Books and Records Demand

In the recent decision of Hoeller v. Tempur Sealy Int’l Inc., C.A. No. 2018-0336-JRS (Del. Ch. Feb. 12, 2019), the Court of Chancery adjudicated a books and records dispute brought pursuant to Section 220 of the Delaware General Corporation Law (“DGCL”).  In a very careful and thoughtful memorandum opinion, Vice Chancellor Slights denied plaintiff’s books and records demand, finding that a proper purpose had not been stated.

Plaintiff’s demand letter alleged that misconduct or wrongdoing occurred in light of defendant’s loss of a major client, Mattress Firm, a long-term customer relationship accounting for a substantial percentage of defendant’s sales.  On the day that the company disclosed to investors that it had issued formal termination notices for all brands supplied to Mattress Firm, the company’s stock fell significantly.

Prior to the filing of the books and records suit, the company produced a subset of documents to plaintiff under a confidentiality agreement, which according to the company demonstrated that no wrongdoing existed in connection with the termination of the contract with Mattress Firm.  Plaintiff, unsatisfied with the production, moved forward with the books and records suit before the Court of Chancery.

Plaintiff alleged three theories of wrongdoing on the part of defendant’s management: (i) “allowing or causing the Company to breach its contracts with [Mattress Firm]”; (ii) “allowing or causing the Company to ruin its relationship with its most important customer”; and (iii) “allowing or causing the Company to make false and misleading statements to the investing public related to the fact that the Company’s relationship with its key client, Mattress Firm, had soured, and was at significant risk of termination.”

Vice Chancellor Slights declined to find that a credible basis to infer wrongdoing was established that would otherwise entitle plaintiff to inspect company books and records. This in spite of the fact that “[a]s the lowest standard of proof known in our law, credible basis requires that the plaintiff demonstrate only some evidence of wrongdoing, not that wrongdoing actually occurred.” Slip op. at 20 (internal quotations omitted).

The Court noted that Plaintiff’s theory of mismanagement was that “a customer of Mattress Firm’s significance ‘doesn’t, at the drop of a hat, just leave. Something smells. There is smoke. I suspect there’s fire.'”  However, the Court found that plaintiff had not met his burden, finding it and other allegations “too thin a reed upon which to rest a ‘credible basis’ finding of wrongdoing.”  Slip op. at 3.

Key Takeaway: Although the credible basis to infer wrongdoing standard presents a very low burden in Section 220 disputes, this case nonetheless demonstrates that a plaintiff cannot meet this standard merely through conjecture or speculation.  Rather, at minimum some evidence of wrongdoing must be presented in order to support such a standard.

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 cneff@foxrothschild.com.

In the recent decision of CHC Investments LLC v. Firstsun Capital Bancorp, C.A. No. 2018-0610-KSJM (Del. Ch. Jan. 24, 2019), the Court of Chancery dismissed a books and records action brought pursuant to Section 220 of the Delaware General Corporation Law (“DGCL”), in light of a parallel pending plenary action.  The Court stated that seeking inspection under Section 220 of the DGCL to investigate pending claims is problematic for a number of reasons.

First, Vice Chancellor McCormick noted that plenary and Section 220 complaints are “inherently contradictory”, because by filing a plenary complaint, a stockholder represents that it has sufficient information to file the action.  On the other hand, to commence a books and records action to support a plenary claim, “a stockholder must represent that the information is necessary to its plenary claims.” Slip op. at 7.

Second, using “Section 220 inspections to investigate pending plenary claims undermines well-established discovery law”, as “discovery rules dictate what information relevant to its claims the stockholder may receive and when the stockholder may receive that information.”  Slip op. at 7.

However, notwithstanding the above points, “in special circumstances”, a books and records demand has been granted while a plenary action is pending. Slip op. at 8. Such special circumstances include where a plenary action has been dismissed but with leave to amend, (King v. VeriFone, 12 A.3d 1140 (Del. Jan. 28. 2011)), or when a plaintiff must comply with a statute of limitations and the “timing pressures are caused by the defendant, or, at least, not caused by the plaintiff.”  Slip op. at 9 (citing Khanna v. Covad Communications Group, Inc., C.A. No. 20481-NC, 2004 WL 187274 (Del. Ch. Jan. 23, 2004)).

