory provision in its charter did not extinguish Plaintiff’s claims because only monetary liability for duty of care claims, but not loyalty claims, are extinguished by a 102(b)(7) exculpatory provision.

Finally, the Court determined that Plaintiff had adequately pled claims for aiding and abetting against Fortress, Holiday, and their related defendant entities.  The Court found that Plaintiff had adequately pled the requisite scienter as to each because Fortress-affiliated directors on New Senior’s board alone set the terms of the property management agreement with Holiday.  The close relationship between Fortress and its affiliated defendant entities was such that scienter could be imputed to each.

The full opinion is available here