In the recent decision of Mehta v. Kaazing Corporation, C.A. No. 2017-0087-JRS (Del. Ch. Sept. 29, 2017), Vice Chancellor Slights examined a stockholder’s books and records request upon a Delaware corporation pursuant to 8 Del. C. § 220. This opinion provides a useful roadmap for parties and practitioners seeking to inspect corporate books and records of a Delaware corporation.
By way of brief background, plaintiff Vikram Mehta is a stockholder of Kaazing Corporation (“Kaazing”). He served as Kaazing’s CEO from October 2013 to April 2015, when he was terminated from that position by Kaazing’s board of directors.
Among other things, what led to Mehta’s books and records demand was alleged misstatements by the company concerning its financial well-being to stockholders. For example, in February 2016, Kaazing’s CEO informed shareholders that the Company “ended 2015 with a very strong Q4.” This communication allegedly caused shareholders to invest further into the Company.
However, on March 25, 2016, Kaazing delivered a very different message to its stockholders when it informed them of the need to engage in a $1 million bridge financing so that the Company could continue to operate. According to Mehta, the note associated with the Series 1 bridge financing contained terms favorable to the lender to the detriment of the Company and its shareholders. Without prior notice to shareholders, the Company’s 2016 bridge financing note was thereafter amended twice to allow for investments of up to $2 million.
After certain shareholders (including Mehta) expressed concern regarding the impact of the Series 1 financing on their investment, Kaazing held a shareholder meeting in September 2016, to provide information concerning the Series 1 financing. During this meeting, Mehta and other similarly-situated shareholders again received an invitation to participate in the Series 1 financing on the condition that they sign certain documents that Mehta believed may relinquish shareholder rights under Kaazing’s Investors’ Rights Agreement. Mehta declined to participate. The Series 1 financing led to a dilutive conversion of Mehta’s 506,124 shares of Series B-1 preferred stock to 10,616 shares of common stock.
In January 2017, Mehta sent a Section 220 demand to Kaazing, in which he sought inspection of certain books and records to “(i) ascertain the value of his stock; (ii) ascertain whether there has been mismanagement, waste, or wrongdoing by the Company’s agents and representatives; (iii) determine what impact if any this mismanagement, waste, or wrongdoing, has had, or might have, on the value of Plaintiff’s shares of the Company; and (iv) communicate with other shareholders of the Company concerning the above.” After some, but not all, of the demand documents were produced, Mehta filed a books and records action in the Delaware Court of Chancery in February 2017.
At trial, Mehta continued to advance as his proper purposes the valuation of his membership interest in Kaazing and the investigation of mismanagement, waste or wrongdoing.
Regarding valuation of his stock, the Court noted that “It is settled in Delaware law that the valuation of one’s stock can be a proper purpose for the inspection of books and records if there is a particular need or reason for the valuation. In this case, however, Mehta has not demonstrated that valuing his membership interests justifies inspection since he has failed to identify any reason why he needs to value his membership interests at this time.” Accordingly, the Court declined to provide any documents to Mehta related to this stated purpose.
Regarding the investigation of mismanagement, waste or wrongdoing, the Court was satisfied that Mehta “demonstrated a credible basis to suspect wrongdoing that justifies further investigation into mismanagement.” Mehta’s evidence of possible wrongdoing points to Kaazing’s stable financial status immediately prior to his termination and the Company’s rather sudden need for bridge financing after his termination, as well as the Board’s apparently contradictory statements in early 2016 regarding the Company’s financial success in 2015.
After determining the propriety of Mehta’s stated purposes, Vice Chancellor Slights then addressed whether the requested categories of documents were narrowly tailored to the stated purpose of investigating mismanagement or wrongdoing.
This decision reinforces the notion that requesting documents for valuation purposes, while generally upheld as a “proper” purpose, will alone not suffice unless plaintiff also demonstrates what they plan to do with such documents. Practically speaking, often times demand letters state that the stockholder seeks to value their shares in order to determine whether to sell their stock or purchase more stock in the company, or for tax or estate planning purposes. However, idle curiosity will not suffice.
Carl D. Neff is a partner with the law firm of Fox Rothschild LLP. Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at firstname.lastname@example.org.