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JD Holdings, L.L.C. v. Dowdy

Court of Chancery of Delaware

October 1, 2014

JD HOLDINGS, L.L.C., JONESBORO FUNDING LLC, and EASTGATE FUNDING LLC, Plaintiffs,
v.
JACQUELINE A. DOWDY, as Trustee of THE REVOCABLE TRUST OF JOHN Q. HAMMONS, DATED DECEMBER 28, 1989, AS AMENDED AND RESTATED; JACQUELINE A. DOWDY, as the Personal Representative of the JOHN Q. HAMMONS ESTATE; GREGGORY D. GROVES, as Trustee of THE REVOCABLE TRUST OF JOHN Q. HAMMONS, DATED DECEMBER 28, 1989, AS AMENDED AND RESTATED; THE REVOCABLE TRUST OF JOHN Q. HAMMONS, DATED DECEMBER 28, 1989, AS AMENDED AND RESTATED; HAMMONS OF NEW MEXICO, LLC; HAMMONS OF FRISCO, LLC; HAMMONS OF COLORADO, LLC; HAMMONS OF ARKANSAS, LLC; HAMMONS OF SOUTH CAROLINA, LLC; CITY CENTRE HOTEL CORPORATION; HAMMONS OF HUNTSVILLE, LLC; HAMMONS OF OKLAHOMA CITY, LLC; HAMMONS OF LINCOLN, LLC; HAMMONS OF FRANKLIN, LLC; HAMMONS OF RICHARDSON, LLC; RICHARDSON HAMMONS, LP; JOHN Q. HAMMONS CENTER, LLC; CHATEAU LAKE, LLC; JQH " EAST PEORIA DEVELOPMENT, LLC; JOHN Q. HAMMONS FALL 2006, LLC; JQH " FT. SMITH DEVELOPMENT, LLC; JQH " GLENDALE, AZ DEVELOPMENT, LLC; JQH " KANSAS CITY DEVELOPMENT, LLC; JQH " LA VISTA III, DEVELOPMENT, LLC; JQH " LA VISTA CONFERENCE CENTER DEVELOPMENT, LLC; JQH " MURFREESBORO, DEVELOPMENT, LLC; JQH " NORMAN DEVELOPMENT, LLC; JQH " NORMAL DEVELOPMENT, LLC; JQH " OKLAHOMA CITY BRICKTOWN DEVELOPMENT, LLC; JQH " ROGERS CONVENTION CENTER DEVELOPMENT, LLC; JQH " SAN MARCOS DEVELOPMENT, LLC; HAMMONS OF SOUIX FALLS, LLC; HAMMONS OF TULSA, LLC; JQH " LA VISTA CY DEVELOPMENT, LLC; JQH " ALLEN DEVELOPMENT, LLC; and JQH " CONCORD DEVELOPMENT, LLC, Defendants. JACQUELINE A. DOWDY, as Trustee of THE REVOCABLE TRUST OF JOHN Q. HAMMONS, DATED DECEMBER 28, 1989, AS AMENDED AND RESTATED; JACQUELINE A. DOWDY, as the Personal Representative of the JOHN Q. HAMMONS ESTATE; GREGGORY D. GROVES, as Trustee of THE REVOCABLE TRUST OF JOHN Q. HAMMONS, DATED DECEMBER 28, 1989, AS AMENDED AND RESTATED; THE REVOCABLE TRUST OF JOHN Q. HAMMONS, DATED DECEMBER 28, 1989, AS AMENDED AND RESTATED; HAMMONS OF NEW MEXICO, LLC; HAMMONS OF FRISCO, LLC; HAMMONS OF COLORADO, LLC; HAMMONS OF ARKANSAS, LLC; HAMMONS OF SOUTH CAROLINA, LLC; CITY CENTRE HOTEL CORPORATION; HAMMONS OF HUNTSVILLE, LLC; HAMMONS OF OKLAHOMA CITY, LLC; HAMMONS OF LINCOLN, LLC; HAMMONS OF FRANKLIN, LLC; HAMMONS OF RICHARDSON, LLC; RICHARDSON HAMMONS, LP; JOHN Q. HAMMONS CENTER, LLC; CHATEAU LAKE, LLC; JQH " EAST PEORIA DEVELOPMENT, LLC; JOHN Q. HAMMONS FALL 2006, LLC; JQH " FT. SMITH DEVELOPMENT, LLC; JQH " GLENDALE, AZ DEVELOPMENT, LLC; JQH " KANSAS CITY DEVELOPMENT, LLC; JQH " LA VISTA III, DEVELOPMENT, LLC; JQH " LA VISTA CONFERENCE CENTER DEVELOPMENT, LLC; JQH " MURFREESBORO, DEVELOPMENT, LLC; JQH " NORMAN DEVELOPMENT, LLC; JQH " NORMAL DEVELOPMENT, LLC; JQH " OKLAHOMA CITY BRICKTOWN DEVELOPMENT, LLC; JQH " ROGERS CONVENTION CENTER DEVELOPMENT, LLC; JQH " SAN MARCOS DEVELOPMENT, LLC; HAMMONS OF SOUIX FALLS, LLC; HAMMONS OF TULSA, LLC; JQH " LA VISTA CY DEVELOPMENT, LLC; JQH " ALLEN DEVELOPMENT, LLC; JQH " CONCORD DEVELOPMENT, LLC, Counterclaims Plaintiffs,
v.
JD HOLDINGS, L.L.C., Counterclaim Defendant, and ATRIUM HOTELS, LP., and ATRIUM GP, LLC, Third-Party Defendants.

