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Chancery Denies Books and Records Inspection Brought to Advance the Stockholder’s Interests as a Creditor

Georgia Notes 18, LLC v. Net Element, Inc., C.A. No. 2021-0246-JRS (Del. Ch. Nov. 18, 2021)
Plaintiff, a stockholder and creditor of the defendant company, demanded to inspect the company’s books and records pursuant to 8 Del. C. § 220. The company objected, arguing that the plaintiff had failed to state a proper purpose for inspection and had a primary improper purpose. The Court found in the company’s favor, determining that plaintiff sought documents for the primary improper purpose of seeking pre-litigation discovery in connection to its interests as a creditor.

Plaintiff’s manager and sole member, a long-time friend of the company’s CEO, entered into a term loan note with the company in favor of the plaintiff. Later that year, a third party agreed to purchase the company’s debt, including the note. Shortly thereafter, the company canceled the note at a $3.5 million discount. In unrelated litigation, the plaintiff’s manager discovered that additional proceeds from the debt exchange amount were distributed to four transferees. Plaintiff subsequently sought books and records from the company pursuant to Section 220. In its demand, the plaintiff’s stated purpose was to investigate the CEO’s misconduct as a company director and officer in connection with the $3.5 million discount and transfer of additional proceeds. Contending that the stated purpose was not the plaintiff’s actual purpose for seeking inspection, the company refused to produce the documents and the plaintiff brought a Section 220 proceeding in the Court of Chancery.

At trial, the plaintiff contended that there were two purposes for seeking documents relating to the company’s alleged “wrongdoing and improper conduct” in connection with the debt exchange: (1) to support a claim against the company as plaintiff’s former creditor, and (2) to support a fiduciary duty claim against the company’s CEO in a derivative action. The Court, in finding that the demand’s primary purpose was the former, cited testimony from the plaintiff’s manager explaining that “the purpose of all these investigations” was to demonstrate that plaintiff had been defrauded as a creditor by the company’s CEO in connection with the challenged conduct. Because Section 220 is not a tool to obtain pre-litigation discovery to enhance a nominal stockholder’s causes of action against the company as a creditor, the Court ruled in the company’s favor and denied inspection. 

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