In Sanders v. Ohmite Holding, LLC, C. A. No. 5145-VCL (Del. Ch. Feb. 21, 2011), read opinion here, the Delaware Court of Chancery clarified the rights of a member of an LLC to demand certain books and records of an LLC.

Issue Addressed

 Whether the member was entitled to books and records, pursuant to Section 18-305 of the Delaware LLC Act ( 6 Del. C. Section 18-305), for a period prior to him becoming a member of the LLC? Answer: Yes.

Short Factual Background

Max Sanders loaned $2 million to a member of an LLC and received a security interest in the member’s units as collateral. That member later transferred his interests back to Sanders. In the interim, the member’s units were diluted and instead of having the 7.75% stake that he thought he had, the LLC told Sanders that he only had what the Court described as a "nigh microscopic"  stake of merely 0.000775%. Sanders made a formal demand for 8 categories of books and records relating to why his units were diluted and the value of his interest as well as the performance of the LLC’s management. The LLC denied the request in total. After this action was filed, the LLC did provide tax returns and financial statements but not all the documents requested. Based on that information, the Court found that Sanders had a reasonable basis to believe that additional units were issued to an affiliated party at a deep discount, and thus, questioned whether the LLC received proper consideration for the additional units that were issued.

Holding

The Court determined that Sanders had a proper purpose for inspecting the books and records and that the documents he requested were necessary for him to fulfill that purpose, regardless of whether they pre-date when he formally acquired member status. Thus, summary judgment was granted for Sanders.

Procedural Posture

Both parties filed cross motions for summary judgment which the Court treated as the equivalent of a stipulation for decision on the merits based on the record submitted with the motions, pursuant to Chancery Rule 56(h).

Brief Overview of Key Legal Principles Discussed

As the Court observed:

Section 18-305(a) of the LLC Act provides a member of an LLC with the right,
“upon reasonable demand for any purpose reasonably related to the member’s interest as
a member” of the LLC, to obtain the following records:

(1) True and full information regarding the status of the
business and financial condition of the limited liability
company;

(2) Promptly after becoming available, a copy of the
limited liability company’s federal, state and local income tax
returns for each year;
. . . .
(5) True and full information regarding the amount of cash
and a description and statement of the agreed value of any
other property or services contributed by each member and
which each member has agreed to contribute in the future,
and the date on which each became a member; and

(6) Other information regarding the affairs of the limited
liability company as is just and reasonable.

 6 Del. C. § 18-305(a). The inspection right is subject to “such reasonable standards(including standards governing what information and documents are to be furnished . . . ) as may be set forth in a limited liability company agreement or otherwise established by
the manager.” Id.

The rights of Sanders were co-extensive with Section 18-305 of the LLC Act because the LLC Agreement did not limit those rights. The Court observed that the extensive case law surrounding the rights of a shareholder to books and records of a corporation under DGCL Section 220 are often considered by analogy in the LLC context. Likewise, the following basic rules apply:

  • There must be a "proper purpose" for the inspection;
  • That proper purpose must be reasonably related to such person’s interest as a member;
  • The requested books and records must be reasonably required to fulfill the stated purpose.

Delaware cases have established several proper purposes in this context, including:

  • valuation of one’s ownership interest
  • investigation of potential wrongdoing and mismanagement. Note that in order to satisfy this proper purpose, one need not prove wrongdoing. Rather, it suffices in this context to merely present a "credible basis" to suspect wrongdoing and from which the court may "infer" wrongdoing that would warrant further investigation.

In this case, the Court explained that wrongful dilution that benefits a majority holder establishes a credible basis from which the Court can infer that further investigation is warranted.

The Court also remarked that the data received need not be used to file a derivative suit and that it may also be used, for example, to "communicate with … management" and to determine whether to retain or dispose of one’s interest.

A core inquiry in these types of cases is whether the documents requested are "essential and sufficient" to satisfy the party’s stated purpose. See footnote 2 and related text that comments on the lack of precision in these words that are used by the courts in these types of matters, and what the Court calls the "strange" choice of  "bi-partite phrasing".

Among the documents that the Court determined were reasonable to request in order to advance the stated purpose, were minutes of meetings that discussed the number and pricing of the units issued, and records relating to any opportunity that Sanders had to buy the units at the same price. The Court cited to cases in the Section 220 context to support its decision to allow the records requested for a period prior to the date that Sanders became a member because the records from that earlier period obviously had an impact, for example, on the value of the fully diluted units he currently owned.