Here, the Court found that plaintiff failed to demonstrate that special circumstances existed, and therefore granted defendant’s motion to dismiss the books and records complaint.

Key Takeaway: This decision reinforces the notion that a books and records action, when brought to obtain information to support a potential plenary action, should be adjudicated prior to filing the plenary action itself.  Absent special circumstances, the books and records action may be subject to dismissal.

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 cneff@foxrothschild.com.

A director of a Delaware corporation is afforded broad rights under 8 Del. C. § 220(d) to inspect a corporation’s books and records.  In the recent decision of Schnatter v. Papa John’s Int’l, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), the Delaware Court of Chancery examined a books and records demand by John Schnatter, who is the largest stockholder and founder of Papa John’s pizza company.  Schnatter sought to inspect certain categories of documents and communications related to his ultimate ouster as the CEO of the corporation.

The opinion is significant in that Chancellor Bouchard ordered the production of communications pertaining to this dispute from directors’ personal email accounts and on their electronic devices, along with text messages.  In other words, e-discovery is fair game in books and records actions under the appropriate circumstances. In addition, the Court held that Schnatter’s commencement of an action for breach of fiduciary duty in his capacity as a stockholder did not serve as a basis to reject his inspection demand in his capacity as a director of the corporation.

Further, Chancellor Bouchard noted that a director should not be required to sign a confidentiality agreement as a condition to obtaining records.  That is so because directors of Delaware corporations owe fiduciary duties to maintain the confidentiality of corporate documentation.  “Delaware law has long suggested that directors need not sign confidentiality agreements to obtain documents under Section 220.”  Slip op. at 44.

By contrast, “there is a ‘presumption that the production of nonpublic corporate books and records to a stockholder making a demand pursuant to Section 220 should be conditioned upon a reasonable confidentiality order.’”  Slip op. at 44-45 (quoting Disney v. Walt Disney Co., 857 A.2d 444, 447 (Del. Ch. 2004) (emphasis added)). See also Jefferson v. Dominion Holdings, Inc., in which the Court provided guidance on confidentiality agreements entered in Section 220 actions.  C.A. No. 8663-VCN (Del. Ch. Sept. 24, 2014).  A prior post summarizing the Jefferson decision can be found here.

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 cneff@foxrothschild.com.

In the recent decision of In re UnitedHealth Group, Inc. Section 220 Litig., C.A. No. 2017-0681-TMR (Del. Ch. Feb. 28, 2018), the Court of Chancery granted plaintiff’s Section 220 demand.  The Court found that allegations raised in a complaint filed by the U.S. Department of Justice (“DOJ”) against the Defendant corporation, UnitedHealth Group, Inc. (“UnitedHealth”) established a credible basis to infer wrongdoing or mismanagement based on the allegations in the qui tam action, when such allegations were sufficiently supported by documentation and testimony.

In 2017, a qui tam action was filed against UnitedHealth under the False Claims Act for alleged pervasive practice of defrauding Medicare. In the complaint, UnitedHealth was accused of “up-coding” patient risk data and failing to delete incorrect diagnoses, resulting in overpayments from Medicare.  The DOJ intervened in the action, alleging that since at least 2005, despite repeat warnings, UnitedHealth has violated both Medicare regulations and the False Claims Act.

Several stockholders of UnitedHealth filed an action under Section 220 of the DGCL in the Court of Chancery to investigate: (i) mismanagement by the D&Os of UnitedHealth, (ii) possible breaches of fiduciary duties by the D&Os, and (iii) the independence of the board of directors, including whether pre-suit demand would be futile.