Submitted: September 3, 2014

David J. Teklits, Kevin M. Coen, MORRIS, NICHOLS, ARSHT & TUNNEL LLP, Wilmington, Delaware; Scott A. Edelman, Alan J. Stone, Jed M. Schwartz, MILBANK, TWEED, HADLEY & McCLOY LLP, New York, New York; Attorneys for Plaintiffs JD Holdings, L.L.C., Jonesboro Funding, LLC, and Eastgate Funding, LLC, Counterclaim Defendant JD Holdings, L.L.C., and Third Party Defendants Atrium, Hotels, LP, and Atrium GP, LLC.

Shannon Larner Brainard, Richard R. Wier, Jr., MARSHALL DENNEHY WARNER COLEMAN & GOGGIN, Wilmington, Delaware; Janene Marasciullo, WILSON ELSER MOSKOWITZ EDELMAN & DICKER LLP, New York, New York; Attorneys for Defendants, Counterclaim Plaintiffs, and Third Party Plaintiffs Jacqueline A. Dowdy and Greggory D. Groves as Trustees of the Revocable Trust of John Q. Hammons, Dated December 28, 1989, As Amended and Restated.

Blake Rohrbacher, Thomas A. Beck, Susan M. Hannigan, RICHARDS, LAYTON & FINGERS, P.A., Wilmington, Delaware; C. Vincent Maloney, Jonathan R. Buck, Jade D. Lambert, PERKINS COEI LLP, Chicago, Illinois; Attorneys for All Defendants, Counterclaim Plaintiffs, and Third Party Plaintiffs Other Than Jacqueline A. Dowdy and Greggory D. Groves as Trustees of the Revocable Trust of John Q. Hammons, Dated December 28, 1989, As Amended and Restated.

MEMORANDUM OPINION

LASTER, Vice Chancellor.

In 2005, hotel-entrepreneur John Q. Hammons entered into a complex transaction involving a public company he controlled, various private entities that he also controlled, and a third party investor (the "2005 Transaction"). In the 2005 Transaction, the public stockholders received cash and Hammons received assorted consideration that included a short-term loan of $25 million, a long-term loan of $275 million, and a preferred equity interest in the privately held post-transaction entity. This structure allowed Hammons to exit from the public markets, obtain a degree of liquidity, and avoid a deemed sale that would trigger capital gains taxes.

Hammons's counterparties in the 2005 Transaction were entities affiliated with Jonathan Eilian. Eilian emerged with operational control of the post-transaction entity and ownership of all of its common equity. Eilian and Hammons also entered into an agreement that gave Eilian a right of first refusal and various other rights regarding hotels that Hammons had developed and owned through separate entities that were not part of the 2005 Transaction, or which the parties anticipated that Hammons would develop and own outside of the post-transaction entity after the 2005 Transaction closed (the "ROFR Agreement" or "RA").