Postscript

Although the result of this case may be a positive one for the member seeking the books and records, it may also be described in some ways as a Pyrrhic victory, for several reasons. First, the opinion describes the litigation that was initiated in Illinois by the member way back in November 2007 in his first attempt to address the issues involved. Now, over three (3) years later he obtains some judicial relief–but the story does not end there. The member still does not have the documents. I suspect that there is a good chance that the LLC will not be forthcoming in a prompt and complete manner with all the documents they are required to produce pursuant to this opinion. To the extent that the opinion requires "categories of documents" there is plenty of opportunity for the company to engage in Fabian tactics. I’m not in any way suggesting that the company in this case will do so. I’m simply commenting based on my experience that if the company did so, it would not be unprecedented.

The takeaway, in my view, about these cases, is that requests by members or shareholders for books and records are not for the faint-hearted and are not for those who do not have the financial stamina, or the financial tenacity to spend considerable sums in legal fees to pursue litigation if the company is determined to make the process as expensive as possible, especially in light of the American Rule pursuant to which each party pays its own fees, regardless of who wins the case.

Lavi v. Wideawake Deathrow Entertainment LLC, C.A. No. 5779-VCS (Del. Ch. Jan. 18, 2011), read letter ruling here.

Issue Addressed

The issue decided by the Court of Chancery in this books and records action under Section 18-305 of the Delaware Limited Liability Company Act was whether a motion to dismiss the complaint should be granted in light of the multiple documents that were attached to the motion that went beyond what the Court could properly consider at the early stages of the summary proceeding. Thanks to counsel for the plaintiff, David L. Finger, a Delaware litigator, for forwarding this letter ruling to us.

Brief Overview of Decision

This short 3-page letter ruling can be most efficiently summarized in classic bullet point fashion as follows:

1) The Court emphasizes in several parts of the ruling that books and records actions in Delaware are summary proceedings that should receive prompt trial dates.

2) The author of the letter ruling in this case does not favor dispositive motions in books and records cases, in light of their nature as summary proceedings, “when a trial can take place within two months of filing” a complaint, (although, in the past, other members of the Court have granted dispositive motions in books and records cases).

3) The Court provides pointed instruction on motion practice to the extent that a motion to dismiss under Rule 12(b)(6) is contrasted with a motion for summary judgment. Specifically, the Court explained that when documents beyond those contained or referenced in the pleadings are attached to a motion to dismiss, it is converted into a motion for summary judgment.

4) The Court explained that it could not properly consider all the documents attached to the motion of the defendant through either judicial notice or otherwise. Instead, the Court denied the motion and ordered the parties to submit a proposed schedule for a prompt trial “as is contemplated in books and records actions.”

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.

 

 

JAKKS Pacific, Inc. v. THQ/JAKKS Pacific, LLC, Del. Ch., No. 4295-VCL (May 6, 2009), read opinion here.

 Pursuant to Section 18-305 of the Delaware Limited Liability Company Act (6 Del. C. Section 18-305), the plaintiff in this case sought an inspection of the books and records of an LLC. The complaint was filed on January 16, 2009. A one-day trial was held on March 31, 2009. The post-trial briefing concluded on April 27, 2009. One should note the procedural speed with which this matter was decided.

In sum, the court explained that there was not a “proper purpose” as required for a books and records demand. The stated purposed was recounted on page 8 of the slip opinion, but the court “drilled down” to determine that the “real purpose” was not “reasonably related to the specific interests of the member making the demand.” The court found that after trial, the plaintiff did not establish, by a “preponderance of the evidence” the existence of a “proper purpose” for inspection. (citing Somerville S. Trust v. USV Partners, LLC, 2002 WL 1832830, at *5, (Del. Ch.))  At page 10 of the slip opinion the court explained that it will not simply take the “stated proper purpose” at face value. Rather, it will require evidence to support that proper purpose. That requirement was not met in the case. For example, although the court stated that in most circumstances a valid purpose for a demand would be to value the interest one had in a company, in this case the court determined that such a stated purpose was largely meaningless since the valuation was the subject of a previous arbitration, the decision for which was expected at any time.
 

This decision provides a helpful example of the substantial amount of time and money that can be spent in a books and records demand case–only to "come up dry".