The Court of Chancery granted the plaintiffs’ books and records request, based upon the extensive allegations raised by the DOJ in the qui tam action against UnitedHealth.  The Court distinguished this from Graulich v. Dell, Inc., 2011 WL 1843813 (Del. Ch. May 16, 2011), which held that a plaintiff cannot rely exclusively on a complaint that has not been found to state a viable claim as evidence
of a credible basis of wrongdoing.  Here, the Court found that the complaint filed by the DOJ was heavily supported by documents and testimony, including depositions from twenty of Defendant’s employees and Defendant’s production of over 600,000 documents after the DOJ conducted a five-year investigation.

While Vice Chancellor Montgomery-Reeves generally ruled in favor of the plaintiff stockholders, their request for email communications from certain high-level executives of the company was denied.  The Court found that “email communications are more the exception than the rule” in a Section 220 action.

Key Takeaway: This decisions demonstrates that the Court may take into account allegations raised in a separate complaint to determine whether there is a credible basis to infer wrongdoing or mismanagement, when such complaint is supported by sufficient and extensive supporting documents and testimony.

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 cneff@foxrothschild.com.

In the recent decision of Wilkinson v. Schulman, C.A. No. 2017-0138-VCL (Del. Ch. Nov. 13, 2017), the Court of Chancery denied a Section 220 books and records demand on the basis that even though the demand stated a “proper purpose”, the purpose was merely crafted by counsel for the stockholder in a lawyer manufactured litigation.

The Court found that Wilkinson’s service as a nominal plaintiff for his law firm, Levi & Korsinksy LLP (“L&K”), in this action is consistent with his past relationship with the firm. Wilkinson has served as a plaintiff for L&K in at least seven lawsuits, most of which challenged mergers.

In denying the demand, Vice Chancellor Laster found that “In this case, the trial record established that the purposes for the inspection belonged to Wilkinson’s counsel, L&K, and not to Wilkinson himself. Wilkinson simply lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel.”

Further to this point, “The mere statement of a proper purpose, however, will not automatically satisfy § 220(b).”  Pershing Square, L.P. v. Ceridian Corp., 923 A.2d 810, 817 (Del. Ch. 2007).

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 cneff@foxrothschild.com.

In the recent DGCL Section 220 books and records decision of The City of Cambridge Retirement System v. Universal Health Services, Inc.C.A. No. 2017-0322-SG (Del. Ch. Oct. 12, 2017), the Court of Chancery considered the propriety of a condition imposed by the defendant corporation in a confidentiality agreement that any subsequent litigation relying on corporate records produced in the action be deemed to incorporate by reference all such records produced (the “Incorporation Condition”).  Stated differently, the defendants and/or its directors wished to be able to rely on all documents produced in the books and records action to move to dismiss an anticipated derivative action.

Vice Chancellor Glasscock upheld the Incorporation Condition.  Section 220(c) of the Delaware General Corporation Law (“DGCL”) conveys on the Court discretion to “prescribe any limitations or conditions” on the inspection of corporate records by a demanding stockholder “as the Court may deem just and proper.”  8 Del. C. § 220(c).

The Court noted that “imposition of such a condition has been found appropriate in previous cases in this Court under Section 220, on the ground that it appropriately permits a defendant to respond to ‘cherry-pick[ed] documents’ that are taken ‘out of context,’ by pointing the Court to other documents already produced for assistance in determining the reasonableness of inferences drawn in any follow-on complaint.” Slip op., at 6.  The Court held that an incorporation condition “provides a remedy for the unreasonable anti-contextual use of a limited subset of the documents produced, in support of a complaint untenable when examined under the full universe of documents obtained.”  Id. at 6-7.

Plaintiff objected on the grounds that a defendant may manipulate the universe of documents by producing only a self-selected subset of documents of its choosing, without any punishment for failing to produce harmful documents.  The Court observed that the same could be said of a motion for summary judgment, in which a defendant wrongfully withholds documents in bad faith.  Vice Chancellor Glasscock posed the question: “does the risk of such potential malfeasance outweigh the benefits of allowing the court to eliminate complaints involving misleading citations to a limited subset of records?”  Id. at 8.  The answer was no.  The Incorporation Condition of the confidentiality agreement was upheld by the Court under 8 Del. C. § 220(c).

