In Barry Leistner v. Red Mud Enterprises LLC, C.A. No. 2023-0503-SEM (Del. Ch. Dec. 8, 2023), the Delaware Court of Chancery addressed Plaintiff Barry Leistner’s exceptions to a Magistrate’s Final Report that denied his books and records request regarding Red Mud Enterprises LLC. Leistner, a member and investor of the company, previously obtained a default judgment against Red Mud’s principals but continued business relations with them. After becoming a member of Red Mud, he made a comprehensive books and records demand, which the company deemed unreasonable.

The Magistrate found the company’s denial justified, asserting that Leistner’s purposes were primarily to pursue his interests as a judgment creditor and to involve himself in the company’s day-to-day management, a role not guaranteed by the LLC agreement. Upon review of Leistner’s exceptions, Vice Chancellor Glasscock concurred with the Magistrate’s decision, emphasizing that Leistner’s document request was excessively broad, extending beyond what was necessary for a stockholder’s purpose.

The Court rejected Leistner’s request to at least tailor the demand for valuation materials, maintaining that the decision is without prejudice to him seeking books and records in the future upon a reasonable demand for valuation or other stockholder purposes. The Court held that late-discovered evidence is considered relevant to potential future litigation.

The Court also acknowledged the separate contract-based litigation seeking documents, but specific performance was deemed unnecessary as the records have already been produced. In conclusion, the Court denied Plaintiff’s exceptions based on the Magistrate’s well-reasoned ruling, emphasizing the overbroad nature of Leistner’s document request.

Key Takeaway

This decision underscores the need for a plaintiff seeking to inspect a Delaware company’s books and records to ensure that their request is narrowly tailored to a stated proper purpose. Overbroad requests not tethered to a stockholder interest will be subject to denial by the Court.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

On August 1, 2023, amendments to the Delaware General Corporation Law (“DGCL”) went into effect, simplifying processes for Delaware corporations to take specific corporate actions. The changes focus on authorizing certain stock splits and altering a corporation’s authorized shares.

Key points of the amendments:

Section 242 – Amendments to Certificate of Incorporation:

Stockholder approval is no longer required for a charter amendment implementing a forward stock split if the corporation has only one class of outstanding stock and that class is not divided into series.

The threshold for stockholder approval of a charter amendment for a reverse stock split is reduced to a majority of votes cast, provided specific conditions are met (e.g., listing on a national securities exchange).

Like reverse stock splits, the voting threshold for a charter amendment to increase or decrease the number of authorized shares may be approved by a majority of votes cast, under specified conditions.

Section 228(e) – Notice of Action by Consent:

The amendment clarifies the date for determining the stockholders entitled to notice when action is taken by written consent without a meeting.

Public corporations can now provide such notices online, simplifying administrative burdens.

Section 157 – Power to Delegate Authority to Issue Options:

Building on the 2022 amendments, Section 157 now allows boards to delegate authority to determine terms for acquiring shares through options or rights.

Technical changes include specifying parameters and empowering the delegate to decide significant terms.

Section 204 – Ratification of Defective Corporate Acts:

Amendment streamlines requirements for filing a certificate of validation upon ratification of defective corporate acts.

The information needed in the certificate has been simplified, reducing administrative burdens.

Section 272 – Mortgages or Pledges of Assets:

Clarifies that the vote of a majority-in-interest of stockholders is not required for certain transactions involving the exercise of secured party rights or alternative transactions authorized by the board.

Section 262 – Appraisal Rights:

Expands transactions triggering statutory appraisal rights to include transfers, domestications, and continuances.

Requires withdrawal of a demand for appraisal rights within 60 days after the effective date of the triggering transaction, with approval from the corporation after 60 days.

Additionally, there are clarifying changes to provisions governing the creation and issuance of stock, actions under a plan of conversion, and the authority of a corporation resulting from a conversion or domestication to issue bonds and other securities.

Key Takeaways: These changes allow Delaware corporations to streamline corporate actions and respond more swiftly in the capital markets. The amendments eliminate the impact of abstentions on stockholder votes, facilitating actions for publicly traded corporations, especially those with large retail stockholder bases and low voting participation. Corporations can now proceed with certain actions that previously required extensive stockholder outreach without being hindered by abstentions.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

In the decision of Barbey v. Cerego, Inc., C.A. No. 2022-0107-PAF (Del. Ch., Sept. 29, 2023), the Delaware Court of Chancery considered the proper constitution of a Delaware corporation’s board of directors under Section 225 of the Delaware General Corporation Law (“DGCL”) after members of the board of directors were removed following a corporate inversion.  The Court determined that the plaintiff did not meet its burden of proof to challenge the removal of board members, and therefore the removal of the entire board, and their replacement by a new sole director, was effective.

