Icahn Memorandum In Support Of Dismiss Motion

SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK ------------------------------------------------------------------- X : : R2 INVESTMENTS, LDC, : : Plaintiff, : : v. : : CARL C. ICAHN, CARL J. GRIVNER, VINCENT : INTRIERI, ADAM DELL, KEITH MEISTER, : FREDRIK GRADIN, ROBERT KNAUSS, PETER : SHEA, ARNOS CORPORATION, HIGH RIVER : LIMITED PARTNERSHIP, ACF INDUSTRIES : HOLDING CORPORATION, STARFIRE : HOLDING CORPORATION, and : : XO HOLDINGS, INC. : : Defendants and : Nominal Defendant. : ------------------------------------------------------------------- X

Index No. 601296/09 Hon. Charles E. Ramos, J.S.C. Motion Sequence No.: 004

MEMORANDUM OF LAW OF DEFENDANTS CARL C. ICAHN, CARL J. GRIVNER, VINCENT INTRIERI, KEITH MEISTER, PETER SHEA, ARNOS CORPORATION, HIGH RIVER LIMITED PARTNERSHIP, ACF INDUSTRIES HOLDING CORPORATION, STARFIRE HOLDING CORPORATION, and XO HOLDNGS, INC. IN SUPPORT OF THEIR MOTION TO DISMISS

STORCH AMINI & MUNVES PC Bijan Amini, Esq. Two Grand Central Tower 140 East 45th Street, 25th Floor New York, New York 10017 (212) 490-4100

HERBERT BEIGEL & ASSOCIATES Herbert Beigel, Esq. (admitted pro hac vice) 63561 East Vacation Drive Saddlebrooke, AZ 85739 (520) 797-9188

TABLE OF CONTENTS Page TABLE OF AUTHORITIES .......................................................................................................... ii I.

PRELIMINARY STATEMENT .............................................................................................1

II.

STATEMENT OF MATERIAL FACTS ...............................................................................3

III.

A.

INTRODUCTION .........................................................................................................3

B.

THE 2008 TRANSACTION..........................................................................................4

ARGUMENT ..........................................................................................................................6 A.

APPLICABLE LEGAL STANDARDS ON A MOTION TO DISMISS......................6

B.

COUNTS ONE AND TWO MUST BE DISMISSED BECAUSE THEY FAIL TO STATE A CAUSE OF ACTION .......................................................6 1.

Plaintiff has not, and indeed cannot, allege a lack of independence by the Special Committee, which approved the Transaction...........................................9 a. Robert Knauss ...............................................................................................11 b. Adam Dell .....................................................................................................12 c. Fredrik Gradin ...............................................................................................13

2.

The Special Committee’s actions approving the Transaction are immune to challenge under the business judgment rule .......................................................14

3.

The exculpatory clause of the Certificate of Incorporation insulates the Defendants from liability ....................................................................................18

C. COUNT THREE DOES NOT STATE A CAUSE OF ACTION FOR WASTE OF CORPORATE ASSETS ..............................................................................................19 D. COUNT FOUR DOES NOT STATE A DIRECT CAUSE OF ACTION BY PLAINTIFF AGAINST DEFENDANT CARL ICAHN AND HIS AFFILIATES ....20 E. COUNT FIVE DOES NOT STATE A CAUSE OF ACTION FOR VIOLATION OF 8 DEL. C. §122 AS AN ILLEGAL CORPORATE GIFT ...........................................22 CONCLUSION ..............................................................................................................................23

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TABLE OF AUTHORITIES Cases

Page:

Aronson v. Lewis, 473 A.2d 805 (Del. 1984) ..........................................................................................8, 9, 12, 14 Beam v. Stewart, 845 A.2d 1040 (Del. 2004) ................................................................................................10, 12 Benefore v. Jung Woong Cha, C.A. No. 14614, 1998 Del. Ch. Lexis 28 (Del.Ch. Feb. 20, 1998) ..........................................10 Bishop v. Maurer, 33 A.D.3d 497, 498; 823 N.Y.S.2d 36 (1st Dept. 2006), aff’d 9 N.Y.3d 910, 875 N.E.2d 883, 844 N.Y.S.2d 165 (2007) ...............................................6 Brehm v. Eisner (In re Walt Disney Co. Derivative Litig.), 906 A.2d 27 (2006) ......................................................................................................14, 15, 20 Cal. Pub. Emples Ret. Sys. v. Coulter, C.A.No. 19191, 002 Del Ch. Lexis 144 (Del Ch. Dec. 18, 2002) ...........................................10 Cincinnati Bell v. Ameritech, 1996 Del. Ch. LEXIS 116 (Del. Ch. Sept. 3, 1996).................................................................18 Gabelli v. Liggett, Group, 1983 Del. Ch. Lexis 418 (Del Ch. 1983) ........................................................................21 n. 22 Gantler v. Stephens, 965 A.2d 695 (Del. 2009) ...................................................................................14, 17, 17 n. 19 Gilbert v. El Paso Corp., 1988 Del. Ch. LEXIS 150 (Del. Ch. Nov. 21, 1988) ...............................................................22 In Whose Interest: An Examination of the Duties of Directors and Officers in Control Contests, 26 Ariz. St. L.J. 91 (1994) .......................................................................................................11 IT Litig. Trust Inc. v. D'Aniello (IT Group Inc.), 2005 U.S. Dist. LEXIS 27869 (D. Del. Nov. 15, 2005) ..........................................................18 Lewis v. Vogelstein, 699 A.2d 327 (Del. Ch. 1997)..................................................................................................20 Kohls v. Duthie, 765 A.2d 1274 (Del. Ch. 2000)................................................................................................10

