This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
The Delaware Court of Chancery recently granted a Sahara Enterprises Inc. investor’s books-and-records demand to know how the allegedly underperforming investment company was being run after finding that the directors’ and officers’ duty to manage includes keeping accessible records of what they did, in Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020). A more concise list of takeaways about this case also appears on these pages.
Vice Chancellor J. Travis Laster’s July 22 memorandum opinion said Section 220 of the Delaware General Corporation Law does not require the trustee of The Avery L. Woods Trust to specify why she needs to value her Sahara shares in order for valuation to serve as a proper purpose for inspection.
He said after a 2001 reorganization, Sahara, a privately held Delaware corporation with its headquarters in Chicago, functions as a holding company that owns 99 percent of the stock of investment company Sahara Enterprises LLC and the LLC’s managing member SMCO, holds the other 1%. That left SEI owning none of its investments directly, the court said.
SEI reported its revenue and costs bundled with the sister firms, allegedly making it difficult for trustee Avery L. Woods to determine why SEI consistently underperformed the market and whether the cost of managing the investments was inflated by “paying compensation to directors, officers, and employees to manage the managers who manage its investment portfolio.” She also suspected lack of oversight and mismanagement.
After receiving a fraction of the information she demanded as a stockholder, Woods filed a books and records action in Chancery in March which Sahara said should be dismissed because it was only a holding company and SMCO made the investment decisions and kept the relevant records.
The Vice Chancellor said one of Wood’s purposes is to value her shares and, “valuation of a stockholder’s investment in a corporation, particularly where the corporation is privately held, has long been recognized as a proper purpose under 8 Del. C. § 220.”
He rejected Sahara’s argument that Woods failed to show she actually had a proper purpose and “the mere incantation of an accepted ‘valuation’ purpose in a private corporation is [not] sufficient.” That position is “contrary to Delaware law,” because it “would require that a stockholder establish both a proper purpose (valuing shares) and an end use for the resulting valuation,” the court said.
Woods also established a reason to investigate wrongdoing, and “inspecting the company’s books and records can help the stockholder to ferret out whether that wrongdoing is real and then possibly file a lawsuit if appropriate,” Vice Chancellor Laster ruled.
Although the company’s poor performance, without more, has not been sufficiently protracted or extreme to draw an inference of wrongdoing, the tactical position that Sahara took during the litigation points to conflicts that might bolster Wood’s case, he said.
Sahara argued that it had none of the operating records Woods demanded because those functions were the province of SMCO and that it had no control over SMCO — or even access to its records.
First, the court said, that position conflicts with Sahara’s statements to shareholders that the reorganization would have no effect on the management of their assets or their access to records of the company’s operation.
Second, the court said, by representing that Sahara did not have any responsive books and records, it created a credible basis to suspect that Sahara’s “directors have abdicated their statutory responsibilities.” If Sahara’s board of directors relied on SMCO, then the Sahara board “should have, at a minimum, books and records documenting the board’s good faith reliance on and active oversight of SMCO.”
At a minimum, the board owes duties of care and loyalty, so even if it delegates some of its authority, it retains the duty of oversight, which would include record-keeping to show that it fulfilled that function, the Vice Chancellor ruled.
Regarding which documents must be produced for each category’s stated purpose, he said they must be “essential and sufficient to [its] stated purpose.”
How directors and senior officers are compensated and whether they are the beneficiaries of any related-party transactions are basic facts that stockholders are entitled to know and investors are entitled to know how their fiduciaries are taking money out of the corporation, the Court said. “A stockholder should not have to point to a valuation purpose or assert suspicions about corporate wrongdoing to be able to learn how much money the directors and senior officers are receiving.”
In addition, the vice chancellor said Sahara’s annual reports did not make clear who the various officers and directors listed worked for and investors are entitled to know (i) who the Sahara senior officers are, (ii) how much compensation they receive, and (iii) whether Sahara has entered into related party transactions with any officers or directors.
“The Trust’s desire to know this information is itself a proper purpose,” and the Trust is entitled to a court order for the production of any documents from the allied companies that their controllers could “access in the normal course of business,” he said.