Background

Carego Japan, Inc., a Japanese company and wholly owned subsidiary of Carego, Inc., a Delaware corporation, initiated a corporate inversion when it offered to swap shares of Carego Japan in exchange for the outstanding shares of Carego through a tender offer. The inversion would give Carego Japan a supermajority of Carego’s outstanding shares.  Once that was accomplished, Carego Japan took action to remove the existing board of directors of Carego, including Plaintiff Barbey. 

Barbey challenged the removal based on the argument that the inversion was invalid.  Specifically, he argued that Carego did not give adequate notice of the special meeting of the board at which Carego authorized Carego Japan to commence the tender offer.

Section 225 of the DGCL permits any stockholder or director to apply to the Delaware Court of Chancery to determine the validity of any election, appointment, removal or resignation of any director or officer of any corporation. 8 Del. C. § 225.   These are “in rem proceedings” which only exert jurisdiction over the corporation and may only provide relief concerning the corporate office.  Slip op. at 15. Other types of ultimate relief beyond what is necessary to determine the proper holder of a corporate office may only be obtained through a plenary action through which the court would exercise jurisdiction over affected parties. Id.

To resolve the issues presented, the Court had to determine whether the board meeting at issue was a regular meeting of the board or a special meeting of the board. Only a special meeting required notice.  The Court analyzed Carego’s bylaws to determine whether the meeting held was properly described as a regular meeting or a special meeting, as well as the notice requirements under the bylaws.

The key findings of the Court for purposes of this Section 225 action were: (i) although a regular meeting did not require notice under the bylaws, a special meeting did require notice which was not properly given under Carego’s bylaws, thereby making the actions taken at the special meeting void.

Nonetheless, the Court found that, even though Barbey did not anticipate or address the issue of whether the inversion and tender offer even required approval by Carego’s board, board action was not required to authorize Carego Japan’s tender offer that resulted in it becoming the majority stockholder of Carego. Therefore, the actions taken by the new majority stockholder to remove the board and appoint a new sole director were effective.

In sum, the Court explained that the plaintiff merely focused its case on whether or not there was proper notice for a special board meeting and whether the actions taken at the meeting were void, but even though the Court found that meeting to be void, the Vice Chancellor also held that the corporate inversion making Carego Japan the majority stockholder properly authorized it to remove all of the board members.

Takeaway

The Barbey decision demonstrates that while Delaware courts emphasize the fundamental principle that a special meeting held without due notice to all directors is not lawful, a plaintiff nonetheless has the burden of proof to show that a subsidiary lacked authority to commence a tender offer that results in it becoming the parent company’s majority stockholder.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

In the decision of James Rivest v. Hauppauge Digital, Inc., No. 442, 2022 (Del. July 10, 2023), the Delaware Supreme Court considered the extent to which a Delaware corporation’s production of books and records under Section 220 of the Delaware General Corporation Law should be subject to confidentiality restrictions.

Background

James Rivest was a “deep value” investor and the beneficial owner of Hauppauge Digital, Inc. stock, purchased in the over-the-counter (OTC) securities markets. Hauppauge had been a Nasdaq-listed company but “went dark” and voluntarily de-listed from the exchange around 2014. Its shares continued to trade in over-the-counter (OTC) markets.

In 2019, Rivest sought to inspect Hauppauge’s financial records for valuation purposes. Hauppauge did not respond to Rivest’s request, and eventually, Rivest filed a complaint with the Delaware Court of Chancery to compel inspection of the records under Section 220. Hauppauge did not respond, and Rivest requested that the court enter a default judgment.

The court entered a default judgment against Hauppauge on April 24, 2020. Later that day, the court received a mailed response from Hauppauge. While the letter was received after the April 24 hearing, the postmark on the letter indicated it was timely mailed on April 20, 2020. 

Hauppauge then filed a motion to vacate the default judgment under Court of Chancery Rule 60(b)(1). In its motion, Hauppauge argued that its good faith effort to comply with the Court’s deadline should be sufficient to prevent a default judgment, especially given the raging COVID-19 pandemic. It also believed it had put forth a meritorious defense against revealing the requested financial information because it believed it was no longer required to comply with securities rules regarding disclosure of financial statements.

The Court considered Hauppauge’s arguments and vacated the default judgment. Hauppauge did not object to disclosure, as long as the records were subject to confidentiality requirements. In reliance upon the rationale of Tiger v. Boast Apparel, Inc., 214 A.3d 933 (Del. 2019), the Court of Chancery rejected this argument, holding that Rivest was entitled to the records free of any restrictions, and ordered Hauppauge to disclose the records. Hauppauge appealed this judgment to the Delaware Supreme Court.

