Ar Francis Pileggi's invaluable corporate law blog, Frank Reynolds draws our attention to a new opinion by Delaware Vice Chancellor Travis Laster: Woods v. Sahara Enterprises, Inc. and links an earlier post on the same case from Mr. Pillegi himself.
Counselor Pileggi identifies the following takeaways from the case:
- 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.
Reynolds summarizes key parts of the court's opinion as follows:
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. ...
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.
All of which got me to thinking about Section 220.
A shareholder must have a proper purpose for requesting a 220 inspection. If the Company denies the shareholder access to its records, the shareholder may sue in the Chancery Court. Under subsection 220(c), if the shareholder only seeks access to the shareholder list or stock ledger, the burden of proof is on the Company to show that the shareholder is doing so for an improper reason. If the shareholder seeks access to other corporate records, however, the shareholder must prove that s/he is doing so for the requisite proper purpose.
“The paramount factor in determining whether a stockholder is entitled to inspection of corporate books and records is the propriety of the stockholder’s purpose in seeking such inspection.” CM & M Gp., Inc. v. Carroll, 453 A.2d 788, 792 (Del. 1982). “A proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder.” DGCL § 220(b) (emphasis supplied).
As Pileggi notes, Vice Chancellor Travis Laster’s new Woods opinion summarizes the proper purposes recognized by Delaware courts:
Prior cases have recognized that a stockholder can state a proper purpose by seeking
- to investigate allegedly improper transactions or mismanagement;
- to clarify an unexplained discrepancy in the corporation’s financial statements regarding assets;
- to investigate the possibility of an improper transfer of assets out of the corporation;
- to ascertain the value of his stock;
- to aid litigation he has instituted and to contact other stockholders regarding litigation and invite their association with him in the case;
- “[t]o inform fellow shareholders of one’s view concerning the wisdom or fairness, from the point of view of the shareholders, of a proposed recapitalization and to encourage fellow shareholders to seek appraisal”;
- “to discuss corporate finances and management’s inadequacies, and then, depending on the responses, determine stockholder sentiment for either a change in management or a sale pursuant to a tender offer”;
- to inquire into the independence, good faith, and due care of a special committee formed to consider a demand to institute derivative litigation;
- to communicate with other stockholders regarding a tender offer;
- to communicate with other stockholders in order to effectuate changes in management policies;
- to investigate the stockholder’s possible entitlement to oversubscription privileges in connection with a rights offering;
- to determine an individual’s suitability to serve as a director;
- to obtain names and addresses of stockholders for a contemplated proxy solicitation; or
- to obtain particularized facts needed to adequately allege demand futility after the corporation has admitted engaging in backdating stock options.
Woods v. Sahara Enterprises, Inc., 2020 WL 4200131, at *4-5 (Del. Ch. July 22, 2020).
Delaware courts have made clear that the existence of an improper secondary purpose is not enough to deny the shareholder access. Because “a shareholder will often have more than one purpose, [§ 220(b)] has been construed to mean that the shareholder’s primary purpose must be proper; any secondary purpose, whether proper or not, is irrelevant.” BBC Acquisition v. Durr-Fillauer Medical, 623 A.2d 85, 88 (Del.Ch.1992). This invites litigation as to what the shareholder’s primary purpose is and then whether it is proper.
Even if the shareholder manages to convince the court that his primary interest is, say, valuing shares, if the Company is able to show the shareholder also has an improper secondary purpose, the court may circumscribe the shareholder’s access so as to protect legitimate corporate proprietary interests. Safecard Servs., Inc. v. Credit Card Serv. Corp., 1984 WL 8265 (Del.Ch.1984).
A new hurdle is suggested by Travis’ new opinion in Woods. In it, he draws a sharp distinction between three distinct levels of corporate books are records:
- Formal Board Materials: “The starting point (and often the ending point) for an adequate inspection will be board-level documents that formally evidence the directors’ deliberations and decisions and comprise the materials that the directors formally received and considered (the “Formal Board Materials”). A corporation should be able to collect and provide its Formal Board Materials promptly and with minimal burden. In many organizations, the corporate secretary maintains a central file for each board meeting in either paper or electronic form that contains the minutes and other Formal Board Materials for that meeting.” Woods, 2020 WL 4200131, at *11.
- Informal Board Materials: “If the plaintiff makes a proper showing, an inspection may extend to informal materials that evidence the directors’ deliberations, the information that they received, and the decisions they reached (“Informal Board Materials”). Informal Board Materials generally will include communications between directors and the corporation’s officers and senior employees, such as information distributed to the directors outside of formal channels, in between formal meetings, or in connection with other types of board gatherings. Informal Board Materials also may include emails and other types of communication sent among the directors themselves, even if the directors used non-corporate accounts.” Id. at *12.