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Michelson v. Duncan, 407 A.2d 211 (Del. 1979) ........................................................................................................22 Official Comm. of Unsecured Creditors of Integrated Health Servs. v. Elkins, 2004 Del. Ch. LEXIS 122 (Del. Ch. Aug. 24, 2004) .........................................................18, 19 Oliver v. Boston Univ., No. 16570, 2000 WL 1091480 (Del. Ch. July 18, 2000)...........................................................7 Potter v. Arrington, 11 Misc. 3d 962, 810 N.Y.S.2d 312 (NY Sup. 2006) .....................................................6 n. 9, 7 Puma v. Marriott, 283 A.2d 693 (Del. Ch. 1971)..................................................................................................20 Rales v. Blasband, 634n A.2d 727 (Del. 1993) ........................................................................................................9 The Defining Tension in Corporate Governance in America, 52 Bus. Law 393 (1997)...........................................................................................................10 Unimarts v. Nirenberg, 1996 Del. Ch. LEXIS 95 (Del. Ch. Aug. 9, 1996) ...................................................................19 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (1985) ................................................................................................................17 Winer v. Queen, 503F.3d 319 (3d Cir. 2007).................................................................................................6 n. 9 Statutes: New York C.P.L.R. § 3014 ..............................................................................................................1 New York C.P.L.R. § 3211(a)(1) and (7) ........................................................................................1 8 Del. C. § 122 ...............................................................................................................................22 10 Del. C. § 102(b)(7) ....................................................................................................................18

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Defendants, CARL C. ICAHN, CARL J. GRIVNER, VINCENT INTRIERI, KEITH MEISTER, PETER SHEA, ARNOS CORPORATION, HIGH RIVER LIMITED PARTNERSHIP, ACF INDUSTRIES HOLDING CORPORATION, STARFIRE HOLDING CORPORATION, and XO HOLDNGS, INC. (“Defendants”), by their attorneys, submit this Motion to Dismiss Plaintiff’s Complaint, pursuant to NY CPLR §§ 3211 (a)(1) and (7) for failure to state a cause of action on its face and based on documentary evidence. In support of this Motion, Defendants submit this Memorandum of Law and the Affirmation of Herbert Beigel, Esq., sworn to on the 7th day of July, 2009 (“Beigel Aff.”), attesting to Exhibits A through K. I.

PRELIMINARY STATEMENT In a rambling complaint of fifty-six pages that is the antithesis of the requirement that a

complaint consist of “plain and concise statements” in paragraphs, each with a “single allegation” (NY CPLR §3014), Plaintiff challenges a transaction (“Transaction”), whereby on July 25, 2008, XO Holdings, Inc. (“XO”), a publicly held national telecommunications company, (a) issued and offered new preferred stock to shareholders (the “SPA”, also referred to from time to time as the “Offering,” annexed to the Beigel Aff. as Exhibit D), and (b) entered into an Amended Tax Allocation Agreement (“ATAA,” annexed to the Beigel Aff. as Exhibit B)1 with defendant Starfire Holding Corporation (“Starfire”), an affiliate of defendant Carl C. Icahn (“Icahn”). (The SPA and the ATAA also are collectively referred to as the “Transaction.”) Plaintiff claims that Defendants breached their fiduciary obligations to XO and to Plaintiff by entering into the Transaction, because (a) the ATAA, which amended the preexisting Tax Allocation Agreement (“TAA,” annexed to the Beigel Aff. as Exhibit C) that governed the allocation of XO’s net operating loss (“NOL”) for tax purposes, constituted the 1

A tax allocation agreement is commonly used to allocate income tax liabilities, including benefits from the use of NOLs, between a parent corporation and a subsidiary, where the subsidiary and the parent are consolidated for income tax purposes.

waste of a corporate asset, and (b) the Offering improperly diluted minority shareholders. Further, Plaintiff alleges that the independent Special Committee of XO’s Board of Directors wrongfully failed to pursue potential acquisitions of XO by third parties. See the Complaint annexed to the Beigel Aff. as Exhibit A, ¶ 2.2 However, as shown below, the Complaint fails to adequately allege any breach of fiduciary obligation or waste of a corporate asset because even if the facts alleged in the Complaint are treated as true, the independent Special Committee diligently negotiated and evaluated the Transaction with the assistance and advice of an independent financial advisor and independent counsel before recommending and voting to approve the Transaction. Moreover, the Special Committee obtained an increased financial benefit for XO in the ATAA. Plaintiff’s Complaint consists of five counts, the first three of which are denominated as derivative claims on behalf of XO for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and waste of corporate assets. The fourth claim is brought by Plaintiff as a direct claim, alleging that Mr. Icahn and certain of his affiliates owed Plaintiff a direct fiduciary obligation which they breached by entering into the Transaction. The fifth claim, not denominated as a direct or derivative claim – although clearly derivative in nature – alleges that the “Individual Defendants” caused XO to make an unlawful gift of the NOLs by entering into the ATAA. As shown below, each of the five counts fails to state a cause of action upon which any relief can be granted.3

2

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Plaintiff incorrectly and overbroadly refers to Mr. Icahn as identical to Defendant Starfire. Plaintiff has no basis in fact to support this allegation, and the law does not excuse this sleight of hand. Prior to this motion to dismiss, Defendants Adam Dell, Fredrik Gradin, and Robert Knauss (the “Special Committee Defendants”), served their Answer. However, they have filed a joinder to this Motion to Dismiss.

2

STATEMENT OF RELEVANT FACTS4

II.

A. INTRODUCTION XO was reorganized in a bankruptcy court approved Plan of Reorganization in early 2003. Since that time, Mr. Icahn has been the majority shareholder. XO has continuously operated, aided throughout by infusions of capital by Mr. Icahn and others. Yet, since 2005, Plaintiff and its affiliates, apparently disappointed in their investment in XO, have sought to obstruct XO’s efforts to improve its financial condition.5 Indeed, although Plaintiff was afforded the opportunity to purchase shares in the Offering, it elected not to do so, choosing almost a year later to instead file this spurious action, challenging the Transaction, despite the fact that it resulted in a substantial infusion of cash and capital for XO and eliminated XO’s substantial debt.6 Notwithstanding the excessive length of the Complaint, Plaintiff’s core allegations clearly lack merit. Moreover, the Complaint, under the guise of providing the Court allegedly relevant background, inappropriately and contrary to a stipulation entered into by Plaintiff in a previous Delaware Chancery action, uses the proceedings and settlement of that action to improperly allege a scheme by Defendants to damage XO and its minority shareholders. Plaintiff knows well that the Stipulation forever prohibits it from using the settlement, its terms, or any of the proceedings leading to the settlement “in any manner whatsoever.”7 Yet, not only 4

The recited facts are undisputed or conceded in Plaintiff’s Complaint, or otherwise supported and confirmed by documentary evidence.