For the last 16 years, these pages have featured many highlights of court decisions addressing the right of a stockholder, or a member of an LLC, to demand a company’s “books and records“. Regular readers will recall much commentary about why the exercise of such rights are not for the fainthearted.

Why this decision is important: The Delaware Court of Chancery’s pithy ruling in Pettry v. Gilead Sciences, Inc., C.A. No. 2020-0132-KSJM (Del. Ch. July 22, 2021), provides guidance to litigators in general, and corporate litigators in particular, that “glaringly egregious” is where the line is drawn for determining when fees will be shifted. This illuminates the amorphous “bad faith” articulation of the standard that must be triggered before the losing party will be required to pay the attorneys’ fees of the victor as an exception to the general “American Rule” that each party pays its own legal fees. To be sure, other decisions have shifted fees, and this letter decision is filled with copious citations to many prior Chancery opinions that provide a solid foundation for the court’s reasoning. The court also cited to key cases that explain the substantive requirements of DGCL Section 220.  See, e.g., AmerisourceBergen Chancery decision, highlighted here, and upheld by the “Supremes”, as noted here.

In this recent ruling, the Court of Chancery clarified the standard the court will apply to shift fees and require the company who has engaged in improper litigation tactics to pay the attorneys’ fees of the stockholder seeking the books and records of a company. In this case, the court granted a request for attorneys’ fees that have been reported to be about $1.7 million through the trial. The post-trial decision in this matter that granted the requested access to books and records provides more background about this case and was featured on these pages

Commentary on court decisions too numerous to count appearing on these pages has included the statutory prerequisites for successfully demanding corporate books and records, and the ruling in this case assumes familiarity with those requirements. Thus, the most useful approach for this short blog post is to highlight via bullet points the notable quotes with the most widespread applicability for those who toil in the vineyards of corporate and commercial litigation in Delaware.

Money Quotes:

  • “Gilead argued that Plaintiffs had not met the credible basis requirement to investigate wrongdoing–a requirement that imposes ‘the lowest possible burden of proof’–even though Plaintiffs had ample support for their proposition.” See footnote 10, which recites examples of that support from the post-trial opinion.
  • Gilead incorrectly opposed the inspection requests by arguing (wrongly) that any claims being investigated would be dismissed–but the Court instructed that under Delaware law: “…the stockholder need not demonstrate that the alleged mismanagement or wrongdoing is actionable in order to be entitled to inspection.” See footnote 11 and accompanying text.
  • “… where this court shifts fees to curb and correct for overly vexatious litigation behavior, a showing of glaringly egregious litigation conduct is enough.” (emphasis added) Slip op. at 5.  (Glaringly egregious is a more useful formulation than “bad faith alone”, and specific examples were provided in this ruling.)
  • The court added that: “To the extent a finding of bad faith is necessary, then the court can infer bad faith based on the litigation conduct alone.” Slip op. at 5-6. In this case, the court found that inference to be appropriate based on the examples provided and references to the post-trial opinion–highlighted on these pages.

Supplement: I was quoted by The Delaware Business Court Insider, as well as by a publication of Financial Times called Agenda about the impact of this decision.

