Mickman v. American International Processing, L.L.C., Del. Ch., No. 3869-VCP (July 28, 2009), read opinion here.
This opinion decides issues related to a demand for books and records pursuant to the terms of an LLC Operating Agreement.
The issues addressed are more precisely formulated as follows: (1) How broad is the definition in the agreement of the phrase “all books and records”; (2) Does “access” to such books and records include the right to photocopies; and (3) Is there a basis to award attorneys’ fees based on the conduct of the defendant?
Overview of Ruling
First, the court held that the plaintiff was entitled to copies of the general ledgers of the LLC – – and not simply the ability to read them, based on both: (1) The language of the Operating Agreement; and (2) Section 18-305 of the Delaware LLC Act, found in Title 6 of the Delaware Code.
The court observed that it has been previously established in Delaware that LLC Agreements can grant members inspection rights that exceed the rights provided for in the statute. Second, the court did not agree that the defendants conducted the litigation vexatiously or in bad faith and therefore denied the request for fees and costs filed by the plaintiff.
A specific sub-issue in this case was whether the phrase in the agreement: “shall have access to all books and records,” included the “general ledger.”
The court made the common observation that it often looks to Delaware corporate statutes and case law when interpreting similar provisions in an LLC Agreement “due to the paucity of reported decisions in the LLC context”.
The court reviewed prior case law and how those cases described what was included in the phrase “all books and records” and noted that the phrase commonly referred to the grant of broad inspection rights, including general ledgers. (citing Helmsman Mgmt. Servs., Inc. v. A & S Consultants, Inc., 525 A.2d 160, 163 (Del. Ch. 1999)).
The court’s reasoning included the fact that nothing in the Operating Agreement implied that defendants intended to limit the breadth of documents or to use the phrase “all books and records” in a more restrictive manner than in its ordinary meaning. Moreover, defendants did not offer any plausible alternative interpretation under which the general ledgers would fall outside the scope of the phrase “all books and records.” See generally Arbor Place, L.P. v. Encore Opportunity Fund, LLC, 2002 WL 205681, at *3 (Del. Ch. Jan. 29, 2002).
Access Includes the Right to Obtain Photocopies
The court reasoned that in the context of this case the right to access the general ledgers included the right to obtain photocopies of those ledgers. Although the agreement did not define the term “access,” the term is commonly used in defining inspection rights under the analogous corporate books and records statute in Section 220(b) of the Delaware General Corporation Law, where, for example, “if a shareholder is granted inspection rights, the shareholder has a right ‘to make copies of the document. Long before the statute was enacted, courts similarly found that, ‘if there be a right to examine . . . a corresponding right is to make the examination beneficial by taking copies thereof.’” (citing State v. Superior Oil Corp., 13 A.2d 453, 463 (Del. Super. 1940); and Ostrow v. Booney Forge Corp., 1994 WL 114807, at *10 (Del. Ch. Apr. 6, 1994)). The court noted that in the Ostrow case, the Chancery Court had granted inspection rights that included the right to make copies even though an applicable agreement did not expressly provide a right to make copies.
However, the court noted that the demand under Section 18-305 of the Delaware LLC Act is different than the demand based on the terms of the Operating Agreement in this case which only required one-day written notice prior to a request for access to documents.
Request for Attorneys’ Fees
The court carefully considered but quickly rejected the request for attorneys’ fees that were sought based on the claim that the defendants refused in bad faith to provide the documents requested. The court referred to the American Rule followed in Delaware which is that, generally speaking, each party pays its own fees, with limited exceptions based, for example, on bad faith in opposing the relief being sought in the lawsuit. That bad faith exception authorizes an award of attorneys’ fees if defendants’ conduct “forced the plaintiff to file suit to ‘secure a clearly defined and established right’” (citing McGowan v. Empress Entm’t, Inc. 791 A.2d 1, 4 (Del. Ch. 2000)). In order to prevail based on that argument, the plaintiff was required to show “by clear evidence that she had a clearly defined right to inspect defendants’ books and records, and defendants’ conduct forced her to litigate to enforce that right.”
In part, the court rejected any fee shifting because of the factual and legal issues that remained for trial, about whether or not plaintiff was a member of one of the LLCs involved, in light of the discrepancy between the reference to her as a member in the tax return and Schedule K-1, but her omission from the list of members in the Operating Agreement. (This issue of membership was not waived but for purposes of the instant decision only it was not contested.)
In closing I want to point out a key part of this opinion that will be important for those involved in business litigation. Specifically, notwithstanding one of the parties being included in the tax return of the LLC and the Schedule K-1, the court allowed to proceed to trial an issue of whether that person was a member of the LLC because she was not listed as a member in the LLC’s Operating Agreement. Thus, being included as part of the tax return, ipso facto, was not enough to establish ownership in the LLC, at least in light of other contrary documentary evidence.