5

Although the Complaint does not reflect how much plaintiff paid for its XO shares, in January 2003, when Plaintiff first invested in XO (see Beigel Aff., Ex. A at ¶ 19), XO stock traded at approximately $3.50-$5.00 per share. Currently, the stock trades at approximately $ .30 per share.

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Indeed, even before filing this suit, before the Transaction was entered into, an affiliate of plaintiff transmitted to the Board of Directors of XO three malicious letters falsely claiming XO was insolvent and threatening litigation. See Beigel Aff., Exhibit F. We discuss these letters below at pages 18-19, demonstrating the lack of merit of the Complaint and Plaintiff’s bad faith.

7

See the Stipulation of Compromise, Agreement, and Release, annexed to the Beigel Aff. as Exhibit K at ¶ 10.

3

does Plaintiff continually refer to that case to support its core allegations that Mr. Icahn and the other Defendants have engaged in a long-running scheme to breach their fiduciary obligations to XO, Plaintiff also treats the settlement as a supposed admission of wrongdoing, which it is not. Simply put, this Court should not consider or countenance such allegations, and the Complaint could and should be dismissed on this basis alone. B. THE 2008 TRANSACTION On July 25, 2008, XO entered into the Transaction. The Transaction included the SPA and ATAA. The terms of the SPA and the ATAA had been negotiated by the Special Committee of independent directors (Defendants Gradin, Knauss, and Dell) and its independent counsel, Dechert LLP. The Special Committee also had retained Cowen and Company (“Cowen”) as its independent financial advisor. The SPA and ATAA were approved by the Special Committee; indeed, the only members of the Board who voted on and approved the Transaction were the members of the Special Committee and Carl Grivner, XO’s Chief Executive Officer. See Minutes of the Board of Directors of July 17 and July 24, 2008 and the Minutes of the Special Committee of July 24, 2008, annexed collectively to the Beigel Aff. as Exhibit I.8 Pursuant to the SPA, Mr. Icahn’s affiliated corporations (including Defendants ACF Industries Holding Corporation, Arnos Corporation, and High River Limited Partnership) obtained the right to purchase an aggregate of 555,000 shares of XO’s 7% Class B Convertible Preferred Stock and an aggregate of 225,000 shares of the XO’s 9% Class C Perpetual Preferred Stock (collectively, the “Offering”). The Offering’s $780 million purchase price was paid through the retirement of approximately $450.758 million of XO’s senior indebtedness held by the Icahn affiliates, and the balance of $329.242 million was paid in cash. In connection with the

8

The other defendants on the Board, Messrs. Icahn, Intrieri, Meister, and Shea did not vote.

4

Offering, XO and Starfire also entered into the ATAA, which governed how the Icahn affiliates could use XO’s NOLs and the benefit accruing to XO in such circumstances. See Beigel Aff., Ex. B at ¶ 4(d). While the NOLs certainly had significant value to Mr. Icahn, they are currently valueless to XO (since it generates losses). Yet, Starfire agreed to pay XO 30% of his tax savings immediately upon using $900 million of the NOLs (or any part thereof). This was a more favorable allocation than previously provided for in the original Tax Allocation Agreement, which did not require any payment at all from Starfire unless and until XO earned a profit. Thus, the ATAA provided XO with an increased benefit over the original Tax Allocation Agreement, which had been formally approved by the Bankruptcy court on January 15, 2003. See Beigel Aff., Ex. J. Following the execution of the SPA, XO offered certain of its large minority shareholders, including Plaintiff, the opportunity to participate in the Offering. On August 5, 2008, XO sent to Plaintiff and other minority shareholders an information statement for the offering of additional shares of Convertible Preferred Stock and Perpetual Preferred Stock. See the “Information Statement” annexed to the Beigel Aff. as Exhibit E. The Information Statement outlined the terms of the Offering and provided instructions on how to participate. In addition, the Information Statement invited minority shareholders to attend an informational meeting on August 14, 2008, with representatives of XO management. The Offering expired at 5:00 P.M. EST on August 18, 2008. Id. at p. 3. Plaintiff elected not to purchase a single share.

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III.

ARGUMENT A. APPLICABLE LEGAL STANDARDS ON A MOTION TO DISMISS Although, as shown below, Plaintiff’s claims are insufficient on their face, and as a

matter of law, this Court may consider documentary evidence, where such evidence plainly contradicts the factual allegations of the Complaint. In Bishop v. Maurer, 33 A.D.3d 497, 498, 823 N.Y.S.2d 36 (1st Dep’t 2006), aff’d, 9 N.Y.3d 910, 875 N.E.2d 883, 844 N.Y.S.2d 165 (2007), the Court stated: Generally, on a motion to dismiss brought pursuant to CPLR 3211, the court must ‘accept the facts as alleged in the complaint as true, accord plaintiffs the benefit of every possible favorable inference, and determine only whether the facts as alleged fit into any cognizable legal theory' " (Morgenthow & Latham v Bank of N.Y. Co., 305 AD2d 74, 78, 760 NYS2d 438 [2003], lv denied 100 NY2d 512, 798 NE2d 350, 766 NYS2d 166 [2003], quoting Leon v Martinez, 84 NY2d 83, 87-88, 638 NE2d 511, 614 NYS2d 972 [1994]). The court, however, is not required to accept factual allegations, or accord favorable inferences, where the factual assertions are plainly contradicted by documentary evidence (Robinson v Robinson, 303 AD2d 234, 235, 757 NYS2d 13 [2003]; Biondi v Beekman Hill House Apt. Corp., 257 AD2d 76, 81, 692 NYS2d 304 [1999], affd 94 NY2d 659, 731 NE2d 577, 709 NYS2d 861 [2000]). We demonstrate below that based solely on the Complaint and accepting the facts as alleged as true, the Complaint fails to state any cognizable cause of action. We also submit documentary evidence where appropriate to confirm factual arguments. B. COUNTS ONE AND TWO MUST BE DISMISSED BECAUSE THEY FAIL TO STATE A CAUSE OF ACTION9 As an initial matter, we note that Counts One and Two treat the Amended Tax Allocation Agreement and the Offering as a single transaction, which Plaintiff pleads as a derivative claim. As such, the counts suffer from two defects, which alone require dismissal: (a) the challenge to 9

As to the application of substantive law to the allegations of the Complaint, which exclusively deal with the duties of directors of corporations, because XO is a Delaware corporation, Delaware law applies. See e.g., Winer v. Queen, 503 F.3d 319, 338 (3d Cir. 2007); Potter v. Arrington, 11 Misc. 3d 962, 965-66, 810 N.Y.S.2d 312 (NY Sup. 2006).