URL
https://www.delawarelitigation.com/tag/502/
https://www.delawarelitigation.com/tag/6-del-c-%c2%a7-18-111/
https://www.delawarelitigation.com/tag/6-del-c-%c2%a7-18-305/
https://www.delawarelitigation.com/tag/6-del-c-section-17-1101/
https://www.delawarelitigation.com/tag/6-del-c-section-18-1101/
https://www.delawarelitigation.com/tag/ab-initio/
https://www.delawarelitigation.com/tag/aba-journals-blawg-100/
https://www.delawarelitigation.com/tag/abigail-myers-legrow/
https://www.delawarelitigation.com/tag/accounting/
https://www.delawarelitigation.com/tag/adequate-security/
https://www.delawarelitigation.com/tag/admission-pro-hac-vice/
https://www.delawarelitigation.com/tag/advance-notice-bylaws/
https://www.delawarelitigation.com/tag/advancement-of-feesaffirmative-claimsfrancis-g-x-pileggi/
https://www.delawarelitigation.com/tag/advancement/
https://www.delawarelitigation.com/tag/advancement/page/2/
https://www.delawarelitigation.com/tag/advancementindemnificationattorneys-fees-from-trusttrust-litigation/
https://www.delawarelitigation.com/tag/advancementindemnificationfees-on-feescorporate-litigation/
https://www.delawarelitigation.com/tag/advancementindemnificationsection-145/
https://www.delawarelitigation.com/tag/adverse-inference/
https://www.delawarelitigation.com/tag/adverse-witness/
https://www.delawarelitigation.com/tag/affidavits-attached-pleadings/
https://www.delawarelitigation.com/tag/affiliate-defined/
https://www.delawarelitigation.com/tag/affirmative-defenses/
https://www.delawarelitigation.com/tag/agency/
https://www.delawarelitigation.com/tag/agent/
https://www.delawarelitigation.com/tag/agents-duty-to-principal/
https://www.delawarelitigation.com/tag/agreement-to-agree/
https://www.delawarelitigation.com/tag/aicpascienterpleading-the-fifth-amendmentfiduciary-v-contract-claimsequitable-fraudcommon-law-fraudrule-56summary-judgment/
https://www.delawarelitigation.com/tag/aiding-and-abetting/
https://www.delawarelitigation.com/tag/ali-corp-gov-principles/
https://www.delawarelitigation.com/tag/allocation-of-settlement-proceeds/
https://www.delawarelitigation.com/tag/alter-ego/
https://www.delawarelitigation.com/tag/alternative-pleading/
https://www.delawarelitigation.com/tag/amend-stipulation/
https://www.delawarelitigation.com/tag/amended-complaint/
https://www.delawarelitigation.com/tag/amended-v-supplemental-pleading/
https://www.delawarelitigation.com/tag/amendment-to-complaint/
https://www.delawarelitigation.com/tag/amendment/
https://www.delawarelitigation.com/tag/american-rule/
https://www.delawarelitigation.com/tag/amici-curiae/
https://www.delawarelitigation.com/tag/amicus-curiae-brief/
https://www.delawarelitigation.com/tag/amicus-curiae/
https://www.delawarelitigation.com/tag/annual-meetings/
https://www.delawarelitigation.com/tag/annual-pileggi-lecture/
https://www.delawarelitigation.com/tag/annual-review-of-key-delaware-corporate-and-commercial-decisions/
https://www.delawarelitigation.com/tag/annual-shareholders-meeting/
https://www.delawarelitigation.com/tag/annual-tulane-corporate-law-institute/
https://www.delawarelitigation.com/tag/anti-reliance-clause/
https://www.delawarelitigation.com/tag/apparent-authority/
https://www.delawarelitigation.com/tag/appeal-of-summary-possession/
https://www.delawarelitigation.com/tag/appeals/
https://www.delawarelitigation.com/tag/appellate-review-standards/
https://www.delawarelitigation.com/tag/appellate-standard-of-review/
https://www.delawarelitigation.com/tag/appointment-of-receiver/

Why This Decision is Noteworthy: A recent Delaware Court of Chancery decision should be read by all corporate litigators who need to know when a director can be prevented from receiving books and records of a corporation on whose board he serves. Bizzari v. Suburban Waste Services Inc., C.A. No. 10709-JL (Del. Ch. Aug. 30, 2016). I published an article about this case for the magazine of the National Association of Corporate Directors.

Background: This case involves a closely held company in which the founder was later fired when a new stockholder who acquired a 1/3rd interest joined forces with an original stockholder who owned another 1/3rd interest in the company. This opinion provides a rare instance in which the court denies a director unfettered access to the books and records of a corporation on whose board he serves, but this case also involves somewhat extreme facts which are not often replicated.

Analysis: This blog is replete with summaries of many decisions involving stockholders and directors who demand books and records of a corporation or an LLC under DGCL § 220 and the analogous section of the Delaware LLC Act at 6 Del.C. § 18-305. A common theme in the multitude of such cases highlighted on these pages is that what appears to be a relatively simple statute that allows few successful defenses, nonetheless–on a practical level, is often met with expensive and protracted litigation (which is, by court guideline, supposed to be a summary proceeding). To the extent this case lasted for more than a year (through no fault of the court, in light of a stay to allow for settlement discussions), and involved discovery; pre-trial briefing; a trial; and post-trial briefing which gave the stockholder and director who demanded books and records very little of what was sought, this case is consistent with the referenced common theme observed by this writer in the many Section 220 cases reviewed on these pages over many years.

Still, this opinion provides an excellent recitation of the multi-faceted, nuanced prerequisites for demanding books and records, including the recognized proper purposes and the limited defenses available.

