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 ruled, on an issue of first impression, that The We Company’s management did not have the authority to unilaterally preclude a director faction from accessing the office space provider’s privileged information in a dispute over a Japanese investment group with a controlling interest in the matter of In re WeWork Litigation, C.A. No. 2020-0258-AGB, opinion issued (Del. Ch. Aug. 21, 2020).

Chancellor Andre Bouchard’s Aug. 21 opinion ordered We Co. to quickly produce privileged information relating to the circumstances under which management abruptly replaced a specially-appointed two-director committee that had sued investor SoftBank Group Corp. and its ally, SoftBank Vision Fund with a new committee that had agreed to drop the suit.

Delaware law on its head

“It is the board of directors of a corporation—not management—that has the ultimate responsibility for overseeing the affairs of the corporation under 8 Del. C. § 141(a)” but in claiming the right to shield company privileged information from a warring board of directors, “management turns these bedrock principles of Delaware law on their head,” the Chancellor wrote.

He said a special committee of the We Company’s board of directors formed in October 2019 had investigated the circumstances of SoftBank’s proposal to help stave off the company’s liquidity crisis by instituting corporate reforms and investing $3 billion in a stock buy that never transpired.

The special committee, on behalf of We Company, charged in its April Chancery suit, that investors SoftBank and SoftBank Vision Fund breached a contract to use their best efforts to consummate the $3 billion stock buy tender offer; but one month later the company recruited two new temporary directors to form a new special committee to undo the original committee’s work.

New vs. Old Committee

The original committee’s members opposed a motion by the new committee to dismiss their suit and sought information on how the new committee was established and how it may have been influenced by the company’s management, the Chief Executive Officer of which was chosen by SoftBank, he said.  Their suit did not seek access to the new committee’s legal advice.

The Chancellor said in Kalisman v. Friedman, Vice Chancellor J. Travis Laster elaborated on the fundamental principle of Delaware law that a director’s right to information is essentially unfettered in nature,” and “directors of Delaware corporations are generally entitled to share in legal advice the corporation receives.”  Kalisman v. Friedman WL 1668205 (Del. Ch. Apr. 17, 2013).

Kalisman said one exception to that principle is that “a board or a committee can withhold privileged information once sufficient adversity exists between the director and the corporation such that the director could no longer have a reasonable expectation that he was a client of the board’s counsel.”

No exceptions here

But in this case, the board made no decision to withhold privileged information from the special committee after analyzing whether those directors had a “reasonable expectation that [they were] a client of the board’s counsel.”  Instead, “management made that decision unilaterally” he said.

“Directors of a Delaware corporation are presumptively entitled to obtain the corporation’s privileged information as a joint client of the corporation” he said in ordering production, “and any curtailment of that right cannot be imposed unilaterally by corporate management untethered from the oversight and ultimate authority of the corporation’s board of directors.”

 

The Delaware Statute of Limitations for contract claims v. claims for wages was compared and contrasted in Weik, Nitsche & Dougherty, LLC v. Pratcher, C.A. No. 2018-0803-MTZ (Del. Ch. Aug. 26, 2020). In sum:

  • Delaware has a three-year statute of limitations for most contract claims pursuant to 10 Del. C. section 8106
  • For wage claims, generally a one-year statute of limitation applies under 10 Del. C. section 8111, but:
  • where those types of claims overlap and the dividing line between them is not clear, then:
  • this letter ruling should be read carefully for its analysis of this topic. See Slip op. at 15-19.

A one-page Delaware Court of Chancery letter decision recently addressed the practical issue created by the intersection of a public trial with the confidential treatment of the content of pleadings and other court filings that have been cloaked with the protection of Rule 5.1 of the Court of Chancery Rules. Bottom line: the court will not close the entire proceedings of a public hearing or trial notwithstanding the confidential treatment given to court filings under Rule 5.1–but rather, if testimony or other disclosures of a confidential nature are expected to arise during the trial “the public (if any) may be briefly excused from the hearing.” Searchlight PST, L.P. v. MediaMath, Holdings, Inc., C.A. No. 2020-0652-SG (Del. Ch. Aug. 24, 2020).