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the Offering may not be brought as a derivative claim; and (b) Plaintiff improperly failed to make a pre-suit demand on XO’s Board of Directors. The law is clear that Plaintiff cannot derivatively challenge that part of the Transaction whereby XO issued and offered preferred shares to its shareholders. As a New York court, interpreting Delaware law, stated: The Delaware Supreme Court recently held that whether a claim is direct or derivative turns solely on the following questions: who suffered the alleged harm, the corporation or the plaintiff stockholders individually; and who would receive the benefit of any recovery, the corporation or the stockholders individually. (Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1033 [Del 2004].) Further, in order to establish that the injury was a direct injury rather than a derivative one, a stockholder must demonstrate that the duty breached was owed to him or her and that he or she can prevail without showing an injury to the corporation. (Tooley v Donaldson, Lufkin & Jenrette, Inc., 845 A.2d at 1039; In re J.P. Morgan Chase & Co., 906 A.2d 808, 2005 WL 1076069, 2005 Del Ch LEXIS 51 [2005].) Potter v. Arrington, 11 Misc. 3d 962, 810 N.Y.S.2d 312, 317 (NY Sup. 2006). Plaintiff complains that the Offering diluted its shares – in other words, reducing its already preexisting minority position in XO. See Beigel Aff., Ex. A at ¶ 2. However, a claim of dilution emphasizing the diminishment of voting power has been consistently categorized as a direct claim. See, e.g., Oliver v. Boston Univ., No. 16570, 2000 WL 1091480 at *6 (Del. Ch. July 18, 2000). Here, a successful challenge of the Offering, where Plaintiff seeks its rescission, would not only exclusively benefit the minority shareholders by restoring some measure of minority voting power, but it would, in fact, harm XO by depriving it of the substantial cash infusion and elimination of its debt that the Offering provided. In other words, the Complaint does not allege, nor can it allege, that the Offering harmed XO or that a recovery under Counts One and Two would benefit XO.

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Consequently, Plaintiff’s derivative challenge to the Offering must fail. Moreover, because Counts One and Two derivatively attack the Offering and the ATAA as a single transaction, the Counts must be dismissed in their entirety.10 Even assuming that Plaintiff’s claims in Counts One and Two properly state derivative claims, they must be dismissed because Plaintiff did not make a pre-lawsuit demand and has no legal excuse for failing to do so.11 Thus, the case law makes perfectly clear that pre-suit demand is only to be excused in cases where “facts are alleged with particularity which create a reasonable doubt that the directors’ action was entitled to the protections of the business judgment rule.” Aronson v. Lewis, 473 A.2d 805, 808 (Del. 1984).12 For the reasons set forth below, Plaintiff has not, and cannot, allege with particularity any facts that create a reasonable doubt that the business judgment rule does not apply. See infra, at p. 13. This requirement is far from a mere “technicality.” Rather, it goes to the very heart of corporate governance. The “demand requirement embraces the policy that directors, rather than stockholders, manage the affairs of the corporation.” Aronson, 473A.2d at 810. The Aronson court then goes on to stress the importance of the demand requirement: By its very nature the derivative action impinges on the managerial freedom of directors. Hence, the demand requirement…exists at the threshold, first to insure that a stockholder exhausts his intracorporate remedies, and then to provide a safeguard against strike suits. Thus, by promoting this form of alternate dispute resolution, rather than by immediate recourse to litigation, the demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of corporations. Id. at 811-12. 10

Plaintiff appears to recognize this defect, because it separately and derivatively challenges the ATAA in Count Three.

11

This argument also applies to Counts Three and Five, which are styled as derivative claims.

12

As discussed below (at pages 13 et. seq. ), the business judgment rule provides the Special Committee with a favorable presumption that precludes liability for alleged breaches of fiduciary obligation where the Special Committee, as here, is comprised of independent members.

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1. Plaintiff has not, and indeed cannot, allege a lack of independence by the Special Committee, which approved the Transaction. A threshold issue in determining whether Plaintiff’s Complaint can survive a motion to dismiss – and, indeed, as referenced above, whether pre-suit demand is excused – is whether Plaintiff has adequately pled that the members of the Special Committee lacked independence. Here, Plaintiff has not pled, or cannot plead, facts sufficient to call into question the independence of the Special Committee. Under Delaware law, a plaintiff bears a heavy burden, and must allege a great deal in order to overcome the presumption of independence. Thus: A director is considered interested where he or she will receive a personal financial benefit from a transaction that is not equally shared by the stockholders. . . Directorial interest also exists where a corporate decision will have a materially detrimental impact on a director, but not on the corporation and the stockholders. In such circumstances, a director cannot be expected to exercise his or her independent business judgment without being influenced by the adverse personal consequences resulting from the decision. Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993). Here, Plaintiff alleges that a relationship existed between the Special Committee directors and Mr. Icahn, the controlling shareholder. However, such allegations are insufficient to establish a lack of independence, where the only fact allegations are that the Special Committee directors owed their positions on the Board to the controlling shareholder. Thus, in Aronson, the court held that the fact that a 47% stockholder personally selected each member of the board was insufficient to find lack of independence. 473 A.2d at 805. The Aronson court succinctly noted that “it is not enough to charge that a director was nominated or elected at the behest of those controlling the outcome of a corporate election. That is the usual way a person becomes a corporate director.” Id. at 816. Moreover, the court noted that “proof of majority ownership of a company does not strip directors of the presumptions of independence, and that their acts have

