OTK Associates, LLC v. Robert Friedman, et al., C.A. 8447-VCL (Del. Ch. Feb. 5, 2014) (Laster, V.C.)
In this opinion, the Court of Chancery denied in substantial part motions to dismiss claims arising out of a since-abandoned restructuring transaction between Morgans Hotel Group Co. and its largest investor, Yucaipa Companies, LLC. Drawing the facts solely from the allegations of the complaint and giving the plaintiff the benefit of all reasonable inferences, the Court held that plaintiff OTK Associates, LLC, which had recently prevailed in a proxy contest electing its own slate of directors to the Morgans board, had stated viable claims for declaratory relief and damages.
Morgans Hotel Group Co. (“Morgans” or the “Company”) is a Delaware corporation that owns and operates boutique hotels, including the Delano Hotel in Miami Beach and The Light Group, which develops and operates venues in Las Vegas. The complaint alleged, and the Court accepted as true for purposes of the pending motions, that affiliates of Yucaipa Companies, LLC exercised “effective control” over Morgans through ownership of debt and equity, as well as contractual rights and board representation. Yucaipa is controlled by Ronald Burkle.
In late 2011, Morgans began considering a restructuring of Yucaipa’s investment and formed a special committee to consider a potential transaction. By February 2012, negotiations had reached an impasse, and Morgans began to consider alternative transactions, including a rights offering not involving Yucaipa and the sale of the Delano Hotel. After learning of this development in June 2012, allegedly from a member of the special committee, Yucaipa objected, threatened litigation, and proposed a transaction in which Yucaipa would acquire the Delano Hotel, The Light Group, and the Delano brand in exchange for Yucaipa’s holdings in Morgans. In August 2012, Yucaipa amended its proposal by offering to backstop a $100 million rights offering at a 26% premium to the Company’s then-current stock price. The complaint alleged that Yucaipa’s financial advisor believed that few stockholders would be likely to participate in a premium-priced rights offering, and that Yucaipa would emerge with 35% of the Company’s common stock. In September 2012, the special committee recommended that Morgans move forward with the Yucaipa proposal.
In February 2013, Morgans announced that it would hold its annual meeting on May 15 and that the record date for the meeting would be March 22. On March 15, OTK Associates, LLC (“OTK”), which owned 13.9% of the Company’s common stock, announced that it intended to nominate a competing slate of directors. On March 19, Jason Kalisman, a member of the special committee and OTK’s designee on the Morgans board of directors, told the other special committee members that he did not believe the directors could support the Yucaipa transaction in compliance with their fiduciary duties, and asked to be informed immediately whether formal approval of the transaction was imminent. The complaint alleged that, during the ensuing weeks, Yucaipa and Morgans prepared to sign the final transaction documents and that Kalisman was not advised of these developments, despite his requests.
On Friday, March 29, the board and special committee received notice of, and materials for, meetings of the special committee and the board of directors scheduled for the following day (the Saturday before Easter Sunday) to consider approval of the Yucaipa transaction. Kalisman attended the special committee and board meetings the following day, but objected to both on the ground that he was not provided sufficient notice or time to review the written materials relating to the proposed transaction.
At the March 30 special committee meeting, the special committee voted to form a subcommittee consisting of all the special committee members other than Kalisman. The subcommittee met immediately thereafter and voted unanimously to recommend the Yucaipa transaction, which was thereafter approved by the board. The board also voted to postpone the annual meeting from May 15 to July 10 and reset the record date from March 22 to May 29, which would allow stockholders who acquired stock in the $100 million Yucaipa-backed rights offering to vote those shares at the annual meeting. The board also voted to exempt Yucaipa from Section 203 of the DGCL and to approve an amendment to the Company’s stockholder rights plan that would permit Yucaipa to acquire up to 32% of the Company’s common stock. Other stockholders, including OTK, remained subject to Section 203 and to the rights plan’s 15% ownership threshold. Because OTK already owned 13.9% of the Company’s stock, it would not be able to fully participate in the rights offering.
On April 1, 2013, Kalisman, in his capacity as a director, filed a derivative complaint in the Court of Chancery seeking a temporary restraining order and preliminary injunction. The Court granted OTK’s motion to intervene on April 4. On April 9, Morgans announced that it had voluntarily rescheduled the rights offering to close after the record date for the annual meeting, mooting Kalisman’s TRO application. On May 14, the Court entered a preliminary injunction enjoining Morgans from implementing any of the board resolutions passed on March 30, which prohibited consummation of the Yucaipa transaction until the full committee and board considered the matter at properly noticed meetings and also had the effect of restoring the annual meeting date to May 15 with a record date of March 22. The May 15 meeting was convened and adjourned to June 14.