A recent Court of Chancery decision is almost as noteworthy for what it decided as for what was not decided. In JUUL Labs, Inc. v. Grove, C.A. No. 2020-0005-JTL (Del. Ch. Aug. 13, 2020), Delaware’s court of equity enforced an exclusive forum selection clause in a company charter, based at least in part on the internal affairs doctrine, to prevent a stockholder in a Delaware corporation from filing suit in California in reliance on a California statute to demand the inspection of corporate records, notwithstanding a California statute that appears to allow a stockholder to sue in California for corporate records if the Delaware company has its principal place of business in California.

What the court did not decide is whether a stockholder may contractually waive her rights under DGCL section 220. Count this writer as a skeptic on that point. The court reviewed several overlapping agreements, such as a stock option exercise agreement, that the stockholder signed and that purported, at least in the company’s view, to waive inspection rights under DGCL section 220. Some of the agreements were governed by Delaware law and some by California law.

This decision could be the topic of a law review article due to the many core principles of corporate law and doctrinal underpinnings the court carefully analyzes. Alas, for now, I’ll only provide a few bullet points with an exhortation that the whole opinion be reviewed closely.

    • The court provides an in-depth discussion of the foundational concepts that undergird the internal affairs doctrine as it applies to the request for corporate records, as well as related constitutional issues that arise.
    • But footnote 7 acknowledges contrary authority that suggests that a local jurisdiction may apply its law to a demand by a local resident for corporate records of a foreign corporation.
    • The court compares DGCL section 220 with its counterpart in the California statutory regime.
    • The exclusive forum selection clause in the charter was addressed, and the court explained that but for this provision, the California court would be able to apply DGCL section 220.
    • Importantly, the court emphasized that is was not deciding whether a waiver of DGCL section 220 rights would be enforceable. Although at footnote 14 the court provides citations to many Delaware cases that sowed doubt about the viability of that position–but then the court also cited cases at footnote 15 that more generally recognized the ability to waive even constitutional rights.
    • Footnote 16 cites to many scholarly articles, and muses about the public policy aspects of the unilateral adoption of provisions in constitutive documents, such as forum selection clauses in Bylaws. Early in the opinion, at footnote 7, by comparison the court waxes philosophical about the concept of the corporation as a nexus of contracts–as compared to it being viewed as a creature of the state. The latter view has implications about the exercise of one state’s power in relation to other states, especially when private ordering may be seen as private parties exercising state power by proxy.
    • By coincidence or otherwise, this decision was published the same week that a California court in another case refused to enforce a Delaware forum selection clause because the California court ruled that forcing a California resident to litigate in the Delaware Court of Chancery would deprive that resident of a constitutional right to a jury trial.
    • The foregoing hyperlink leads to an article in Delaware Business Court Insider of Aug. 7, 2020, that describes an apparent settlement to allow the case to proceed in Delaware Superior Court, a trial court of general jurisdiction with juries available. The counterpart suit in Delaware has its own procedural history. See William West v. Access Control Related Enterprises, LLC, et al., C.A. No. N17C-11-137-MMJ-CCLD, opinion (Del. Super. June 5, 2019).

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.

In a recent ruling that clarified the scope of Delaware’s power to validate defective corporate actions, the Chancery Court denied Applied Energetics Inc.’s summary judgment motions on three of four claims in a dispute with a former officer and director it accused of overreaching for power and compensation in Applied Energetics Inc.  v. Farley, et al., No. 2018-0409 JTL, opinion issued (Del. Ch. Aug. 11, 2020).

Vice Chancellor J. Travis Laster’s Aug. 11 opinion granted the struggling company summary judgment on its claim that as the sole remaining member of a three-director board, George Farley clearly lacked board authority to issue himself twenty-five million shares and grant himself a $150,000 yearly salary.

But the vice chancellor declined Applied Energetics’ bid to dismiss Farley’s counterclaims that:

(1) under Section 205 of the Delaware General Corporation Law, the court has the power to validate defective corporate acts that were within the power of the corporation to take,

(2) the court could theoretically validate a decision to grant Farley a salary, and

(3) Farley is entitled to compensation under an unjust enrichment theory (i.e., that the company profited by getting his services for too little), because when the record is construed in Farley’s favor, there is evidence to support an award under a theory of quantum meruit.