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been taken in good faith and in the best interests of the corporation.” Id. at 815. Simply put, it is not the law that a director lacks independence simply because the corporation is controlled by a majority shareholder. Similarly, personal friendship, without more, does not cast sufficient doubt on a directors’ independence: [F]riendship must be accompanied by substantially more in the nature of serious allegations that would lead to a reasonable doubt as to a director’s independence. That a much stronger relationship is necessary to overcome the presumption of independence at the demand futility stage becomes especially compelling when one considers the risks that directors would take by protecting their social acquaintances in the face of allegations that those friends engaged in misconduct. To create a reasonable doubt about an outside director’s independence, a plaintiff must plead facts that would support the inference that because of the nature of a relationship or additional circumstances other than the interested director’s stock ownership or voting power, the non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director. Beam v. Stewart, 845 A.2d 1040, 1052 (Del. 2004); Cal. Pub. Emples Ret. Sys. v. Coulter, C.A. No. 19191, 2002 Del. Ch. LEXIS 144, at *28-29 (Del. Ch. Dec. 18, 2002) (observing that an allegation of a lifelong friendship with an interested party alone is not sufficient to raise a reasonable doubt of a director's disinterest or independence); Kohls v. Duthie, 765 A.2d 1274, 1284 (Del. Ch. 2000) (holding that a personal friendship between a member of a special committee of the board and an interested party to the challenged transaction, as well as the fact that the interested party had once given the director a summer job, were insufficient to challenge the director's ability to exercise his independent judgment with respect to the transaction); Benefore v. Jung Woong Cha, C.A. No. 14614, 1998 Del. Ch. LEXIS 28, at *9 (Del. Ch. Feb. 20, 1998) (stating that an allegation of a longtime friendship was not sufficient to raise a reasonable doubt about a director's ability to exercise his judgment independently of his friend); The Defining Tension in Corporate Governance in America, 52 Bus. Law. 393, 406 (1997)

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(“Friendship, golf companionship, and social relationships are not factors that necessarily negate independence. . .There is nothing to suggest that, on an issue of questioning the loyalty of the CEO, the bridge partner of the CEO cannot act independently as a director. To make a blanket argument otherwise would create a dubious presumption that the director would sell his or her soul for friendship.”); In Whose Interest: An Examination of the Duties of Directors and Officers in Control Contests, 26 Ariz. St. L.J. 91, 127 (1994) (recognizing that many factors – including personal integrity, honesty, concern about their business reputations, and the threat of liability to shareholders – may motivate directors to exercise their judgment independently of corporate executives). Here, Plaintiff’s Complaint alleges nothing other than the conclusory statement that the Special Committee Defendants owed their positions as directors to Mr. Icahn. See Beigel Aff., Ex. A at ¶¶ 25-31. Furthermore, while Plaintiff has sued each and every board member, it is beyond dispute that it was only the three members of the Special Committee who recommended approval of the Transaction and then voted to approve the Transaction along with XO’s Chief Executive Officer, Carl Grivner.13 Thus, even assuming the truth of the allegation that the Special Committee members owed their seats to Mr. Icahn, XO’s majority stockholder, this allegation falls far short of what is necessary in order to create a reasonable doubt as to the independence of these directors, as do allegations of personal and other professional relationships that the Special Committee members had with Mr. Icahn. a. Robert Knauss The allegations regarding Mr. Knauss are found in ¶ 29 of the Complaint. See Beigel Aff., Ex. A. Plaintiff alleges Mr. Knauss has a “long history with Defendant Icahn and considers 13

The Complaint contains no material allegations whatsoever against Defendant board members Intrieri, Meister, and Shea, as well as Mr. Grivner, and therefore, the Complaint must be dismissed against these Defendants on this basis alone.

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Icahn to be a ‘friend,’” has been “involved with Icahn in connection with WestPoint International, Inc., Phillip Services Corporation and VISX Technologies;” and summarily states that because of Mr. Knauss’ “long -standing relationship with Icahn, and because Icahn controls the majority of XO’s outstanding commons stock, Defendant Knauss is beholden to Icahn and owes his position as a director of XO to Icahn.” Id. The Complaint does not, and indeed cannot, allege any other facts in support of its claim that Knauss is somehow tainted. These allegations, as the courts consistently have held, are insufficient as a matter of law to establish a lack of independence.14 Noticeably absent is any allegation that Mr. Knauss would financially benefit from the challenged transaction. Similarly, there is no allegation that Knauss’ “relationship” with Icahn is such that it would lead to a reasonable doubt as to Knauss’ independence. In fact, there is no allegation about anything, other than the fact that Knauss has served on the boards of three companies associated with Mr. Icahn (XO, WestPoint and PSC) and was on a slate of proposed directors for a fourth (VISX). The case law resoundingly concludes that these facts are insufficient to cast doubt on the independence of directors. “The shorthand shibboleth of ‘dominated and controlled directors’ is insufficient.” Aronson, 473 A.2d at 816; see Beam v. Stewart, 845 A.2d at 1050 (“Allegations of mere personal friendship or a mere outside business relationship, standing alone, are insufficient to raise a reasonable doubt about a director’s independence.”) Thus, Mr. Knauss is entitled to the presumption of independence. b. Adam Dell Plaintiff’s allegations as to Mr. Dell are equally ineffective to defeat the presumption of independence. Plaintiff merely states that Mr. Dell has been a member of XO’s Board of

14

See pp. 8-10, supra.

