DFG Wine Company, LLC v. Eight Estates Wine Holdings, LLC, C.A. No. 6110-VCN (Del. Ch. Aug. 31, 2011). This decision was initially sealed and not available to the public until recently.
This is a books and records action involving an LLC, based on Section 18-305 of the Delaware LLC Act. In this post-trial 31-page opinion, the Court granted in part the request for documents.
DFG sent a written demand in late 2010 for 16 categories of documents. The stated purposes for seeking the records were two-fold: (1) To determine the value of its investment in Eight Estates; and (2) To determine whether it should appoint a representative to sit on the board of managers. The 16 categories of requested records were itemized on pages 4 through 6 of the letter opinion. After an exchange of letters in which Eight Estates maintained that neither the LLC Agreement nor 6 Del. C. Section 18-305 required the production of the requested records, and after making a final request on Dec. 7, 2010 for reconsideration, DFG filed this lawsuit on January 4, 2011.
On January 24, 2011 Eight Estates provided DFG with the documents described at page 7 of the slip opinion. The LLC Agreement defined the rights of members and managers to inspect the books and records of the company and itemized specific records including tax returns and financial statements to which members and managers were entitled.
The issues for trial were whether Eight Estates completely satisfied the demands of documents requested in categories 1, 4 and 6. Eight Estates satisfied categories 2, 3 and 5 after the complaint was filed but did not provide any documents responsive to categories 7 to 17.
Why this Decision is Useful
This ruling provides helpful explanations about the scope of documents that are required to be produced for those seeking to value a closely-held company. The Court explained that because members of a closely-held LLC “do not have access to the same quantity of information available from the regulatory filings of publicly traded companies . . .,” they should “be given slightly broader access rights.” See footnote 23.
The Court also explained that the right of limited liability company members to inspect books and records of a limited liability company’s subsidiaries is not made explicit by 6 Del. C. Section 18-305, but nonetheless, Delaware courts have recognized that the statute provides a right to inspect the records of such subsidiaries where “the facts at least suggested the absence, in reality, of separate entities.” See footnotes 24 and 25 (relying on DGCL Section 220(b)(2) by analogy).
The Court also observed that Section 18-305(c) limits the inspection rights granted to members of an LLC to the extent that the LLC “has the opportunity to establish a good faith belief that disclosure of the desired information would not be in the best interest of the entity . . . .” (citing Arbor Place, L.P. v. Encore Opportunity Fund, LLC, 2002 WL 205681, at *5 (Del. Ch. Jan. 29, 2002)). Moreover, unlike a Section 220 case, a limited liability company is a creature of contract and the LLC Agreement may grant inspection rights that are “in addition to and separate from” the statutory inspection right.
The Court, unsurprisingly, concluded that the purpose of valuation was a proper purpose.
The Court also determined that it was a proper purpose to seek books and records for the purpose of determining whether to appoint someone, and if so, who to appoint as a member of the board of managers of the LLC. The Court compared Section 18-305(b), which gives managers the right to examine all the materials described in Section 18-305(e), with the provision of Section 18-305(c) which allows for a good faith defense to a books and records action involving members – – but not managers.
Importantly, the Court emphasized, by reliance on a Delaware Supreme Court decision (in footnote 36), that so long as a single proper purpose related to one’s role as a stockholder is established, all other purposes are irrelevant (relying on DGCL Section 220).
Records of Subsidiary of LLC
The Eight Estates LLC had no value apart from its subsidiary known as Ascentia. The Court distinguished the Arbor Place case because unlike that case and subsidiaries of the LLC in that opinion, the facts in this case “suggest the absence, in reality, of separate entities.” The Court reasoned that it would be unfair under these circumstances to require a member of Eight Estates to attempt to value its holdings without providing access to the records of the only asset of the LLC, which are the records of the subsidiary, in order to allow the member to value that asset. See footnote 43 citing to a decision involving piercing the corporate veil, which relies on a combination of factors and an overall element of unfairness as opposed to a single factor.
Although the Court allowed the company to redact any information that would be in the nature of trade secrets, the Court was not persuaded by the defense that the member seeking the information would be using that information in order to “cherry pick” or otherwise damage the competitive position of the company.
See footnote 50, referring to Section 18-305(c) which provides that an objective standard is applied to the belief of a manager that certain information is in the nature of a trade secret–but a subjective standard is applied to a belief of a manager that certain disclosures would not be in the best interest of the company.
The Court also rejected the defense that because a large number of hard copy documents were produced in a separate arbitration proceeding, which were designated as “for attorneys’ eyes only,” that the members seeking books and records would not be able to obtain those same documents in this case.
Scope of Relief and Specific Documents Required to be Produced
The Court determined that state tax returns of the subsidiary were not part of the enumerated documents that members were entitled to under the LLC Agreement, but such returns would be part of the “true and full information regarding the status of the business” to which it was entitled under Section 18-305(a)(1).
The Court also explained that the company did not establish a good faith belief that withholding the information would not be in the best interest of the company, and thus required state tax returns to be produced. The Court also required the production of the “independent auditor’s report and financial statements” as well as the unaudited financial statements because those documents are reasonably related to the purpose of valuing the membership interests.
The Court also required the production of Employment Agreements with key employees which would be included within the category of “information regarding the affairs of the limited liability company” pursuant to Section 18-305(a)(6), and these documents also contribute to the valuation of the interest in the LLC, and there was no basis to establish the belief of a manager that withholding those records would be in the best interest of the company.
The production of a general ledger of the subsidiary was also required based on Section 18-305(a)(1). The Court mandated the production of business plans and budgets including projections for future performance, and all documents related to such estimates or projections, subject only to redaction for trade secrets.
The Court also ordered the production of documents related to inventory and non-inventory assets that it determined would be necessary to value an interest in the LLC or its subsidiary. Likewise, the Court ordered the production of documents related to the relationship of the company with its creditors such as any loan agreements, notes, mortgages and other debts or liabilities. In addition, the Court required the production of information regarding grape contracts which apparently have great value in connection with valuing a winery. The Court permitted the production of either the grape contracts themselves or a summary of the contracts that shows how many contracts it has and has had since 2008 and related information about the contracts.