History

Applied Energetics Inc., a Delaware-chartered company headquartered in Tucson, Ariz., began engineering and marketing products for the defense and securities industries in 2002 after the 9/11 attacks, but after enjoying some initial success, went into a steep decline in 2006, according to the court.

Farley was the sixth director when he joined the board, but by 2015 he was one of two remaining directors when he and the other director agreed that he should be the principal officer, who would be the official face of the firm, which had a share value of $0.0002 and had been delisted from NASDAQ.

After a group of insurgent shareholders mustered the support of 58 percent of the investors in March 2018 to remove Farley and fill the three director vacancies, Farley resigned his principal officer position, claiming that during his watch, the company’s share price rose 844% to $0.076 per share and that he received only $69,500 out of approximately $300,000 in salary he believes he was owed.

The litigation

The company filed this suit in July 2018 against Farley and AnneMarieCo. LLC, a stock repository for his children, asserting claims for breach of fiduciary duty, aiding and abetting breaches of fiduciary duty, conversion, and fraudulent transfer and seeking cancellation of the defendants’ shares.  It claimed that while Farley said he was trying to re-launch and/or sell the foundering company, he misused his status as the sole officer and director to gain power and revenue he was not entitled to have.

Applied Energetics won a January 23, 2019, preliminary injunction from Justice Tamika Montgomery-Reeves, then a Vice Chancellor, to preclude what the company said was the threat that Farley would abscond with its dwindling resources.  Applied Energetics Inc.  v. Farley et al., No. 2018-0409 TMR, injunction decision issued (Del. Ch. Jan. 23, 2019).

The summary judgment ruling

The company then revised its complaint and sought summary judgement on its claim that none of the actions Farley took while principle executive and sole director, from February 10, 2016, until March 9, 2018 – including the $150,000 salary and stock grants – were valid.  It also sought summary judgment on the four counter-claims Farley filed in response to the amended complaint.

In his Aug. 11 opinion, Vice Chancellor Laster said the actions Farley took on behalf of the three-member board while it was without a quorum were invalid and could not be validated under Section 205 because Section 141 of the DGCL requires a majority of the board for any vote or written consent and a single director cannot remedy that defect by decree.

“Because Farley lacked authority as the sole remaining director to amend the bylaws, the stockholders were the only intra-corporate actor with the power to amend the bylaws between February 10, 2016, until March 9, 2018,” the vice chancellor said.  “The precedents on implicit bylaw amendments consistently apply the doctrine to favor stockholder rights, not to favor incumbent director rights.”

He said the shares Farley purportedly transferred to AnneMarieCo. are invalid because, “under Delaware law, invalid shares in the hands of innocent third parties remain invalid.”

As to Farley’s counterclaim that the court has the power under Section 205 to validate his grant of shares or salary to himself, the vice chancellor said only after a trial can the court determine whether it can or will do that, so that motion must be denied at this juncture.

He explained that the Delaware General Assembly enacted Sections 204 and 205 of the DGCL to create the ability “to overrule the existing precedents requiring that defective stock and acts be found void.” He said the “keystone” provision is Section 204(a) which states that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified.”

The section hinges on the distinction between “power” and “authorization,” he said.  “Properly understood, the concept of corporate power refers to whether the entity has been granted the ability to engage in a given act,” but “the concept of authorization refers to whether the proper intra-corporate actors or combination of actors, such as the corporation’s officers, directors, or stockholders, have taken the steps necessary to cause the corporation to take the given act.”

Applied Energetics had the power to take the challenged actions, the vice chancellor said; the question was whether Farley was authorized to employ that power, and the court has to decide whether he could have properly obtained that authorization.

Farley’s inability to satisfy those authorization requirements was just that—a “failure of authorization that can be validated under Section 205, not an absence of corporate power that cannot,” he said in denying summary judgment on Farley’s counterclaims other than the unjust enrichment claim.

The vice chancellor denied the company summary judgment on that claim because Farley had no contract and, “in the absence of a valid contract, principles of quantum meruit come into play and can support a recovery under a theory of unjust enrichment.”

