Rock Solid Gelt Ltd. v. The SmartPill Corp., C.A. No. 7100-VCN (Del. Ch. Oct. 10, 2012).
Issue Presented: Whether a request for books and records was overly broad in connection with information sought to value one’s interests in a closely held company.
This case involved an investment by Rock Solid in The SmartPill Corporation. Its purchase of preferred stock included anti-dilution provisions, liquidation preferences, redemption rights and other protective provisions. Subsequent rounds of financing, however, involved reduced valuations of the company and the elimination of certain rights of the preferred shareholders in connection with the conversion of all preferred shares to common stock. Rock Solid did not contest that SmartPill had the power to do so but sought books and records to determine possible breaches of fiduciary duty in connection with the lack of independence of board members, and to investigate the independence of the one-person special committee.
This opinion provides an helpful overview of applicable case law regarding Section 220. As in the recent Chancery decision in Lennard, highlighted on these pages here, it was agreed by the parties that Rock Solid complied with the form and manner requirements of Section 220, but there was a disagreement on whether the “proper purpose” requirement was satisfied and whether the scope of the documents requested was too broad. Compare recent Delaware Supreme Court decision in News Corp. highlighted on these pages here, in which the Court upheld the dismissal of a Section 220 complaint based on a failure to satisfy the statutory form and manner requirements.
Valuation is a well-recognized proper purpose for the inspection of books and records. See footnote 36. However, regarding the purpose of investigating whether the board committed breaches of fiduciary duty and whether the special committee was indeed independent in connection with the supplemental financing, Rock Solid was required to present “some evidence” of possible mismanagement that would warrant further investigation of the matter. Although it was not required to conclusively establish wrongdoing, there must be a credible basis demonstrated from which the Court can infer possible mismanagement that would warrant further investigation.
The Court referred to a previous Chancery decision in Grimes v. DSC Communications Corp., 724 A.2d 561 (Del. Ch. 1998), which held that a plaintiff stating a purpose to investigate the independence of the special committee, without more, is
“at least entitled to receive copies of the special committee report, minutes of the meeting of the special committee, and minutes of any meeting of the board of directors relating to the creation or the recommendation of the special committee.”
The Grimes court held that it would require further showing of need before requiring the company to produce additional documents.
In footnote 50, the Vice Chancellor in the instant decision noted that mere allegations that a member of the special committee is dependent upon controlling stockholders is not sufficient to call his independence into doubt.
Also noteworthy is the comment of the Court in footnote 54 that despite the arguments of SmartPill that Rock Solid had “an ulterior motive for its books and records request,” because Rock Solid established at least one primary proper purpose, Section 220 relief will not be defeated by the fact that it may also have a secondary improper purpose. (citations to cases in footnote 54 omitted.)
Also instructive is the observation of the Court that: “A stockholder’s perception that a fellow shareholder was able to acquire additional shares on favorable terms does not, without more, support a conclusion that mismanagement or other improper conduct was a foundation for the Fox SPA.”
The Court found that the request for books and records was overly broad and although the Court was tempted to reject the broad request and was not happy in serving in the role of an editor of the request to make them comply with the “rifled precision” required, the Court, in effect, did edit the requests, and provided a list of the documents that it would order produced, which was a shorter list than requested.
For example, at page 23 of the slip opinion, the Court cited the documents that Rock Solid requested for its valuation. Although valuation is a proper purpose, the Court found that the documents requested were overly broad and on page 24 of the slip opinion listed the documents that the Court would require the production of, for valuation purposes.