The plaintiffs in this action are entities affiliated with Eilian. The defendants are predominantly entities that were affiliated with Hammons. The plaintiffs originally filed suit to resolve certain disputes over the ROFR Agreement. During the pendency of the case, Hammons passed away. The ROFR Agreement addresses the parties' obligations upon Hammons's death, but the parties could not agree on its requirements. The plaintiffs then amended their complaint to seek a determination that the ROFR Agreement imposes an affirmative obligation on Hammons's estate, a trust Hammons created, and the entities Hammons controlled to sell the hotels covered by the ROFR Agreement for cash within two years of Hammons death, subject to Eilian's right of first refusal. The defendants contend that the ROFR Agreement does not create any affirmative obligation to sell and, if it did, would be void under the rule against perpetuities. These are the principal claims; the parties have raised other issues and arguments.

The parties have cross-moved for judgment on the pleadings as to certain counts of the complaint and counterclaims. As to Count X of the Complaint, which seeks a declaration that the ROFR Agreement applies to property interests owned by three specific entities, the plaintiffs' motion for judgment on the pleadings is denied. As to the other counts at issue, judgment is granted in favor of the plaintiffs and against the defendants.

I. FACTUAL BACKGROUND

Because the parties have cross-moved for judgment on the pleadings, the facts are drawn from the operative pleadings and the documents incorporated by reference. When evaluating each movant's motion, the facts are viewed in the light most favorable to the non-movant. The background facts are largely undisputed, although the parties disagree about their implications.

Additional facts are drawn from decisions in prior litigation in this court. After the announcement of the 2005 Transaction, stockholder plaintiffs challenged the deal. They argued that Hammons breached his fiduciary duties as a controlling stockholder by structuring the 2005 Transaction to secure personal benefits for himself, and they contended that Eilian's acquiring entities aided and abetted Hammons's breaches of duty. Hammons was the principal defendant in that case, and Eilian participated actively. The litigation generated a summary judgment opinion, In re John Q. Hammons Hotels Inc. S'holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2, 2009) [hereinafter the "Summary Judgment Opinion" or "SJ Op." ], and a post-trial opinion, In re John Q. Hammons Hotels Inc. S'holder Litig., 2011 WL 227634 (Del. Ch. Jan. 14, 2011) [hereinafter the "Post-Trial Opinion" or "PT Op." ]. The Summary Judgment Opinion included a thorough discussion of the events leading up to the 2005 Transaction and its terms, and the Post-Trial Opinion incorporated that discussion by reference and adopted its contents as post-trial findings of fact. See id at *2 ("I will not repeat the extensive (and identical) factual background of the case, which has been thoroughly documented in [the Summary Judgment Opinion.] All of the factual details recited in my earlier opinion are fully adopted here.") (footnote omitted). This decision relies on the findings of fact made in the Post-Trial Opinion, although it cites to the Summary Judgment Opinion for the details of those findings.

A. Hammons And His Hotel Companies

In 1994, Hammons formed a Delaware corporation called John Q. Hammons Hotels, Inc. Because shares issued by this entity traded publicly, this decision refers to it as the "Public Hotel Company." It had two classes of common stock: Class A shares with one vote per share, and Class B shares with fifty votes per share. The Class A shares were issued to the public. The Class B shares were privately held. Through a revocable trust created by Hammons under a trust agreement dated December 28, 1989 (the "JQH Trust"), Hammons owned approximately 5% of the Class A shares and all of the Class B shares. These combined holdings gave Hammons control over nearly 76% of the Public Hotel Company's outstanding voting power. Hammons served as Chairman and CEO of the Public Hotel Company.

The Public Hotel Company used the proceeds of its initial public offering to purchase a 28% general partner interest in a privately held Delaware limited partnership called John Q. Hammons Hotels, LP (the "Hotel Limited Partnership"). Through the JHQ Trust, Hammons owned the remaining 72% of the Hotel Limited Partnership's equity as its sole limited partner. Through his control over the Public Hotel Company, Hammons controlled the Hotel Limited Partnership. The Hotel Limited Partnership in turn owned various entities that either owned or managed hotels.

