Why This Decision is Noteworthy: A recent Delaware Court of Chancery decision should be read by all corporate litigators who need to know when a director can be prevented from receiving books and records of a corporation on whose board he serves. Bizzari v. Suburban Waste Services Inc., C.A. No. 10709-JL (Del. Ch. Aug. 30, 2016).
Background: This case involves a closely held company in which the founder was later fired when a new stockholder who acquired a 1/3rd interest joined forces with an original stockholder who owned another 1/3rd interest in the company. This opinion provides a rare instance in which the court denies a director unfettered access to the books and records of a corporation on whose board he serves, but this case also involves somewhat extreme facts which are not often replicated.
Analysis: This blog is replete with summaries of many decisions involving stockholders and directors who demand books and records of a corporation or an LLC under DGCL § 220 and the analogous section of the Delaware LLC Act at 6 Del.C. § 18-305. A common theme in the multitude of such cases highlighted on these pages is that what appears to be a relatively simple statute that allows few successful defenses, nonetheless–on a practical level, is often met with expensive and protracted litigation (which is, by court guideline, supposed to be a summary proceeding). To the extent this case lasted for more than a year (through no fault of the court, in light of a stay to allow for settlement discussions), and involved discovery; pre-trial briefing; a trial; and post-trial briefing which gave the stockholder and director who demanded books and records very little of what was sought, this case is consistent with the referenced common theme observed by this writer in the many Section 220 cases reviewed on these pages over many years.
Still, this opinion provides an excellent recitation of the multi-faceted, nuanced prerequisites for demanding books and records, including the recognized proper purposes and the limited defenses available.
Court’s Reasoning: The primary basis for the court’s reasoning in this case was centered on the somewhat unusual facts. The court found during trial that the director and stockholder, who was also a member and manager of an affiliated LLC, engaged in efforts to compete with and inflict reputational harm on the entities. The plaintiff’s actions in that regard were “driven by his intense hatred of the entities’ other two owners and principles.” Together with the familial relationship of the plaintiff with one of the entities’ main competitors, it makes the “prospect of the plaintiff misusing the books and records both real and troubling.”
In sum, the court concluded that “the entities have carried their rather substantial burden of proving that the plaintiff’s demand to inspect books and records in his capacity as a director and manager is not motivated by a proper purpose.”
Key Defenses for Entities Opposing Demands for Corporate Books and Records:
The defense of the corporation and LLC in this matter that was largely successful. The entities demonstrated to the satisfaction of the court that the plaintiff did not have a credible basis from which the court could infer possible mismanagement or wrongdoing–based on the allegations in the complaint. Equally important was the court’s finding that notwithstanding the stated purpose for the demand which was proper, the “true purpose” for the plaintiff’s demand of books and records was “to compete with, and inflict reputation harm on, Suburban Waste because of his personal animus toward” the other two principals and managers of the entities.
Importantly, the general rule is that a director should be entitled to unfettered access to the books and records based on the need of a director to fulfill his duty to oversee a company. That presumption, however, was rebutted in this instance because of the evidence shown at trial that the director in the past not only competed with the companies but attempted to damage their reputation–even if it may have been contrary to his economic interests. The court determined that his primary purpose in demanding inspection of the documents was to gain access to confidential information with the aim of harming the company.
Although one of the stated purposes was valuation, and the court explained why that was a proper purpose, and why he would be given limited “high level” financial information for purposes of valuing his stocks, the additional information he requested would not be provided based on the following improper purposes that the court found were the primary reason the stockholder wanted to obtain the books and records: (1) The purpose was adverse to the company; (2) The purpose was not related to a legitimate interest of the stockholder; and (3) It was intended to harass the corporation. See footnote 36.
The foregoing was true notwithstanding the general principle that as long as the primary purpose of the stockholder to obtain books and records is legitimate, “any secondary purpose is considered irrelevant.” See footnote 35. Although the threshold to establish that the stated purpose is not the primary purpose can be challenging, the facts of this case made that defense more easily available for the corporation.
There are many other gems in this opinion regarding the many nuances of the prerequisites of, and defenses to, demands for books and records which makes this opinion essential reading for those interested in knowing the latest iteration of Delaware law on this topic.
An important procedural note in this case that is important for corporate litigators is the court’s commentary on the impact on this Section 220 case of a subsequently filed plenary action. By subsequently filing a plenary action, the court concluded that the plaintiff had sufficient information under Rule 11 to file the plenary complaint without first inspecting the books and records sought in this action. The court reasoned that by filing the subsequent plenary action, the plaintiff in this case effectively “conceded that the books and records he seeks are not necessary or essential to his stated purpose of investigating mismanagement or wrongdoing.” Moreover, the court reasoned that the plaintiff “can complete any additional investigation under the much broader discovery that will be available to him” in the plenary action.
This reasoning should be compared with another very recent Chancery opinion that made similar observations about the interface between a Section 220 action and a subsequently filed plenary action while both cases were pending at the same time. See In Re Investors Bancorp, Inc. Stockholder Litigation, highlighted on these pages.
Another useful practice tip is contained within this opinion to the extent that it describes the types of documents that are necessary for purposes of valuing an interest in a closely-held company. This should be compared with a Chancery decision in Lim v. The PowerWise Group, Inc., highlighted on these pages, in which the Court of Chancery required an extensive list of data to be provided in order for a valuation to be completed. That list of data was based on one of the leading treatises on valuation, authored by Shannon Pratt.
The point here is that even if valuation is the stated proper purpose, vigorous litigation can result regarding what specific documents are necessary in order to satisfy the proper purpose of valuation. The court observed in the instant case that some of the documents sought for valuation purposes were in reality sought primarily to obtain information about clients and vendors and creditors in order to allow the plaintiff “to further his vendetta” against the other two stockholders, one of whom was the plaintiff’s wife and the other was a former friend of the plaintiff, who was sleeping with the plaintiff’s wife during the plaintiff’s marriage.
Although there are others, the last practice tip that I will note in this overview is that, unlike for a stockholder demand, in a demand for a stockholder list, and/or when a director is demanding books and records, the corporation has the burden of proof to establish that the purpose for the inspection is improper. In this case, the evidence at trial demonstrated that the plaintiff’s motives were “inconsistent with his fiduciary obligations and with the interests of Suburban Waste and its stockholders.” Thus, the corporation met its burden of proof.
Postscript: This decision should be compared to an opinion authored by the same jurist and issued one day later in the Pfizer case, also highlighted on these pages. That ruling also featured a successful defense by a corporation that opposed a stockholder demand for corporate records for the stated purposes of valuation and also to investigate alleged mismanagement based on Caremark claims.