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 cneff@foxrothschild.com.

In the recent decision of Mehta v. Kaazing CorporationC.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.

Background

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.

Analysis

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.

Key Takeaway:

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 cneff@foxrothschild.com.

As discussed in various prior posts, a petitioner making a Section 220 books and records demand must state a “proper purpose” to justify inspection. Commonly approved purposes include valuation of stock, and investigation of wrongdoing.

The recent decision of Rodgers v. Cypress Semiconductor Corp., C.A. No. 2017-0070-AGB (Del. Ch. Apr. 17, 2017) sheds light on the standard needed to obtain inspection of books and records to investigate corporate wrongdoing.  There, a former chief executive officer sought inspection to investigate alleged excessive compensation paid to the chairman of the board.  Petitioner also alleged that the chairman violated the company’s code of ethics.

The Court reiterated the point that petitioner need not prove that wrongdoing is actually occurring.  Rather, petitioner need only show, by a preponderance of the evidence, a credible basis from which the Court of Chancery can infer there is possible mismanagement that would warrant further investigation.  Chancellor Bouchard stated that such credible basis may be established through “documents, logic, and testimony”.

The Court also rejected the corporation’s assertion that the stated purpose was not the actual intent behind the demand.    The Court reiterated that it is very difficult to prove that a stockholder’s stated purpose is actually not the true purpose for seeking inspection.  Quoting Pershing Square, L.P. v. Ceridian Corp., “Such a showing is fact intensive and difficult to establish.” 923 A.2d 810, 817 (Del. Ch. 2007).  In light of this high hurdle, Chancellor Bouchard granted petitioner CEO’s inspection demand.

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 cneff@foxrothschild.com.

Under Section 220 of the Delaware General Corporation Law (“DGCL”), only stockholders or directors have standing to make a demand to inspect a Delaware corporation’s books and records.  What happens if, after a books and records demand is made upon the corporation, but before an action is commenced before the Court of Chancery, the stock of the demanding stockholder is extinguished through a merger?  This precise issue was addressed in the recent decision of Weingarten v. Monster Worldwide, Inc., C.A. No. 1293-VCG (Del. Ch. Feb. 27, 2017).

In Weingarten, the plaintiff stockholder’s demand was made before a merger closed, but the petition was not filed until after the merger closed.  The merger extinguished the stockholder status of the plaintiff.

In a matter of first impression, Vice Chancellor Glasscock ruled that the “unambiguous language of Section 220(c) compels a finding that a former stockholder squeezed out in a merger thereafter lacks standing to bring an action under [Section 220]”.  The Court made clear that a plaintiff must be a stockholder at the time the petition is filed with the Court of Chancery, distinguishing decisions in which a stockholder lost standing after filing a complaint, through a merger.

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 cneff@foxrothschild.com.

In selecting lead counsel for a stockholder derivative litigation, the Court of Chancery applies the factors set forth under Hirt v. U.S. Timberland Service Co., 2002 WL 1558342 (Del. Ch. July 3, 2002).  These factors are as follows:

  • the “quality of the pleading that appears best able to represent the interests of the shareholder class and derivative plaintiffs;”
  • the relative economic stakes of the competing litigants in the outcome of the lawsuit (to be accorded “great weight”);
  • the willingness and ability of all the contestants to litigate vigorously on behalf of an entire class of shareholders;
  • the absence of any conflict between larger, often institutional, stockholders and smaller stockholders;
  • the enthusiasm or vigor with which the various contestants have prosecuted the lawsuit; and
  • [the] competence of counsel and their access to the resources necessary to prosecute the claims at issue.

In making the selection, it is noteworthy that the Court of Chancery recently took into account which counsel initiated a books and records demand to support the allegations of its complaint, rather than relying upon publicly known information. This was an important factor in the decision of In re CytRx Corp. S’holder Deriv. Lit. II, C.A. No. 11800-VCMR (Feb. 22, 2017).

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 cneff@foxrothschild.com.