B. The Public Hotel Company Obtains A Right of First Refusal

Hammons's passion was developing hotels. He appears to have been less attuned to the corporate governance consequences of taking other people's money through an initial public offering. The board of directors of the Public Hotel Company (the "Board") believed (correctly) that it, and not Hammons, had the authority to manage the business and affairs of the Public Hotel Company. Hammons and the Board disagreed over matters such as the pace at which Hammons wanted to develop new hotels, the Board's use of stock options to compensate employees, Hammons's hiring of a senior executive without Board approval, and the sale of hotels that the Board (but not Hammons) no longer regarded as core assets. See SJ Op., 2009 WL 3165613, at *3-4.

The disagreement over the pace of hotel development progressed to a point where the Board imposed a moratorium on Hammons's development of new hotels. To resolve the impasse, Hammons and the Board negotiated an agreement that allowed Hammons "to use [Public Hotel] Company resources for his private [hotel] development activities, in exchange for giving the [Public Hotel] Company the opportunity to manage such hotels and acquire them if they were offered for sale." Id. at *3.

C. Hammons Explores Alternatives For The Public Hotel Company.

''In early 2004, Hammons informed the Board that he had begun discussions with third parties regarding a potential sale of [the Public Hotel Company] or his interest in [it]." Id. at *4. Hammons hoped to achieve a transaction that would cash out the Class A stockholders and provide him with a degree of liquidity that could be used (among other things) to develop new hotels. He did not want to incur massive capital gains taxes. To achieve his tax goal, Hammons had to retain an interest in the surviving entity "and continue to have capital at risk." Id

On October 15, 2004, Barceló Crestline Corporation ("Barceló") informed the Board that it had entered into an agreement with Hammons and would be offering $13 per share for all of the outstanding shares of the Public Hotel Company's Class A stock. The deal provided Hammons with a $250 million line of credit. To ensure favorable tax treatment, Hammons's interests in the Public Hotel Company and the Hotel Limited Partnership would be converted into a new class of preferred limited partner interests in the Hotel Limited Partnership that carried a large liquidation preference. Hammons also would receive the Chateau on the Lake Resort, one of the Public Hotel Company's premier properties.

"Recognizing that Hammons's interests in the transaction may not have been identical to those of the unaffiliated [Public Hotel Company] stockholders, the Board formed a special committee to evaluate and negotiate [the] proposed transaction." Id. After Barceló announced its transaction publicly, Eilian contacted the special committee and expressed interest in an alternative transaction. The Board later expanded the special committee's mandate to include responding to requests from interested parties. At least two other parties contacted the special committee. Id. at 6.

During the ensuing process, Eilian eventually offered to acquire all outstanding shares of Class A common stock for $24 per share. With the special committee's permission, Eilian then negotiated and reached an agreement with Hammons on other terms for the transaction. The result was the 2005 Transaction. The Board approved it on June 14, 2005. The Public Hotel Company stockholders approved it on September 15, 2005. The deal closed on September 16, 2005.

D. The Terms Of The 2005 Transaction

The 2005 Transaction was complex and had multiple parts. The framework for the 2005 Transaction was set forth in a Second Amended and Restated Transaction Agreement dated as of September 16, 2005 (the "Transaction Agreement" or "TA"). At bottom, the 2005 Transaction was designed to cash-out the public stockholders and provide Hammons with liquidity "without triggering the tax liability associated with an equity or asset sale." SJ Op., 2009 WL 3165613, at *7.

Eilian participated in the transaction through plaintiff JD Holdings, L.L.C., which the transaction documents refer to as "JDH" or the "Sponsor." At the public company level, the Public Hotel Company merged with an acquisition subsidiary of JD Holdings and emerged as an indirect, wholly owned subsidiary of JD Holdings. Through the merger, each share of Class A common stock was converted into the right to receive $24 per share in cash. Through the JHQ Trust, Hammons received the merger consideration for the 5% of the Class A shares that he owned, and he also received the cash value of his options. See TA § 2.1(b).