On May 16, Yucaipa informed the Morgans board that, in light of the Court’s May 14 decision, there was not yet an agreed-upon transaction and that Yucaipa was imposing a new condition to the deal: that the Company offer to allow OTK the option to join Yucaipa in backing the rights offering, but limit OTK to 32% of the Company’s common stock. Thereafter, neither the special committee nor the board met to consider and approve the Yucaipa transaction, and at the June 14 annual meeting, the Company’s stockholders elected OTK’s full slate of directors.
On June 27, Yucaipa filed suit in New York against Morgans seeking monetary damages, including a $9 million break-up fee, for breach of the Yucaipa transaction agreements. On July 9, OTK filed an amended complaint in the Court of Chancery asserting nine counts. Counts I – VIII sought declarations that the Yucaipa transaction was the product of breaches of fiduciary duty and violated the Company’s bylaws and the special committee charter. Count IX sought a declaration that the Yucaipa transaction agreements are invalid and unenforceable.
The defendants moved to dismiss Counts I – VIII as moot on the grounds that the Yucaipa transaction had been abandoned. The Court denied this motion, finding that Counts I - VIII were not moot because the defendants could potentially be liable for damages, including fees and expenses incurred by Morgans in connection with the since-abandoned Yucaipa transaction.
The Yucaipa-affiliated defendants also moved to dismiss Count IX, which asserted a derivative claim on behalf of Morgans, on the grounds that the plaintiff was required but failed to make pre-suit demand on the Morgans board. The plaintiff argued that demand on the board would have been futile and was therefore excused. The question of demand excusal turned on the identity of the operative Morgans board for purposes of evaluating whether demand would have been futile. The Court held that if the claims in Count IX were sufficiently related to the facts alleged in the original Kalisman complaint, then the operative board would be the board in place at the time the original Kalisman complaint was filed, and demand would be excused as futile. If, however, the claims in Count IX were based on new facts not raised in the first complaint, then the operative board would be the newly-elected board in place at the time OTK filed the amended complaint, and demand would not be excused. The Court found that one of the two grounds for relief in Count IX—that the transaction agreements were unenforceable as a result of fiduciary duty breaches—was sufficiently related to the facts of the original complaint. The other ground—that Yucaipa had repudiated the transaction agreements following the Court’s May 14 preliminary injunction—was based on facts that occurred after the first complaint was filed. Because the amended complaint failed to raise a reasonable doubt that the newly-elected board could have properly exercised independent and disinterested business judgment in responding to a demand, the Court granted the motion to dismiss Count IX as to the latter ground only.
The Yucaipa defendants also moved to dismiss or stay Count IX in light of a provision in one of the transaction agreements between Yucaipa and Morgans selecting courts in New York as the exclusive forum for disputes arising out of or relating to that agreement. The Court denied the motion to dismiss or stay on this ground, finding that the fiduciary duty-based challenge to the Yucaipa transaction was governed by Delaware law and did not arise out of or relate to the agreement that contained the choice of forum provision. The Court also declined to stay Count IX in favor of the action Yucaipa had filed in New York, finding that (i) the Delaware action was first-filed because it relates back to the original Kalisman complaint and (ii) litigation in Delaware would not impose an “overwhelming hardship” on defendants, as would be required to upset plaintiff’s choice of forum where a Delaware action is first-filed.
Finally, the Court declined to dismiss the claims against two of the individual defendants on the grounds that they would be exculpated from monetary damages arising out of any breach of fiduciary duty they may have committed by reason of a Section 102(b)(7) exculpatory provision in the Company’s certificate of incorporation. The Court found that the complaint adequately challenged the disinterestedness and independence of a majority of the board and special committee and rebutted the presumptions of the business judgment rule, making entire fairness the operative standard of review. With respect to Michael Malone, who was a member of the special committee, the Court noted that the complaint included allegations that Malone misled Kalisman regarding the status of the Yucaipa transaction, and found that the complaint supported a pleadings-stage inference that he was acting for a reason other than the best interest of Morgans and its stockholders. The Court likewise found that the allegations of the complaint supported a pleadings-stage inference that Jeffrey Gault, a board member who was alleged to have substantial ties to Ronald Burkle and Yucaipa, breached his duty of loyalty. The Court therefore concluded that it was possible that both Malone and Gault could be found after trial to have committed breaches of fiduciary duty for which exculpation under the Company’s Section 102(b)(7) provision was not available.