- Officer-Level Materials: “In an appropriate case, an inspection may extend further to encompass communications and materials that were only shared among or reviewed by officers and employees (“Officer-Level Materials”).” Id.
Personally, I think that hierarchy is the most important takeaway in the opinion. This is so, because Laster goes on to suggest that there is a clear hierarchy here. Woods is repeatedly given access to Formal Board Materials without much of a showing. A stronger showing is required for Informal Board Materials and Officer Level Materials:
Request (j) seeks “[d]ocuments, correspondence, reports or drafts thereof concerning any investment decision, business plan, valuation, budget, financial guidance, forecast or projections concerning the Company from January 1, 2015 to present.” JX 2 at ’199. The request does not distinguish among Formal Board Materials, Informal Board Materials, or Officer-Level Materials. The detailed nature of the request suggests that it seeks all three.
As framed, request (j) is overly broad. In the abstract, “[t]he importance of forecasts and projections to valuation of a company is so basic that it does not require citation.” Quantum Tech., 2014 WL 2156622, at *12 (Del. Ch. May 14, 2014). Woods is therefore entitled to inspect Formal Board Materials falling into this category. Woods has not proven that Informal Board Materials or Officer-Level Materials concerning financial guidance, forecasts, or projections are necessary and essential to her valuation purpose, and thus she is not entitled to those materials. If she receives Formal Board Materials and determines that they are inadequate for her purpose, then she may renew her request for Informal Board Materials and Officer-Level Materials.
Id. at *13. Earlier Delaware cases established that a Section 220 proceeding should result in an order "circumscribed with rifled precision.” Security First Corp. v. U.S. Die Casting and Development Co., 687 A.2d 563 (Del.1997). Accordingly, the court of chancery must tailor its order for inspection to cover only those books and records that are “essential and sufficient to the stockholder’s stated purpose.” Thomas & Betts Corp. v. Leviton Mfg. Co., 681 A.2d 1026, 1035 (Del. 1996). The shareholder “bears the burden of proving that each category of books and records [being sought] is essential to accomplishment of the stockholder’s articulated purpose for the inspection.” Id.
Laster’s Woods opinion does not include the “rifled precision” quote but does draw on both Thomas & Bettsand Security First in setting the scope of the inspection to which Woods is entitled. Again, he principally tailors that access by focusing on the hierarchy between the various defined levels of materials:
According to Woods, requests (c), (d), (e), and (h) seek information about the Company’s investment strategies. Requests (c), (d), and (e) are actually much broader. They seek
(c) All minutes of meetings of the Company’s Board of Directors (the “Board”) or any committee thereof, including any attachments thereto, from January 1, 2015 to present;
(d) All presentations, agendas, reports or other materials provided to the Board or any committee thereof in preparation for, or review at, any meetings from January 1, 2015 to present; [and]
(e) All notes taken at any meetings of the Board or any committee thereof from January 1, 2015 to present.
JX 2 at ’198–99. These requests thus seek all of the Company’s Formal Board Materials from January 1, 2015, to the present, plus Informal Board Materials in the form of notes.
Request (h) seeks a subset of the foregoing materials. It asks for
[a]ll materials created for or provided to the Board or any committee thereof from January 1, 2015 to present concerning the Company’s investment strategies, any actual or proposed changes to the mix or types of investments made by the Company; returns from any investments; liquidity considerations; or tax consequences of investments for the Company or its stockholders.
Id. at ’199. Request (h) thus seeks Formal Board Materials relating to the Company’s investment strategies, investment holdings, and related issues.
The blanket request to inspect all of a Company’s Formal Board Materials, plus notes of all meetings, is not sufficiently targeted. Request (h) specifically requests Formal Board Materials concerning the Company’s investment strategy and investments, which is a core area of focus for the Demand. Books and records responsive to this request appear sufficient for Woods’ purpose. The Company shall produce materials responsive to Request (h). As to matters falling within the scope of Request (h), the Company shall produce the types of materials called for by Requests (c), (d), and (e). The Company need not produce materials that otherwise would be called for by Requests (c), (d), and (e), but which do not relate to the topics covered in Request (h).
Woods, 2020 WL 4200131, at *11.
All of which suggests that getting at the really interesting stuff—i.e., Informal Board Materials and Officer Level Materials—is going to be tough.
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