Minority Investor Not `Controller’ in Hotel’s Merger: Del. Court

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By Leslie A. Pappas

A group of minority investors’ preferred shares in the Morgans Hotel Group Co. didn’t create a fiduciary duty to other shareholders during the company’s $805 million merger with SBEEG Holdings LLC, a Delaware judge ruled.

The Delaware Chancery Court’s Oct. 24 ruling clarifies the extent to which minority shareholders can become “controllers” that owe fiduciary duties to other investors ( In re Morgans Hotel Group Co. Stockholder Litig. , Del. Ch., No. 12433-VCL, 10/24/17 ).

Former Morgans shareholders claimed in their lawsuit that The Yucaipa Cos., its founder Ron Burkle and five company affiliates breached their fiduciary duties by extracting benefits from the deal, to the detriment of other investors.

Vice Chancellor J. Travis Laster dismissed the case, rejecting the plaintiffs’ argument that the Yucaipa defendants became a controller of Morgans when they invested $75 million in the hotel chain. The judge rejected the argument that a minority shareholder can effectively control a company through certain blocking or veto rights attached to preferred securities.

“The Complaint does not support a reasonable inference that the Yucaipa Defendants were fiduciaries during the period leading up to the merger,” Laster wrote.

Morgans’ acquisition by SBEEG, a privately held Los Angeles-based company that runs boutique lifestyle hotels, closed Dec. 1, 2016.

As part of investments it made in the hotel chain in 2009, The Yucaipa Cos. acquired 75,000 shares of Morgans’ Series A preferred stock, giving Yucaipa consent rights over company mergers, acquisitions, and consolidations.

Majority Interest

Under Delaware law, a stockholder will be treated as a controller that owes fiduciary duties if it owns a majority interest in the corporation, Laster wrote. The Yucaipa defendants didn’t own a majority of Morgans’ common stock; in fact, Burkle owned just 22,367 shares, representing only .00064 percent of the shares outstanding, the judge said.

“The plaintiffs were trying to expand the universe of people or parties who owe fiduciary duties,” Yucaipa’s attorney, Andy Stern of Sidley Austin LLP in New York, told Bloomberg Law Oct. 25.

The plaintiffs argued that the Yucaipa defendants’ consent over the merger transaction made them a controller with fiduciary responsibility to the common stockholder, Stern said.

“Our position with the court was that we were a preferred stockholder,” Stern said. “We weren’t negotiating for the common stockholders, that’s what the board was doing. We were just negotiating for ourselves.”

The decision is good for other investors with consent rights, he said. “Had it gone the other way, we think that any preferred stockholder, any venture capital investor who had consent rights could have been subject to fiduciary duties, which would have vastly changed the market for that kind of investment.”

Phone calls and messages Oct. 25 with attorneys representing the plaintiffs weren’t immediately returned.

To contact the reporter on this story: Leslie A. Pappas in Philadelphia at LPappas@bna.com

To contact the editor responsible for this story: Yin Wilczek at ywilczek@bna.com

For More Information

The decision is at http://src.bna.com/tGV

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