A recent Delaware Court of Chancery decision deserves a passing reference for its analysis of the statutorily-granted equitable jurisdiction to enforce the Delaware Stormwater Management Act. The opinion in Nieves v. Insight Building Co., LLC, C.A. No. 2019-0464-SG (Del. Ch. Aug. 4, 2020), begins with an entertaining history lesson about the Nanticoke Indians in southern Delaware and their participation in the Methodist Church during the 1800s. The introduction also features a reference to the book of Exodus and that biblical description of the seven plagues as resembling in some ways the allegations in the amended complaint of the infestation of homes with various insects due to water-related problems experienced at new homes in a housing development.

Three bullet points will, I hope, suffice for a high-level identification of the substantive legal issues addressed by the court in the event readers would find an opinion that analyzes these issues in a scholarly manner to be useful:

  • The Delaware General Assembly, by statute, gave the Court of Chancery jurisdiction to grant injunctive relief when warranted to enforce the Delaware Stormwater Management Act.
  • The Court delves into the doctrinal underpinning of fiduciary relationships and why they are not typically found between parties to commercial contracts. The Court explains why it did not impose those heightened duties on the developer of a housing community based on the facts presented.
  • The often insurmountable threshold that must be overcome to successfully pierce the corporate veil in Delaware was explained in this decision, along with the reasons why the facts alleged did not satisfy the exacting requirements for such a claim. Those interested in this last issue should consider reading the book Professor Bainbridge, a friend of the blog and a nationally-recognized corporate law expert, co-authored on this topic.

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 Supreme Court recently affirmed a ruling that unique circumstances justified the denial of a dissident investor’s bid to compel a shareholder meeting and director election at Hawk Systems Inc. — even though he met the requirements of Section 211 of the Delaware General Corporation Law, in Spanakos v. Pate, et al., No. 532, 2019, opinion issued (Del. July 31, 2020).

A three-justice panel’s July 31 opinion found Vice Chancellor Joseph Slights did not abuse his discretion by denying the meeting order despite Delaware’s “fundamental policy favoring” such meetings if needed.  The justices endorsed his decision to instead send plaintiff Mark Spanakos back to Florida where he had won judgments that may enable him to return to Delaware’s Chancery Court to demand a director election as a majority shareholder.

Election requests clarified

The novel high court opinion acknowledged that Spanakos met the requirements of DCGL 8 Del. C. §§ 223(a) and 211(c) because Hawk Systems apparently had not held an election in more than a year and had no valid directors, but it agreed with the lower court that a Florida judge could more easily determine whether Spanakos now held a majority share as a result of that litigation.

Section 211 says a Delaware judge may compel an election meeting, but where a simpler alternative solution presented itself, Vice Chancellor Slights did not abuse his discretion by having a Florida court determine Spanakos’ post-judgment holdings rather than having a Chancery Court special master investigate and calculate the result, the panel said.

History

The appeal sprang from the latest of a series of lawsuits Spanakos filed against Hawk and its officers, directors and insiders in the past decade in Florida and Delaware state courts over the control and management of what began as Hawk Biometrics of Canada, Inc., a fingerprint authorization specialist that moved to Palm Beach, Florida, and incorporated in Delaware after a merger.

After winning judgments in two Florida suits over who controlled the company, Spanakos filed a third action which was stayed by a judge who said the plaintiff’s amount of interest in Hawk was crucial, and directed Spanakos to file this Delaware action to determine how many shares of Hawk he owned and whether he was a validly elected director.

He filed suit seeking a declaration under Section 225(a) that he was a validly elected director and the majority shareholder of Hawk Systems; alternately, under DCGL 8 Del. C. §§ 223(a) and 211(c), he sought an order compelling the company to hold an annual shareholder meeting for the election of directors.

Vice Chancellor Slights’ Sept. 19, 2019 memorandum opinion denied both petitions, finding insufficient records of Spanakos’ stock holdings and ruling that until the Florida litigation concerning stock ownership was resolved, an election would be “unworkable.”  Spanakos v. Pate, et al. C.A. No. 2018-0288-JRS, memorandum opinion (Del. Ch. Sept. 19, 2019).

Two appeal questions

Spanakos’ appeal raised two questions:

(1) Whether Spanakos met the statutory prerequisites that would entitle him to a stockholders’ meeting.

(2) Assuming that Spanakos met those prerequisites, whether the court should have granted the relief Spanakos sought.