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Directors since May 2003 and notes that “Icahn included Dell in [his] slate of proposed directors of Yahoo! Inc.” See Beigel Aff., Ex. A at ¶ 26. It also repeats the same legally useless incantation that “because Icahn controls the majority of XO’s outstanding common stock, Mr. Dell owes his position as a director of XO to Defendant Icahn.” Id. As with Mr. Knauss, the allegations against Mr. Dell are wholly insufficient to raise a reasonable doubt about his independence. They amount to nothing more than the innocuous fact that Mr. Dell is on the XO board, of which Icahn is the controlling shareholder, and that Mr. Icahn included Mr. Dell on a slate of directors for Yahoo!. These thinly pled facts fall short of the necessary showing, as the case law repeatedly and unequivocally establishes. c. Fredrik Gradin Plaintiff’s allegations against defendant Gradin are similarly insufficient. Plaintiff alleges unremarkably that Mr. Gradin has been a member of the XO board since August 2004 and notes that he was a member of the Wireline Special Committee.15 See Beigel Aff., Ex. A at ¶ 27. The only additional allegation is, once more, the all too familiar and legally insufficient claim that “because Icahn controls the majority of XO’s outstanding common stock, Defendant Gradin owes his position as a director of XO to Defendant Icahn.” Id. Because of the clear insufficiency of the Complaint’s allegations against the Special Committee, it is entitled to the benefit of the business judgment rule, which, as shown below, provides the Special Committee with the presumption that entering into the Transaction did not breach any fiduciary duty owed to XO. Thus, with the business judgment rule in place, Plaintiff’s Complaint must be dismissed. 15

The Wireline Special Committee was the committee of Board members established in connection with the proposed sale of a part of XO’s assets in 2005, which was never consummated. This withdrawn sale was the focus of plaintiff’s previous Delaware derivative suit, which, as we previously noted is wholly irrelevant to this action.

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2. The Special Committee’s actions approving the Transaction are immune to challenge under the business judgment rule. The business judgment rule is an acknowledgement of the managerial prerogatives of Delaware directors. Aronson, 473 A. 2d at 812. Moreover, the rule is a “presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Id. “Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption.” Id. Therefore, because the Special Committee, which recommended and voted for the Transaction, was comprised of independent directors, the business judgment rule applies. See also, generally, Gantler v. Stephens, 2008 Del. Ch. LEXIS 20, *25 (Del. Ch. Nov. 5, 2008), rev’d on other grounds, 965 A.2d 695 (Del. 2009). Here, Plaintiff’s Complaint fails to allege facts, which, even if proved, would rebut the business judgment’s rule favorable presumption. As Delaware courts have repeatedly held, a court will not substitute its own judgment for that of the board’s, where the approval process was controlled by a Special Committee of independent directors. See generally, Brehm v. Eisner (In re Walt Disney Co. Derivative Litig.), 906 A.2d 27 (2006). The approval by XO’s Special Committee of the Transaction is beyond reproach. Yet, Plaintiff, demonstrating its bad faith even before the Transaction was entered into, put XO on notice of its intent to sue. Thus, on January 24, 2008, an R2 affiliate sent a letter to the members of the Special Committee threatening to sue if they agreed to any deal that Plaintiff considered unfair. That letter stated, “[R2] will challenge any proposed transaction that it perceives to be unfair to XO’s minority shareholders or is otherwise disadvantageous to XO.” See Beigel Aff., Ex. F. The letter also made it very clear that any litigation would be scorched earth and

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threatened to inflict on the Special Committee members personal financial harm: “It is R2’s intent to act immediately, and with every resource available, to challenge the offending transaction and to seek recovery from the company, from Icahn and his associates, and if appropriate from you personally – to the fullest extent possible under Delaware law. Given that you do not have Mr. Icahn’s deep pocketbook to fall back on if the company’s D&O insurance policy does not fully protect you, you should carefully consider your fiduciary duties and legal obligations.” Id. In the exercise of prudence, the Special Committee, as would be expected, sought counsel from its attorneys, the highly regarded law firm of Dechert LLP. Dechert promptly responded to Plaintiff’s threats: The purpose of this communication is to assure you that the members of the Special Committee are well aware of, and take with the utmost seriousness, their fiduciary obligations as independent directors of the company and members of the Special Committee. Since the events that prompted your lawsuit in the Delaware Court of Chancery, the Special Committee has engaged this firm [Dechert] as its independent counsel and Cowen and Company as its independent financial advisor to, among other things, assist the Special Committee in evaluating any refinancing, obtaining of new Capital or other transaction that may involve Icahn or his affiliates.16 See Beigel Aff., Ex. G. Besides what can only be characterized as Plaintiff’s bad faith in its conduct, not the least of which is the frivolousness of its current Complaint, the law is squarely on the side of Defendants as to any allegation that XO’s Board of Directors acted in bad faith. In Brehm v. Eisner, the Delaware Supreme Court evaluated three types of behavior that might warrant the “bad faith” label, and found that two of them did and one did not. First, the Court found that “subjective bad faith,” that is, fiduciary conduct motivated by an actual intent to do harm,” 16

Plaintiff followed up with two additional threatening, malicious letters,. repeating similar false and threatening statements with additional scurrilous flourishes. See Beigel Aff., Ex. F.

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would constitute bad faith. 906 A.2d at 64.17 The Complaint here does not contain any allegation that the Board was motivated by an actual intent to harm XO or its shareholders. Second, the Court addressed whether gross negligence, without more, can constitute bad faith and held “[t]he answer is clearly no.” Id. at 65. Likewise, the third basis, which may support a finding of bad faith, namely, intentional dereliction of duty and a conscious disregard for one's responsibilities is nowhere alleged in the Complaint. Id. at 64-66. It is thus apparent that Plaintiff’s Complaint fails to adequately allege a breach of fiduciary obligation based on lack of good faith (or any other basis), because, first, it fails to allege a lack of independence of the Special Committee Defendants, as a matter of law, and, second, it does not allege that the Board intended to harm XO. Not only is Plaintiff’s Complaint woefully insufficient, as a matter of law, for all the reasons previously discussed, it cannot be reasonably disputed that XO received substantial benefits from the Transaction. XO stood to receive a prompt payment of additional cash pursuant to the ATAA as soon as Starfire received any benefit from the NOLs, without having to wait until XO earned a profit and could use the NOLs, as it would have had to do under the original TAA. Compare Beigel Aff., Ex. B at ¶ 4, with Beigel Aff., Ex. C at ¶ 4. Indeed, Plaintiff effectively concedes this point, having alleged that the original Tax Allocation Agreement “did not require Icahn or Starfire to compensate XO for the use of the net operating losses consumed by them unless XO could have used those losses in future tax years.” See Beigel Aff., Ex. A at ¶ 36. Consequently, it cannot be disputed that XO stands to receive a financial benefit otherwise unavailable in the original TAA.

