Books and Records Demand

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.

Directors of companies generally have broad and unfettered rights to inspect the corporate records in order to fulfill their fiduciary duties owed to the company and its stockholders.  However, that right is not without limits.  When the company can demonstrate that the director sought inspection to compete or harm the company, the Court will deny inspection rights.  That is precisely the ruling in the recent decision of Bizzari v. Suburban Waste Services Inc., C.A. No. 10709-JL (Del. Ch. Aug. 30, 2016).

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 prior posts, in order to prevail in a books and records inspection action, the petitioning party must demonstrate a “proper purpose” for making such demand.  Moreover, when the purpose is to investigate alleged wrongdoing by a board, a “credible basis” to infer such wrongdoing must exist.  [Click here for a post discussing a Delaware Chancery decision supporting this widely-accepted proposition, Southeastern Transportation Authority v. Abbvie, Inc., C.A. No. 10374-VCG (Del. Apr. 15, 2015).]

The recent decision by the Delaware Court of Chancery, Beatrice Corwin Living Irrevocable Trust v. Pfizer, C.A. No. 10425-JL (Del. Ch. Aug. 31, 2016, corrected Sept. 1, 2016) upheld this maxim.  There, the Court considered whether a plaintiff’s stated purpose was proper in connection with inspecting claims of wrongdoing.

The action was brought by the trustees of a trust to inspect books and records of a public company for the purpose of valuing the trust’s shares and investigating possible mismanagement. The plaintiffs asserted that the company violated accounting and disclosure laws by failing to calculate and disclose a particular deferred tax liability.

Former Master, and current Superior Court Judge, the Honorable Abigail LeGrow, found that plaintiffs have shown no credible basis to infer mismanagement or wrongdoing by the board.  The Court found that an obvious defense to the purported claim existed—the board’s reliance on an audit firm for a complicated accounting issue—and thus denied inspection.

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 the Delaware Statutory Trust Act, a beneficial owner of a Delaware statutory trust may seek inspection of the books and records of such trust.  Those rights are codified under 12 Del. C. § 3819.  Section 3819 provides that each beneficial owner of a statutory trust has the right, subject to reasonable standards imposed by the trustees, to inspect the following documents:

  1. A copy of the governing instrument and certificate of trust and all amendments thereto, together with copies of any written powers of attorney pursuant to which the governing instrument and any certificate and any amendments thereto have been executed;
  2. A current list of the name and last known business, residence or mailing address of each beneficial owner and trustee;
  3. Information regarding the business and financial condition of the statutory trust; and
  4. Other information regarding the affairs of the statutory trust as is just and reasonable.

The recent decision by Vice Chancellor Montgomery-Reeves in the case of Grand Acquisition LLC v. Passco Indian Springs DST, C.A. 12003-VCMR (Del. Ch. Aug. 26, 2016) constitutes the first written opinion adjudicating the right to inspect the records of a Delaware statutory trust.

It is worth noting that the Court looked to case law construing rights in the context of LLCs and LLPs.  In addition, the Court confirmed that a contractual right to inspection is only subject to the conditions in the trust statute, 12 Del. C. § 3819, if the Trust agreement language so specifies.  Otherwise, “[beneficial owners” can inspect the Trust’s books and records without complying with Section 3819’s procedural and proper purpose requirements….” (Slip op. at 18).

Given that the trust agreement at issue contained a books and records inspection clause, Section 5.3(c), and the trust agreement did not state that inspection rights were otherwise subject to Section 3819, the Court analyzed the beneficial owners’ rights to inspect books and records under the terms of the trust agreement.  The Court also clarified that the trust’s “improper purpose defense” required the trust to demonstrate proof of probable harm to the trust, which the Court ruled the trust failed to do.

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.

Does an individual who received a void issuance of stock from a Delaware corporation have standing to bring a books and records action under Section 220 of the Delaware General Corporation Law (“DGCL”)?

That issue was addressed in the recent decision of Pogue v. Hybrid Energy, Inc., C.A. No. 11563-VCG (Del. Ch. Aug. 5., 2016).  In Pogue, the defendant, Hybrid Energy, Inc. (“Hybrid” or the “Company”), defended the action on the grounds that Hybrid’s stock issuance to plaintiff James Pogue was void and the stock certificate a nullity.  While chastising Hybrid for taking such a position in the case and making clear the Court was not ruling on other potential causes of action that Pogue could bring, Vice Chancellor Glasscock found that Pogue lacked standing to bring a Section 220 books and records action against Hybrid.

By way of background, Pogue is a former employee of Hybrid. He alleged that the Company purported to issue him 1,000,000 shares of common stock by certificate dated December 29, 2011, at a time when all of the Company’s authorized shares—1,500 in toto—were held by another individual.  However, according to Pogue, at all material times the Company treated him as a stockholder: the void issuance was represented on the company’s ledger, Pogue was by paid dividends, and Hybrid issued to Pogue a Form 1099-DIV along with a revised stock certificate.

Pogue conceded that the stock transfer was void. However, he argued that because he is listed on the company’s stock ledger, that is the sole determinant of stock ownership under Section 220.  The Court disagreed, finding that a stockholder’s “inclusion on the stock ledger states a prima facie, but rebuttable, case that a plaintiff is a statutory stockholder of record; and that, here, the undisputed record rebuts that presumption, precluding Pogue from the relief he seeks.”  Accordingly, the Court granted Hybrid’s motion for summary judgment and dismissed the case.

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.