Chancery Addresses Burdens for Valuation-Related Books-and-Records Inspections, While Finding Defendant’s Asserted Lack of Records Supported Mismanagement-Related Inspection
Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020)
This decision concerning statutory inspection rights under Section 220 of the Delaware General Corporation Law clarifies the requirements of a proper valuation purpose, involves a unique twist concerning a mismanagement-investigation purpose, and provides a helpful summary on the potential scope of books-and-records inspections.
Plaintiff was a stockholder in Sahara Enterprises, Inc. (the “Company”), a privately-held corporation. In 2001, the Company engaged in a restructuring (the “Restructuring”) whereby it transferred its employees and management functions to SMCO, Inc. (“SMCO”), a spinoff entity owned by the Company’s stockholders. The Company transferred its assets to Sahara Investments, LLC—a subsidiary entity in which the Company held a 99% member interest and SMCO held the remaining 1%. The materials distributed to stockholders in connection with the Restructuring stated that the reorganization would “not cause any change in the information available to stockholders.”
Plaintiff identified two primary purposes for its inspection: valuation and investigating potential wrongdoing or mismanagement. The Court found each purpose proper. As the Court observed, “[v]aluation 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.” The Company argued, however, that the Plaintiff could not state a generic valuation purpose, but, instead, had to prove that it actually intends to use the requested books and records to value its shares and why. The Court disagreed. Examining Delaware authority, the Court found that there is no requirement that a stockholder identify an “end use” for its valuation. Rather, according to the Court, a valuation purpose is proper and supports inspection if it is sincere. Here, the Company did not carry its burden to show Plaintiff’s valuation purpose was insincere and pretext for some improper purpose. Accordingly, Plaintiff’s valuation purpose supported inspection.
The Court next turned to Plaintiff’s mismanagement-investigation purpose. Plaintiff’s arguments about the Company’s poor performance, alone, were insufficient to satisfy the requisite “credible basis” standard. But the Court found added support for Plaintiff’s investigation purpose considering the Company’s affirmative defense that it that it lacked and could not access responsive books and records, many of them residing in the sister company, SMCO. That “mootness” defense (1) conflicted with the Company’s representation that the ability of stockholders to obtain information from the Company would not be affected by the Restructuring, and (2) suggested that the Company’s directors may have abdicated their duty of oversight. Accordingly, Plaintiff’s mismanagement purpose also supported inspection.
Finding that Plaintiff was entitled to an inspection, the Court determined the appropriate scope. As the Court explained, stockholders generally seek three categories of documents in Section 220 actions: (1) “board-level documents that formally evidence the directors’ deliberations and decisions and comprise the materials that the directors formally received and considered” (“Formal Board Materials”), (2) “informal materials that evidence the directors’ deliberations, the information that they received, and the decisions they reached” (“Informal Board Materials”), and (3) “communications and materials that were only shared among or reviewed by officers and employees” (“Officer-Level Materials”). As Formal Board Materials can be produced promptly and with little burden, the Court usually grants access to such documents. But to obtain access to Informal Board Materials and Officer-Level Materials, which are more difficult to gather and produce, a plaintiff must sustain its burden to show these additional records are “necessary and essential” to its purpose.
Analyzing Plaintiff’s specific requests, the Court determined that, although Plaintiff was entitled to Formal Board Materials, it had not established that Informal Board Materials and Officer-Level Materials were “necessary or essential” to any of its proper purposes at this time. Thus, Plaintiff was granted an inspection of books and records limited to Formal Board Materials, while given leave to renew its requests for additional materials if the Formal Board Materials proved insufficient. In reaching this conclusion, the Court offered helpful insight on, among other issues, the inspection of director and officer compensation-related materials, and when materials may be considered within a defendant-corporation’s possession, custody, or control for production purposes.