Court’s Reasoning: The primary basis for the court’s reasoning in this case was centered on the somewhat unusual facts. The court found during trial that the director and stockholder, who was also a member and manager of an affiliated LLC, engaged in efforts to compete with and inflict reputational harm on the entities. The plaintiff’s actions in that regard were “driven by his intense hatred of the entities’ other two owners and principles.” Together with the familial relationship of the plaintiff with one of the entities’ main competitors, it makes the “prospect of the plaintiff misusing the books and records both real and troubling.”

In sum, the court concluded that “the entities have carried their rather substantial burden of proving that the plaintiff’s demand to inspect books and records in his capacity as a director and manager is not motivated by a proper purpose.”

Key Defenses for Entities Opposing Demands for Corporate Books and Records:

The defense of the corporation and LLC in this matter that was largely successful. The entities demonstrated to the satisfaction of the court that the plaintiff did not have a credible basis from which the court could infer possible mismanagement or wrongdoing–based on the allegations in the complaint. Equally important was the court’s finding that notwithstanding the stated purpose for the demand which was proper, the “true purpose” for the plaintiff’s demand of books and records was “to compete with, and inflict reputation harm on, Suburban Waste because of his personal animus toward” the other two principals  and managers of the entities.

Importantly, the general rule is that a director should be entitled to unfettered access to the books and records based on the need of a director to fulfill his duty to oversee a company. That presumption, however, was rebutted in this instance because of the evidence shown at trial that the director in the past not only competed with the companies but attempted to damage their reputation–even if it may have been contrary to his economic interests. The court determined that his primary purpose in demanding inspection of the documents was to gain access to confidential information with the aim of harming the company.

Although one of the stated purposes was valuation, and the court explained why that was a proper purpose, and why he would be given limited “high level” financial information for purposes of valuing his stocks, the additional information he requested would not be provided based on the following improper purposes that the court found were the primary reason the stockholder wanted to obtain the books and records: (1) The purpose was adverse to the company; (2) The purpose was not related to a legitimate interest of the stockholder; and (3) It was intended to harass the corporation. See footnote 36.

The foregoing was true notwithstanding the general principle that as long as the primary purpose of the stockholder to obtain books and records is legitimate, “any secondary purpose is considered irrelevant.” See footnote 35. Although the threshold to establish that the stated purpose is not the primary purpose can be challenging, the facts of this case made that defense more easily available for the corporation.

There are many other gems in this opinion regarding the many nuances of the prerequisites of, and defenses to, demands for books and records which makes this opinion essential reading for those interested in knowing the latest iteration of Delaware law on this topic.

Procedural Notes:

An important procedural note in this case that is important for corporate litigators is the court’s commentary on the impact on this Section 220 case of a subsequently filed plenary action. By subsequently filing a plenary action, the court concluded that the plaintiff had sufficient information under Rule 11 to file the plenary complaint without first inspecting the books and records sought in this action. The court reasoned that by filing the subsequent plenary action, the plaintiff in this case effectively “conceded that the books and records he seeks are not necessary or essential to his stated purpose of investigating mismanagement or wrongdoing.” Moreover, the court reasoned that the plaintiff “can complete any additional investigation under the much broader discovery that will be available to him” in the plenary action.

This reasoning should be compared with another very recent Chancery opinion that made similar observations about the interface between a Section 220 action and a subsequently filed plenary action while both cases were pending at the same time. See In Re Investors Bancorp, Inc. Stockholder Litigation, highlighted on these pages.

Another useful practice tip is contained within this opinion to the extent that it describes the types of documents that are necessary for purposes of valuing an interest in a closely-held company. This should be compared with a Chancery decision in Lim v. The PowerWise Group, Inc., highlighted on these pages, in which the Court of Chancery required an extensive list of data to be provided in order for a valuation to be completed. That list of data was based on one of the leading treatises on valuation, authored by Shannon Pratt. 

The point here is that even if valuation is the stated proper purpose, vigorous litigation can result regarding what specific documents are necessary in order to satisfy the proper purpose of valuation. The court observed in the instant case that some of the documents sought for valuation purposes were in reality sought primarily to obtain information about clients and vendors and creditors in order to allow the plaintiff “to further his vendetta” against the other two stockholders, one of whom was the plaintiff’s wife and the other was a former friend of the plaintiff, who was sleeping with the plaintiff’s wife during the plaintiff’s marriage.