On appeal, the Supreme Court upheld the decision of the Court of Chancery, stating that in the absence of compelling evidence of a need for such restriction, Hauppauge was not entitled to any confidentiality protection, and the Court of Chancery’s rejection of a confidentiality provision was not an abuse of its discretion. The High Court held that the Court of Chancery properly weighed the parties’ legitimate interests
under Tiger, concluding that Hauppauge’s interest in placing confidentiality
restrictions on financial statements for closed periods did not outweigh Rivest’s
legitimate interests in free communication.

Takeaway

The Rivest decision is notable in that it demonstrates that Delaware courts will put a corporation to the test to demonstrate why it should be permitted to produce records confidentially in response to a Section 220 books and records demand. If it cannot satisfy this burden, then it will be ordered to make the inspection free and clear of confidentiality restrictions.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

Books and records inspection demands commonly arise in connection with a major transaction of a Delaware corporation, including a merger. The decision of Kosinski v. GGP, Inc., C.A. No. 2018-0540-KSJM (Del. Ch. Aug. 29, 2019) involved such a demand to investigate mismanagement, including whether plaintiff had established a “credible basis” to infer mismanagement.

In Kosinski, a real estate company GGP, Inc. was acquired by another real estate company already owning a percentage of GGP’s common stock.  Plaintiff brought a Section 220 demand arguing that the buyer of GGP was GGP’s de facto controlling shareholder, and that the procedural protections set forth by the Delaware Supreme Court in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014), which required deferential review of a merger process involving a controller, had failed to be implemented.

In opposition, GGP challenged plaintiff’s stated purposes for inspection, arguing that it had formed a special committee to negotiate the merger consistent with Kahn.  However, the Court found that plaintiff pointed to facts suggesting that the special committee failed to obtain a fair price and that its members potentially were interested or lacked independence.   

Thus, plaintiff’s Section 220 demand was granted. The Court of Chancery held that because procedural protections were lacking, the transaction may not have been at arm’s length, and that plaintiff had demonstrated facts to established a “credible basis” to investigate potential breaches of fiduciary duty.

Conclusion

In connection with a merger, a corporation should ensure that all procedural protections are met under under Kahn v. M&F Worldwide Corp. Otherwise, it may be ordered to make documents available for inspection under 8 Del. C. § 220, which could lead to further litigation and potential liability.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

A question often arises as to whether a party making a books and records demand under 8 Del. C. § 220 must enter into a confidentiality agreement in order to inspect responsive documents of the corporation.

The Delaware Supreme Court, in the decision of Tiger v. Boast Apparel, Inc., 214 A.3d 933 (Del. Aug. 7, 2019), shed light on this question. In this opinion, the High Court held that conditioning the inspection of documents demanded under Section 220 of the Delaware General Corporation Law (“DGCL”) upon entry into a confidentiality agreement should be the exception, not the rule, and justification for confidentiality must be provided by the corporation in order to be enforceable.

In the memorandum opinion, the Delaware Supreme Court wrote:

We hold that, although the Court of Chancery may—and typically does— condition Section 220 inspections on the entry of a reasonable confidentiality order, such inspections are not subject to a presumption of confidentiality. We further hold that when the court, in the exercise of its discretion, enters a confidentiality order, the order’s temporal duration is not dependent on a showing of the absence of exigent circumstances by the stockholder. Rather, the Court of Chancery should weigh the stockholder’s legitimate interests in free communication against the corporation’s legitimate interests in confidentiality.

Id. at 934.

In light of this ruling, Delaware corporations receiving a Section 220 inspection demand should be prepared to demonstrate the need for confidentiality, and stockholders making such a demand should be prepared to address the need for free and open communication in connection with the inspection materials.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

Delaware, long viewed to be one of the most business-friendly jurisdictions in the country, has joined the ever-expanding list of jurisdictions that no longer give businesses the benefit of the doubt when it comes to restrictive covenants.

Partners Christina Bost SeatonAmy Epstein Gluck and I explored this issue as set forth herein.

Traditionally, the Delaware Court of Chancery has applied a “less searching” inquiry into the fairness of a restrictive covenant when that covenant was entered into in the context of a sale of a business.  In these cases, the Court of Chancery tends to enforce non-competes, because of the overall viewpoint that when an employee sells their business, they already receive significant financial compensation and actively negotiate the agreements using sophisticated counsel. Accordingly, courts do not have the same concerns about fairness as they do with a non-compete that an employee agrees to at the start of employment.