17

An allegation of bad faith is a legal conclusion, not entitled to a presumption of truth on a motion to dismiss. Disney, 906 A.2d at 68.

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Therefore, the documentary evidence clearly contradicts Plaintiff’s claim that the ATAA was of no benefit to XO. Because the original TAA conferred a benefit on XO and was approved by the bankruptcy court, it can hardly claim now that XO received no benefit from the ATAA, which conferred on XO the opportunity for an increased financial benefit over the original bankruptcy court-approved agreement.18 The final salvo of the first two counts of Plaintiff’s Complaint is the allegation that the Defendants acted improperly by breaching a claimed duty to pursue to consummation alleged solicitations by third parties to purchase all or some of the assets of XO. Quite apart from the fact that this claim also fails because Plaintiff does not sufficiently allege lack of independence and therefore the Board is entitled to the benefit of the business judgment rule, Delaware law is clear that Board members do not have a duty to sell the corporation or its assets, except in extremely limited circumstances, not alleged or present here. Unless the Board’s refusal to sell to a third party is a “defensive action,” no breach of fiduciary obligation may be sustained. Thus, in the absence of any allegation that the Board was faced with a hostile takeover attempt, the refusal to pursue a sale to a third party is not a defensive action and a breach of the Board’s duty. See generally, Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 958 (1985); e.g., Gantler v. Stephens, 2008 Del. Ch. LEXIS 20, *25.19 As one Delaware Court has summarized the applicable law: A majority stockholder in a Delaware corporation owes no duty to sell its holdings in the corporation just because the sale would profit the minority. Bershad v. Curtiss-Wright Corp., Del. Supr., 535 A.2d 840, 844-845 (1987) 18

19

Plaintiff also concedes that XO received a substantial infusion of cash pursuant to the Offering, although it disingenuously tries to downplay this benefit, claiming XO did not need the cash and thus the cash would be “idle.” See Beigel Aff., Ex. A at ¶ 104. Plaintiff, however, fails to allege or explain how a Board approving a transaction that infuses the corporation with capital is acting disloyally or in bad faith, let alone explain how surplus capital harms a corporation. In reversing the lower court’s dismissal of the complaint, the Delaware Supreme Court, while agreeing that the lower correct was correct in rejecting the “defensive” action basis for the claims, found that there was a sufficient basis for the allegation of disloyalty on facts not present in this case, viz., a majority of directors were not independent and disinterested because they had a conflict of interest and personal financial interests. Gantler v. Stephens, 2008 Del. Ch. LEXIS 20, *707-08.

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(holding that a shareholder is under no duty to sell its holdings in corporation even if it is a majority shareholder, merely because the sale would profit the minority). Similarly, directors of the corporation have no obligation to approve a sale of the company's assets, even if such a sale would be advantageous, where the directors rightfully hold a veto of such a sale as shareholders. Thorpe v. CERBCO, Inc., Del. Supr., 676 A.2d 436, 437 (1996) (discussing Thorpe v. CERBCO, Inc., Del. Ch., C.A. No. 11713, Allen, C. (Oct. 29, 1993), Mem. Op. at 10-11, where Chancellor Allen held that a majority stockholder's ownership of its stock includes the property right to cast the controlling vote and to veto a sale of the business, even if a sale would be in the best interests of minority stockholders). Cincinnati Bell v. Ameritech, 1996 Del. Ch. LEXIS 116, *36 (Del. Ch. Sept. 3, 1996). Plainly, Plaintiff’s attack on the Special Committee’s alleged failure to pursue third party bids fails as a matter of law. 3. The exculpatory clause of the Certificate of Incorporation insulates the Defendants from liability. Title 10 of the Delaware Code, Section 102(b)(7), empowers Delaware corporations to limit the liability of their directors as provided in the Certificate. In fact, XO’s Certificate of Incorporation insulates XO’s directors from liability except for any breach of the director's duty of loyalty to the corporation or its stockholders or for any act or omission not in good faith or which involves intentional misconduct or a knowing violation of law. See Beigel Aff., Ex. H at ¶ 9. As a consequence, “[a] defense under § 102(b) (7) may be considered in the context of a motion to dismiss.” Official Comm. of Unsecured Creditors of Integrated Health Servs. v. Elkins, 2004 Del. Ch. LEXIS 122, *37 (Del. Ch. Aug. 24, 2004). Thus, for example, the court in IT Litig. Trust Inc. v. D'Aniello (IT Group Inc.), 2005 U.S. Dist. LEXIS 27869, *41 (D. Del. Nov. 15, 2005), held that the duty of care claims must be dismissed because the corporate defendant’s Certificate of Incorporation contained an exculpation provision. Even allegations of gross negligence are barred by the exculpatory provision. “Actions taken that are even grossly

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negligent. . .will be shielded by a § 102 (b)(7) provision.” Official Comm. of Unsecured Creditors of Integrated Health Servs., 2004 Del. Ch. LEXIS 122, *37.20 Therefore, because XO’s Certificate of Incorporation contains an exculpatory provision, Counts One and Two must be dismissed. C. COUNT THREE DOES NOT STATE A CAUSE OF ACTION FOR WASTE OF CORPORATE ASSETS In Count Three, Plaintiff has extracted the ATAA from the Transaction and attacked its legal propriety as a waste of corporate assets. However, since it is beyond question that XO received a benefit from the ATAA, to wit, the opportunity for immediate payment upon Starfire’s use of NOLs,21 it is absurd, to say the least, to claim that XO’s Board was guilty of wasting a corporate asset, especially where the terms of the ATAA were an improvement over the terms of the original TAA, approved by the XO bankruptcy court. Therefore, it comes as no surprise that the hurdles a plaintiff must negotiate to challenge such a transaction are even higher than conventional attacks on the performance of duties by corporate directors. In a leading Delaware case dealing with what a plaintiff must establish to state a claim for corporate waste, the court stated: The most quoted formulation [of the standard applicable to a claim of corporate waste] is “Where waste of corporate assets is alleged, the court, notwithstanding independent stockholder ratification, must examine the facts of the situation. Its examination, however, is limited solely to discovering whether what the corporation has received is so inadequate in value that no person of ordinary, sound business judgment would deem it worth what the corporation has paid. If it can be said that ordinary businessmen might differ on the sufficiency of the terms, then the court must validate the transaction.” Unimarts v. Nirenberg, 1996 Del. Ch. LEXIS 95, *17-18 (Del. Ch. Aug. 9, 1996) (quoting Saxe v. Brady, 40 Del. Ch. 474, 184 A.2d 602, 610 (Del.Ch. 1962). “A claim of waste will arise only 20

Obviously, if Count One fails, then so does Count Two for aiding and abetting.

