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Willkie Farr Ducks Suit Over Investor’s Loss

(CN) - A real estate mogul whose hotel chain went bankrupt cannot pin his loss on his lawyers, a New York appeals court ruled.

David Lichtenstein retained the law firm Willkie Farr & Gallagher to help extricate him from an investment in Extended Stay Inc., which he and a consortium of investors acquired in 2007 for $8 billion.

The CEO of the Lightstone Group, one of the nation's largest privately held real estate companies, said he was following legal advice when he pushed the hotel chain into bankruptcy in 2009.

With the hotel unable to pay its debt, lenders demanded that Lichtenstein and his company make good on a $100 million guarantee they had executed at the time of the Extended Stay acquisition.

Lichenstein then brought a legal malpractice claim against Willkie Farr, alleging that the lawyers failed to pursue legal defenses that could have kept creditors from collecting on the guarantee.

New York County Supreme Court Justice Melvin Schweitzer dismissed the malpractice suit in 2013 on grounds that the attorneys' advice was well founded.

In affirming on Thursday, a unanimous panel of the Appellate Division's First Division in Manhattan noted that Lichenstein's liability could have been far greater if he had not sought bankruptcy protection for the hotel chain.

To help clear the way for the acquisition of Extended Stay, Lichtenstein included a provision in the mortgage documents guaranteeing that he and Lightstone Group would pay the lenders $100 million if any of several specified "bad boy" acts occurred, including a voluntary bankruptcy filing by the hotel chain.

After the deal closed, Lichtenstein became president, CEO and chairperson of ESI, and the majority of the hotel chain's board of directors were representatives of entities he controlled.

With the hotel chain facing a severe liquidity crisis judt two years later, Lichtenstein retained Willkie Farr to help him find a way out. Lawyers advised him that, as a director of an insolvent corporation, he had a fiduciary duty to lenders, equity holders and employees to seek bankruptcy protection. They also warned Lichtenstein that he might face uncapped personal liability if the lenders brought a derivative action against him for failing to take that step.

In his malpractice suit, Lichtenstein alleged that Willkie Farr failed to recognize that he had defenses against any action seeking to enforce the guarantee, and that any derivative suit by the lenders against him for breach of fiduciary duty would fail. Lichtenstein noted that the entities that make up Extended Stay are limited liability companies. He cited a 2011 ruling by the Delaware Chancery Court in support of his claim that lenders do not have derivative standing to sue the board of directors of LLCs.

The appellate division noted, however, that the ruling Lichtenstein cited came down two years after Willkie Farr's attorneys advised Lichtenstein to seek bankruptcy protection for the hotel chain. "In a legal malpractice action, what constitutes ordinary and reasonable skill and knowledge should be measured at the time of representation," the unsigned ruling states.

Lichtenstein and the other plaintiffs also failed to show that he would have been insulated from liability by the business judgment rule if had had opted not to push the hotel chain into bankruptcy.

"The business judgment rule ... protects only directors who are disinterested, meaning they do not, for example, stand to gain any personal financial benefit in the sense of self-dealing as opposed to a benefit which devolves upon the corporation or all stockholders generally," the court noted.

"The complaint in this case makes it plain that Lichtenstein was not disinterested, because his stewardship of ESI was affected by a conflict between his fiduciary duties as a director of the company and his personal exposure to $100 million in liability on the guarantees in the event of ESI's voluntary bankruptcy," the court concluded.

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