The Court of Chancery has changed its tune. In a trio of recent decisions, the Court has decried restrictive covenants that companies should have known were so overly broad so as not to protect their legitimate protective interests.

As a refresher, Delaware Courts generally enforce a restrictive covenant, such as a non-compete or non-solicitation provision, if: (1) it meets Delaware’s requirements to be an enforceable contract, which requires (a) mutual assent, (b) expressed by a valid offer and acceptance, (c) adequate consideration, and (d) capacity; (2) is reasonable in scope (i.e., the types of activities that are prohibited, and the locations in which they are prohibited) and in duration (i.e., the length of the restrictive covenant); (3) protects the employer’s “legitimate protectible interest”; and (4) is, on the balance, equitable.  As in most states, non-competes are typically subject to the highest scrutiny, non-solicitation provisions are subject to somewhat less scrutiny, and non-competes in the sale of a business are traditionally subject to the lowest scrutiny.

Of the recent trio of cases, the first to call this traditional understanding into question was Kodiak Building Partners, LLC v. Adams, C.A. No. 2022-0311-MTZ (Del. Ch. Oct. 6, 2022). There, Kodiak Building Partners (“Kodiak”) acquired Northwest Building Components, Inc. (“Northwest”), a small manufacturer.  Philip Adams (“Adams”) owned 8% of Northwest and worked as its General Manager.  As part of the deal, Adams received around $1 million.  In exchange, Adams signed a new agreement, which included both non-compete and non-solicitation provisions, and agreed not to engage in any activity that competed with the “Business,” which was defined to include services that were never offered by Northwest.  Adams also agreed not to solicit customers or clients of Northwest or of the “Company Group,” which included the buyer, its subsidiaries, and their “affiliates.”  The geographical scope was within 100 miles of any location where a “Company Group” member did business.

The Delaware Court of Chancery refused to enforce the non-compete and the non-solicitation provisions.

First, Vice Chancellor Zurn held that, while purchasers have a right to protect the goodwill of the business that they acquire, the agreement as written went far beyond that objective because it covered the business of the acquirer and other businesses in the Company Group as well: “Restrictive covenants in connection with the sale of a business legitimately protect only the purchased asset’s goodwill and competitive space that its employees developed or maintained.” Slip op. at 22. The Court further held that buyers can not “restrict[] the target’s employees from competing in other industries in which the acquirer also happened to invest.” Id. at 22-23.  The Court of Chancery also found that the geographic scope was overbroad because it went beyond the territories in which Northwest had operated.

The next case in this recent triumvirate, Ainslie v. Cantor Fitzgerald, LP, Consol. C.A. No. 9436-VCZ (Del. Ch. Jan 4, 2023), involved capital distributions to four partners over four years after they withdrew from the partnership.  If, however, the partners competed during that four-year payout period, they would forfeit their distributions. The effect of the agreement was that the restricted period was four years in length. The Court refused to enforce the agreement.

Even under the more lenient “sale of business” standard, Vice Chancellor Zurn nonetheless held that the forfeiture provision was unreasonable because of the four-year duration and the overly broad definition of “competitive activities.” That definition prohibited activities related to affiliates and not just the entity with which the former partner had been employed. The Court determined that there was no reason to believe that the former employees had any information regarding those entities, and, relying on Kodiak, the Court refused to blue-pencil the restrictions and rendered the entire agreement unenforceable.

Finally, most recently, in Intertek Testing Services NA, Inc. v. Eastman, C.A. No. 2022-0853-LWW (Del. Ch. Mar. 16, 2023), the Court of Chancery again refused to blue-pencil an overbroad agreement.  In that case, Intertek Testing Services, NA, Inc. (“Intertek”) purchased Alchemy Investment Holdings (“Alchemy”), which provided workforce training and consulting to food and cannabis companies.  Eastman, the co-founder, CEO, and a major stockholder of Alchemy, received $10 million in connection with the sale.  Eastman also agreed to a five year non-compete prohibiting him from competing with any business anywhere in the world competitive with Alchemy or its subsidiaries, as conducted by them as of the closing date.  Vice Chancellor Will determined that the global scope was overbroad, particularly because the buyer did not even allege that Alchemy engaged in a worldwide business.  The Court of Chancery refused to blue-pencil the restrictions and struck the entire agreement.

What are the takeaways?

These cases signal the end of the well-worn practice by buyers of attempting to preclude competition against the buyer’s business as well as the acquired business.  While acquirers have long gotten away with this practice due to the Court of Chancery’s willingness to blue-pencil restrictive covenants, such days are over.  Thus, when drafting new restrictive covenants as part of an acquisition, acquirers must limit the scope to the target company’s business.

