March 7, 2012
Edward M. McNally

The Delaware Court of Chancery recently took the largely unprecedented step of appointing a receiver for a Delaware limited liability company. While Jagodzinski v. Silicon Valley Innovation Co. LLC is a short opinion, it has large implications. Here are just a few, but first it is necessary to focus on its odd facts.

Silicon Valley was a books-and-records case. The plaintiff, Christian Jagodzinski, sought access to the records of Silicon Valley, apparently out of concern over how it was being operated (or, actually, not operated) after his investment. He won his case and the court, at least three times, ordered Silicon Valley to let Jagodzinski see the records he sought.

Silicon Valley did not comply with the court's orders, however. Hence, Jagodzinski asked the court to hold Silicon Valley in contempt of court and to appoint a receiver to take over Silicon Valley, even to the point of pursuing claims Silicon Valley might have against third parties. Presumably, what Jagodzinski had in mind were claims against the former managers of Silicon Valley, whom he apparently believed had ruined it to his detriment.

The Court of Chancery largely agreed with Jagodzinski. First, it held Silicon Valley in contempt of court and awarded attorney fees of $10,000 to Jagodzinski. That is hardly surprising given Silicon Valley's failure to comply with the court's orders. Second, the court appointed a receiver for Silicon Valley, but limited the receiver's powers to "retrieving and producing the documents [the] court ordered [Silicon Valley] to produce in the underlying books-and-records litigation and to actions reasonably related to that purpose." That included attempting "to obtain the documents from third parties where [Silicon Valley] reasonably can claim to have control over such documents." The court declined to permit the receiver to pursue claims on behalf of Silicon Valley.

All this raises some interesting implications over the impact of the court's order. To begin with, arguments over compliance with a court's order to produce an entity's records in a books and records case are not unheard of in Delaware. Disputes over claims of attorney-client privilege and access to subsidiary or parent entity records have all been litigated before, even after a plaintiff has established a general right to inspect records of an entity he or she has invested in and shown cause to inspect. The use of a contempt motion, however, is highly unusual, if not unprecedented. Coming up short in defending a contempt motion is not just about losing attorney fees. It seriously jeopardizes a litigant's position before the court. Judges do not like contemptuous conduct. While the court's award in Silicon Valley was comparatively modest, much larger sums have been awarded previously in connection with motions to hold a party in contempt. The use of a contempt motion, rather than the more modest motion to compel common in discovery disputes, may well escalate the war in books-and records-litigation.

Of course, Silicon Valley plainly presents odd and hopefully unique facts. Several failures to comply with the court's orders, a failure to respond to motions filed by Jagodzinski and the failure to replace counsel after its counsel withdrew all contributed to the result of a contempt citation. Nonetheless, Silicon Valley may signal a more vigorous push for all the records a plaintiff seeks in a books-and-records case.

Even more interesting is the court's decision to appoint a books-and-records receiver. While the Silicon Valley receiver cannot pursue claims against its management, what else can he do? For example, may the Silicon Valley receiver obtain records that are otherwise subject to attorney-client privilege? May he ask for tax returns that Silicon Valley itself might request from taxing authorities? And how is the receiver to actually get those records? May he literally take over the entity's place of business to do a search and, if so, who is to control what he reviews in his determination of whether a particular record is one that his client may inspect under the court's order? All these are interesting questions that will need to be answered at some point.

The answers must come from the court, not the receiver who you might think would act like a true court-appointed neutral party to do his best to carry out his duties fairly. For, in Silicon Valley, the company apparently could not pay for a receiver. As a result, the court appointed the plaintiff's "agent ... to serve as the receiver." In short, by its conduct, Silicon Valley let the plaintiff decide what to review, at least initially. If the plaintiff uncovers some heretofore unknown cause of action against Silicon Valley's managers, they cannot call that unfair when they let that happen.

The plain lesson of Silicon Valley is to comply with the court's order in a books-and-records case, even if someone has to pay the costs for the entity. This remains true even when the entity is small or insolvent and there is a temptation to just ignore its legal obligations to avoid expense. After all, document productions ordered by Delaware courts are always fairly targeted and usually limited to what is reasonable. At least Silicon Valley cautions us to carefully consider the proper course of action to take when a court orders you to produce business records, even for an insolvent entity.