Writing for the panel, Justice Tamika Montgomery-Reeves, reasoned under Saxon Indus., Inc. v. NKFW P’rs, 488 A.2d 1298, 1301 (Del. 1984), a stockholder makes a prima facie case for an order compelling a director election by showing:

(1) that he is a stockholder of the corporation,

(2) that a meeting was not held within 30 days of its designated date, or

(3) that a stockholders’ meeting to elect directors has not been held for over thirteen months.

A powerful equity

If the plaintiff shareholder meets those criteria the court may only reject a petition for a stockholders’ meeting when “a powerful equity” supports denying relief, the panel said, quoting In re TransPerfect Glob., Inc., 2017 WL 3499921, at *5 (Del. Ch. Aug. 4, 2017).

“Accordingly, courts only rarely deny proper requests for a stockholders’ meeting, and only for exceptional reasons,” but this is such a case, Justice Montgomery-Reeves explained, noting that the dispute began in Florida and the litigation on the merits is well along toward an award that would determine whether Spanakos owns large blocks of stock.

If the Florida courts clarify their orders and make those awards of stock the case can be resolved quickly, she wrote.  “The Court of Chancery did not abuse its discretion under the specific and unique circumstances in this case when it denied relief at this time and, instead, provided a clear path for Spanakos to return to the Court of Chancery with finalized Florida judgments.”

A recent Delaware Court of Chancery opinion provides insights into nuances of DGCL Section 220 as it relates to the rights of stockholders to inspect corporate books and records, and deserves to be in included in the pantheon of Delaware decisions on this topic. It must be read by anyone seeking a complete understanding of Delaware law on Section 220. In Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020), the court provided warmly welcomed clarity about important nuances of DGCL Section 220 with eminently quotable passages for practitioners who need to brief these issues. See generally  overview of takeaways from 15 years of highlighting Section 220 cases on these pages, and compare a recent Delaware Supreme Court decision featured on these pages about contract-based rights to inspect corporate books and records.

This short blog post will only provide several of those worthy passages in the format of bullet points, but this decision deserves a more comprehensive treatment which is the focus of a separate blog post on these pages.

Among the more noteworthy aspects of this notable decision are the following.

  • A consequential aspect of this jewel of a decision is the instruction by the court that there is no basis in Delaware law to require a stockholder demanding corporate records under Section 220 to explain why the stockholder wants to value her interest in the company–in order to satisfy the recognized proper purpose of valuation. See Slip op. at 11; and 14-15.
  • The court provided an extremely helpful list of many recognized “proper purposes” needed to be shown to satisfy Section 220. See Slip op. at 8-9.
  • The court also recited several examples of what showing is recognized as sufficient to satisfy the “credible basis requirement” to investigate mismanagement pursuant to Section 220. See Slip op. 18-19.
  • An always useful recitation of the basic elements of the fiduciary duty of directors of a Delaware corporation and the subsidiary components of the duty of loyalty and care, are also featured. See Slip op. at 20.
  • The court categorized the specific requests for documents in this case as follows: (i) formal board materials; (ii) informal board materials; and (iii) officer-level materials. Then the court expounds on the different focus applicable to each category.
  • Notably, after quoting the actual document requests, the court found that some of them were overly broad–but the court edited and narrowed some of the requests before concluding that the company was required to produce the court-narrowed scope of documents.

Bonus supplement: Prof. Bainbridge, a nationally prominent corporate law scholar, kindly links to the above post and provides learned commentary on this case and Section 220 jurisprudence generally. Readers should recognize the good professor, a friend of the blog, as the prolific author who scholarship is cited in Delaware Court opinions.

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.

Background

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.

Court’s Analysis

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.

A recent Delaware Supreme Court decision should be required reading for anyone interested in the latest iteration of Delaware law on the contract-based right to demand “books and records” in the alternative entity context. Delaware’s High Court ruled in Murfey v. WHC Ventures, LLC, Del. Supr., No 294, 2019 (July 13, 2020), that the Court of Chancery erred by interjecting into a limited partnership agreement a statutory requirement from Section 17-805 that did not appear in the parties’ agreement.

The great importance of this ruling can best be appreciated by emphasizing that the court did not opine in any manner on the statutory requirements for demanding books and records of a business entity–about which so much has been written on these pages over the last 15 years and about which I recently provided an overview of key decisions with the title for the blog post of: Demands for Corporate Documents Not for the Fainthearted.

