OTK Associates, LLC v. Friedman, et. al., C.A. No. 8447-VCL

By David Bernstein

On February 5, Vice Chancellor Laster issued an opinion regarding the Morgans Hotel Group case. OTK Associates, LLC, directly and derivatively on behalf of Morgans Hotel Group Co., alleged that the Board of Directors of Morgans had breached its fiduciary duties and violated Morgan’s operating documents in connection with a two-part recapitalization transaction with Yucaipa Companies, LLC that VC Laster had previously enjoined. The defendants argued that because the Yucaipa Transaction was not consummated and the related Board actions were blocked by a preliminary injunction, any claims based on these facts would be moot. Citing a Delaware Supreme Court decision, VC Laster said that even though the Yucaipa transactions did not take place, Morgans could have been injured by the breaches of fiduciary duty, such as by incurring uneccessary expenses, and therefore denied the motion to dismiss based on mootness.

The defendants also said the case should be dismissed because between the time the case was originally brought and the time OTK filed an amended complaint, new directors had been elected, and the plaintiff had failed to make a demand upon them as required by Delaware Rule 23.1. VC Laster said that almost all the claims in the amended complaint related to the same facts that were the subject of the original complaint, and because demand would have been futile at the time of the original complaint, there was no need to make a demand on the new Board to assert claims regarding the facts that were the subject of the original complaint, even if the amended complaint raised new theories of liability. He did dismiss a claim based on a subsequent Yucaipa repudiation of the agreements relating to the transactions, because that did not happen until after the original complaint had been filed, and demand on the Board was required with regard to a claim based on new facts.

The principal issue raised by the defendants was an assertion that there was an action pending in the New York courts and, because the transaction documents said they were governed by New York law, the Delaware courts should defer to the New York courts. VC Laster said that the Delaware courts would have honored the choice of law provision if the suit had involved the contract. However, the suit involved claimed breaches of fiduciary duty regarding the way the contract was approved, not the contract itself, and therefore, under the internal affairs doctrine, would be governed by Delaware law. Therefore, he refused to stay the Delaware proceeding. Finally, the Court refused to dismiss claims against two individual directors despite the fact that the Morgans Certificate of Incorporation contained an exculpation clause of the type permitted by Section 102(b)(7) of the General Corporation Law, because the claims raised in the complaint alleged breaches of the directors’ duties of loyalty, which cannot be protected under Section 102(b)(7).

OTK v Friedman

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