The Summary Judgment Opinion summarizes the other steps in the 2005 Transaction:

Although each Class B share initially remained a share of common stock of the surviving corporation, those shares were eventually converted into a preferred interest in the surviving limited partnership . . . . In order to achieve his tax goals, Hammons had to have an ownership interest in the surviving LP and continue to have capital at risk. Accordingly, Hammons was allocated a 2% interest in the cash flow distributions and preferred equity of the surviving LP. Atrium GP, LLC, an Eilian company, became general partner of the surviving LP and received a 98% ownership interest. Hammons's preexisting limited partner interest in [the Hotel Limited Partnership] was converted into a capital account associated with his preferred interest in the surviving LP, which had a liquidation preference of $328 million. When combined with the preferred interest from the conversion of his Class B shares, Hammons's capital account totaled a liquidation preference of $335 million. The partnership agreement provided for events in which the capital account could be distributed during Hammons's lifetime, but because of certain tax consequences, it was anticipated that distribution of the capital account was to occur at Hammons's death.

SJ Op., 2009 WL 3165613, at *7. The obvious reason for keying a distribution or other taxable event off Hammons's death was the step-up in basis that Hammons's heirs would receive under the Internal Revenue Code. See 26 U.S.C. § 1014. Not coincidentally, Hammons received a right of indemnification from the surviving LP for any tax liability incurred from the sale of any of its hotels during his lifetime. SJ Op., 2009 WL 3165613, at *8.

The agreements governing the 2005 Transaction established other rights and obligations. "Importantly, Hammons received a $25 million short-term line of credit and a $275 million long-term line of credit." Id. Eilian subsidized this financing package, which would not have been available on the open market. Id. at *13. The loan package provided Hammons with liquidity and enabled him to continue doing what he loved— developing hotels.

Hammons and Eilian agreed to reciprocal "restrictions on the development of new hotels that would compete with existing hotels owned by either party." Id. at *8. Eilian agreed to continue using Hammons's management company to manage the hotels owned by the Hotel Limited Partnership in return for paying the management company's operating expenses and reimbursing it for Hammons's salary and benefits. Id. Hammons also received a distribution of the Chateau on the Lake Resort. See TA § 2.1(d).

Just as the Public Hotel Company had received a right of first refusal when the Board agreed to permit Hammons to use Public Hotel Company resources to develop his own hotels, Eilian bargained for and obtained the rights provided by the ROFR Agreement as part of the 2005 Transaction. For his part, Hammons secured a right of first refusal to acquire any hotels that Eilian caused the Hotel Limited Partnership to sell. TA § 2.1(k)(iii).

Generally speaking, the ROFR Agreement required Hammons to provide JD Holdings with notice of any third party offer to purchase a JQH Subject Hotel, defined in the ROFR Agreement as any interest in real or personal property "used in the operation of a hotel facility, or any interest in any related convention or entertainment facility, retail facility, parking facility or gaming facility" owned by Hammons or an entity he controlled. RA § 1.1. The ROFR Agreement gave JD Holdings thirty days after receipt of the notice to elect to purchase the property. RA § 2.1(a). If JD Holdings opted to purchase the property, then the parties would be required to "close such sale transaction on substantially identical economic terms, " except that JD Holdings would not be required to pay certain fees, such as broker fees, mortgage transfer fees, and franchise transfer fees, and Hammons would be required to provide JD Holdings with subordinate seller financing equal to 22.5% of the purchase price. Id. § 2.1(b). If JD Holdings declined to purchase the property or did not make an election within thirty days, then Hammons would be free to proceed with the sale. Id. § 2.1(a).

Contrary to the defendants' current position that the ROFR Agreement is invalid, Hammons represented in the Transaction Agreement that he and his entities had "all requisite power and authority to execute and deliver this Agreement . . . and all other agreements and documents to be executed or delivered by such party . . . and to perform its or his obligations hereunder and thereunder." TA § 4.1. Hammons and his entities further represented that each of the Transaction Agreement and all other agreements constituted "a valid and binding obligation" and was "enforceable . . . in accordance with its terms." Id. These representations covered the ROFR Agreement. In the proxy statement issued in connection with the 2005 Transaction, Hammons and his associates disclosed the existence of the ROFR Agreement and described the rights that it granted to JD Holdings without providing any disclosures regarding its purported invalidity.

After the 2005 Transaction, Eilian's entity, JD Holdings, indirectly owned 100% of the equity of what had been the Public Hotel Company. The Hotel Limited Partnership survived the transaction and was renamed Atrium Hotels, L.P. Through Atrium GP, LLC, the successor to the Public Hotel Company in its capacity as the general partner of the Hotel Limited Partnership, JD Holdings owned 100% of the Hotel Limited Partnership's general partner ...


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