I will add to that characterization of Delaware decisions interpreting statutory provisions for demanding corporate documents, a general observation based on the instant decision: Contract-based demands for books and records of business entities are not for the fainthearted either. A few reasons that support my observation include the following:

  • This Supreme Court decision features the en banc Justices split 3-2, along with a less-than-common reversal of a Chancery decision. So, that procedural note underscores that 6 of the best legal minds in Delaware (5 jurists on the high court and 1 in Chancery rendering opinions in this case) cannot find unanimity on this issue.
  • The original demand in this case was made on January 10, 2018. The Chancery complaint was filed in September 2018.  Through no fault of the court system, this final decision on appeal came down on July 13, 2020. About 2 years is still lightening-fast for the period from filing a complaint to a final decision by a state’s highest court, but that still implies substantial legal fees and the need for financial and other types of stamina for someone who is serious about seeking corporate records.
  • Although this decision provides authoritative guidance on this nuance of Delaware business litigation, a careful parsing of the opinion still reveals a fertile field for indeterminacy–which makes it a challenge for the lawyers toiling in this vineyard who are trying to predict the outcome of this type of contract interpretation dispute–even if one need not be concerned with applying the multitude of court decisions applying the statutory provisions for inspection rights in this context.
  • I’ll end my introductory observations on a positive note: despite the plethora of case law interpreting the various statutory provisions for demanding books and records, such as Section 220 and Section 18-305, this decision is a welcome addition to the relatively few published Delaware opinions that address the purely contract-based right to books and records of an alternative entity.

Basic Factual Background

Based on the assumption that readers of this post are familiar with the basics of Delaware law in this area, I’m only highlighting the irreducible minimum amount of facts to provide context for the key legal principles announced.

This case followed a typical pattern. The company provided some documents initially, and at the time of trial the only issue was the very limited documents the company refused to produce. Somewhat unusual was that only one specific type of document was the subject of the trial court decision and the appeal: the K-1 of the other limited partners in the limited partnership. Although the company allowed counsel for the plaintiff and the plaintiff’s valuation expert to review those K-1s, they refused to let the plaintiffs themselves review the K-1s of other limited partners–even subject to the common confidentiality agreement.

The limited partnership agreements involved allowed for a rather broad scope of documents to be demanded, including tax returns which were specifically listed as being subject to production. The company took the curious position that a K-1  (of other limited partners) was not part of the tax returns of the company–or at least not within the scope of documents they need to produce.

Primary Issue Addressed on Appeal

Whether the Court of Chancery erred by injecting into the terms of the agreement that provided for a right to books and records–additional statutory prerequisites. Short answer: yes.

High Court’s Reasoning–Key Takeaways

The majority opinion made quick work of dispensing with the defense that valuation was not a valid basis for requesting the disputed documents or that tax returns were not needed to complete a valuation. See, e.g., footnotes 65 and 66 as well as related text. More notably, the court found that the statutory notion of a “proper purpose” was not applicable to contract-based demands. See, e.g., footnote 53 and accompanying text (quoting with approval prior decisions so holding.)

Also noteworthy is the Court’s reference to dictionary definitions of words, including prepositions, at issue in this case. See footnotes 32 and 33.

The Court reviewed many prior Delaware decisions that addressed when, if ever, it would be appropriate to infer words or conditions that do not appear in the terms of an agreement, such as statutory prerequisites. Slip op. at 18-25.

A key part of the Court’s reasoning was that: because the partnership agreements involved

… do not expressly condition the limited partner’s inspection rights on satisfying a “necessary and essential” condition [a statutory concept], and given the obvious importance of tax return and partnership capital contribution information to the Partnerships’ investors, as evidenced by the agreements, we are not persuaded that such a condition should be implied.

Slip op. at 25

The majority opinion’s “rebuttal” of the dissenting opinion deserves to be read in its entirety. Slip op. 32 to 37. Two especially notable excerpts:

  • ” The words ‘necessary and essential’ do not appear in the written agreements”. Slip op. at 35.
  • “… we also do not agree that the parties to a limited partnership agreement have to expressly disclaim any conditions applied in the Section 220 context (or the Section 17-305 context….)” Footnote 85.