21

The proceeds from the Offering also allowed XO to satisfy its debt.

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in the rare, ‘unconscionable case where directors irrationally squander or give away corporate assets.’ This onerous standard for waste is a corollary of the proposition that where business judgment presumptions are applicable, the board's decision will be upheld unless it cannot be ‘attributed to any rational business purpose’.” Brehm v. Eisner, 906 A.2d at 74 (citations omitted). Further, in Lewis v. Vogelstein, the court stated: [A] waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade. Most often the claim is associated with a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift. If, however, there is any substantial consideration received by the corporation, and if there is a good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste, even if the fact finder would conclude ex post that the transaction was unreasonably risky. Any other rule would deter corporate boards from the optimal rational acceptance of risk, for reasons explained elsewhere. Courts are ill-fitted to attempt to weigh the "adequacy" of consideration under the waste standard or, ex post, to judge appropriate degrees of business risk. 699 A.2d 327 (Del. Ch. 1997). In sum, as we have already noted in the context of Counts One and Two, where Plaintiff challenges the Transaction as a whole, the allegations that the XO Board wasted a corporate asset in entering into the ATAA represent nothing more than quibbling with the amount of consideration, which clearly was substantial. Thus, Count Three must be dismissed. D. COUNT FOUR DOES NOT STATE A DIRECT CAUSE OF ACTION BY PLAINTIFF AGAINST DEFENDANT CARL ICAHN AND HIS AFFILIATES Aside from the obvious, that Count Four redundantly attempts to create a separate duty owed by Mr. Icahn as majority shareholder to minority shareholders including Plaintiff, distinct from his fiduciary obligations as a member of the XO’s Board of Directors, Delaware law simply does not sanction such a claim, where the transaction at issue is approved by independent Board members, as was the case here with the Special Committee. See, e.g., Puma v. Marriott, 283

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A.2d 693, 694 (Del. Ch. 1971) (“I conclude that since the transaction complained of was accomplished as a result of the exercise of independent business judgment of the outside, independent directors whose sole interest was the furtherance of the corporate enterprise, the court is precluded from substituting its uninformed opinion for that of the experienced, independent board members of [the company].”) Moreover, under any circumstances, a plaintiff, in challenging a transaction, must not only overcome the presumption of the business judgment rule but also allege facts sufficient to establish both unfair dealing and unfair price. Here, in the absence of alleging sufficient facts to show a lack of independence by the Special Committee Defendants, Plaintiff cannot overcome the presumption of the business judgment rule with respect to the Special Committee’s approval of the Transaction. As to unfair price, Plaintiff has relied entirely on its allegations of corporate waste, which, as has already been discussed, are insufficient as a matter of law. Moreover, once Plaintiff’s claim of lack of independence fails against the Special Committee Defendants, its direct claim against Mr. Icahn also fails. In short, Plaintiff’s attempt at a direct claim in Count Four does nothing more than reconstitute in a different form the inadequate allegations made in Counts One through Three.22 Finally, Plaintiff has failed to allege that the terms of the Transaction were nonnegotiable. In fact, Plaintiff’s Complaint recounts in detail the intensive negotiations engaged in by the Special Committee, with the assistance of independent advisors. Therefore, the mere fact that Mr. Icahn was a majority shareholder does not, by itself, demonstrate that he dictated the terms of the Transaction. Moreover, there are simply no allegations, other than the generalized flawed allegation that the Special Committee Defendants owed their Board seats to Mr. Icahn, 22

Even in the context of a merger, not present here, a plaintiff must demonstrate “unfair price.” See, e.g., Gabelli v. Liggett, Group, 1983 Del. Ch. Lexis 418 (Del Ch. 1983). In this case, however, there was no merger and no price, but simply, a reasonable method of allocating XO’s losses for tax purposes, to the benefit of XO.

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which defeat the business judgment rule or justify imposing on Mr. Icahn separate liability because of his majority shareholder status. See, e.g., Gilbert v. El Paso Corp., 1988 Del. Ch. LEXIS 150, *30 (Del. Ch. Nov. 21, 1988) (“the directors may take whatever action that, in their proper exercise of business judgment, will best serve the interests of the corporation or the entire body of shareholders. That such action may adversely affect the interests of a particular shareholder subgroup, will, in certain instances, be unavoidable. Nonetheless, no wrongdoing will have occurred if the directors are able to justify the result as furthering a paramount or overriding corporate or shareholder interest.”) In other words, in the absence of allegations that Mr. Icahn or his affiliates disabled the independence of the Special Committee or forced a result on XO and its minority shareholders, no claim is stated. Plaintiff, already a minority shareholder before the Transaction, has not alleged any loss in equity because of the Offering, in which it could have participated, but did not. In short, Count Four adds nothing of value to the previous defective counts. E. COUNT FIVE DOES NOT STATE A CAUSE OF ACTION FOR VIOLATION OF 8 DEL. C. §122 AS AN ILLEGAL CORPORATE GIFT Once it becomes clear, as we believe it has, that Plaintiff has no claim for waste of corporate assets, its tag-along claim for an illegal corporate gift may be summarily disposed of. Clearly, there was consideration for the ATAA, to wit, the adjustment to the original TAA, favorable to XO. Nowhere in the factual allegations is there any basis whatsoever in calling the ATAA a “gift.” The Delaware courts have made it abundantly clear that an unlawful gift is a transfer for no consideration. See, e.g., Michelson v. Duncan, 407 A.2d 211, 216 (Del. 1979) (“The essence of a claim of gift is lack of consideration.”) Thus, having first challenged the ATAA as waste because of inadequate consideration, it claims in Count Five that there was no consideration at

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