Although there are others, the last practice tip that I will note in this overview is that, unlike for a stockholder demand, in a demand for a stockholder list, and/or when a director is demanding books and records, the corporation has the burden of proof to establish that the purpose for the inspection is improper. In this case, the evidence at trial demonstrated that the plaintiff’s motives were “inconsistent with his fiduciary obligations and with the interests of Suburban Waste and its stockholders.” Thus, the corporation met its burden of proof.

Postscript: This decision should be compared to an opinion authored by the same jurist and issued one day later in the Pfizer case, also highlighted on these pages. That ruling also featured a successful defense by a corporation that opposed a stockholder demand for corporate records for the stated purposes of valuation and also to investigate alleged mismanagement based on Caremark claims.

Parkcentral Global, L.P. v. Brown Investment Management, L.P., No. 288, 2010 (Del. Supr., Aug. 12, 2010), read opinion here.

Brief Overview

This Delaware Supreme Court decision affirmed a ruling of the Court of Chancery which allowed a limited partner to demand a list of other limited partners in a hedge fund formed as a limited partnership. (Compare: Delaware Supreme Court decision issued the day before this decision, summarized here, that denied a shareholder’s demand for books and records.) 

Procedural Background

Within three months of filing a complaint to seek books and records, the Court of Chancery held a trial and determined that pursuant to § 17-305 of the Delaware Revised Uniform Limited Partnership Act (DRULPA), as well as the terms of the partnership agreement, the general partner was required to produce a list of limited partners’ names and their last known business, residence or mailing address. The affirmed Chancery decision was highlighted here. Although the Court of Chancery refused to grant a stay pending appeal, on May 27, 2010, shortly after the Chancery opinion, the Supreme Court did grant a stay pending an appeal

Discussion

DRULPA Section 17-305 entitles limited partners to access partner information and records if they make a demand for a purpose reasonably related to their interest as a limited partner. Subsection (a) allows a general partner to establish reasonable standards governing the right to access information. Subsection (f) allows a general partner to restrict the rights of a limited partner to obtain information under Section 17-305.

The stated purpose for which the limited partner sought the data, and which the Supreme Court upheld as a proper purpose, was quoted in the opinion as follows:

“(a)   contact other limited partners in order to investigate claims of the general partner’s mismanagement or breaches of fiduciary duty;
(b)    contact other limited partners to investigate the allegations made in [other] pending litigation;
(c)    contact other limited partners to bring their attention to the [other] litigation….;
(d)    contact other limited partners to investigate potential direct and derivative claims against the partnership’s auditor;
(e)    contact other limited partners to discuss whether any of them would desire to pursue a derivative  and/or a direct claim against the partnership’s auditors.”

Parkcentral argued that federal regulations preempted Delaware law and prohibited disclosure of the shareholder list. It referred to the Gramm-Leach-Bliley Financial Modernization Act of 1999, which provided privacy protections for customers of financial institutions. Pursuant to the Act, several federal agencies including the SEC adopted rules designed to protect the privacy interests of individuals.

Although federal agencies, acting within the scope of their Congressionally delegated authority, may preempt state law, the Court determined that the regulations at issue in this case did not preempt Delaware law.

First, the Court reasoned that one may comply with both § 17-305 and the federal regulations. See Arbor Place, L.P. v. Encore Opportunity Fund, L.L.C., 2002 WL 205681 (Del. Ch. January 29, 2002) (reviewing § 18-305 of the Delaware LLC Act, a parallel to § 17-305, the Chancellor ruled that SEC regulations did not preclude disclosure because they contained an exception to the notice and opt-out requirements in order to comply with state law.)

The Court reviewed the regulations involved which allowed for an exception when necessary to comply with state law. See citations to federal regulations at footnote 23. 

The Court also rejected the argument that the partnership agreement allowed Parkcentral to keep the list of names and addresses of the other partners from disclosure. First, the Court reasoned that Parkcentral did not demonstrate that it had a good faith belief that providing a list of names and addresses would harm the partnership. See footnote 25. The Supreme Court agreed with the finding of the Vice Chancellor after trial that the general partner did not possess a good faith belief that disclosure would harm the partnership. In addition, the Delaware Supreme Court determined that there was no agreement with a third party that would require Parkcentral to keep the information confidential.

SUPPLEMENT: Law.com provides highlights of the case here.