Moreover, if the Court of Chancery is applying this level of scrutiny in the context of a sale of a business, it certainly will apply at least this level of scrutiny to more routine restrictive covenants in the employment context.  Thus, when an acquirer inherits employment agreements that already contain restrictive covenants, if those agreements (like the one in the Kodiak case), by their terms, prohibit the employee from competing with all present and future parents, subsidiaries, and affiliates, there is now a strong reason to believe that those agreements would not be enforceable in Delaware.

We strongly suggest that all companies relying on restrictive covenants under Delaware law review their agreements under the rubric of the three cases discussed here to determine whether new agreements are advisable.  Relying on governing law in Delaware is no longer a panacea for overly broad restrictive covenants.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

In the recent decision of Schoenmann v. Irvin, et al., C.A. No. 2021-0326-SG (Del. Ch. Jun. 2, 2022), the Delaware Court of Chancery denied in part and granted in part Defendants’ motion to dismiss Plaintiff’s direct and derivative claims against Clear Align, LLC and its President, CEO and majority Board member, Angelique Irvin.  While some uncommon issues were addressed, the Court took note of the “plaintiff-friendly inferences that attend a motion to dismiss” (slip op. at 26) and found that certain claims were “reasonably conceivable” and thus survived the motion to dismiss.

First, Defendant Irvin sought dismissal of Schoenmann’s claim that Irvin had breached Clear Align’s LLC Agreement by making non-pro rata distributions to herself on the basis that the statute of limitations had run.  Schoenmann argued the statute had been tolled based on his reasonable reliance on Irvin as a fiduciary, and Irvin countered that Schoenmann had information rights as a Board member and should be held to a higher knowledge standard. The Court found that the facts pled led to a reasonable inference that Irvin had potentially kept certain Board operations from Schoenmann and, thus, the statute of limitations could be found to have tolled. For those years not barred by the statute, Vice Chancellor Glasscock found the allegations “skimpy” but sufficiently pled such that the claim was reasonably conceivable, and Irvin could defendant against it.  (Mem. Op. at 27.)

Second, the Court of Chancery found that Schoenmann failed to state a claim that Irvin breached the implied covenant of good faith and fair dealing when she removed Schoenmann from the Board for initiating an internal investigation.  The Company’s LLC Agreement expressly authorized Irvin to remove a director with or without cause and, under Delaware law, a claim for breach of the implied covenant cannot stand if the conduct is allowed by corporate agreement.

Next, Defendants asked the Court to dismiss Schoenmann’s derivative claims on the grounds that he did not adequately plead that a demand made upon the Board of Directors would have been futile.  This claim was complicated by the frequently changing composition of the Board, as well as pleadings that Irvin often disregarded corporate formalities and documentation.  Giving the Plaintiff the benefit of reasonable inferences, though, Vice Chancellor Glasscock found that Schoenmann had satisfied this standard through facts pled which suggest Irvin’s position could exert considerable influence over other Board members, such that the majority of members could not exercise disinterested judgment had a demand been issued.

Having established demand futility, Plaintiff’s derivative breach of fiduciary duty claim against Irvin was allowed to proceed.  However, Vice Chancellor found that Schoenmann had not adequately pled his derivative claim for breach of contract as there was simply no contractual basis for the claim.

Key Takeaway:  Litigants pursuing a motion to dismiss should be aware that the Court of Chancery will resolve all inferences or questions of fact in the plaintiff’s favor.  Nonetheless, a claim may be susceptible to dismissal, even under Delaware’s plaintiff-friendly pleading standard, when it is unsupported by the underlying contract at issue.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

In the decision of Deann M. Totta, et al. v. CCSB Financial Corp., C.A. No. 2021-0173-KSJM (Del. Ch. May 31, 2022), the Court of Chancery held that the board of directors of Defendant, CCSB Financial Corp. (“CCSB”), misapplied a vote aggregation provision in the corporation’s charter that disenfranchised the shareholder Plaintiffs and, furthermore, was unenforceable under equitable principles.

CCSB’s charter includes a provision which prohibits shareholders from exercising more than 10% of the company’s voting power in an election (the “Voting Limitation”).  Facing a proxy contest from one of the named Plaintiffs, Park G.P., Inc., the directors aggregated Plaintiffs’ shares on the grounds that they were acting in concert and, pursuant to the Voting Limitation, did not count Plaintiffs’ votes above the 10% limit.  This instruction caused Plaintiffs’ nominees to lose the Board election, and Plaintiffs accordingly filed suit under 8 Del. C. § 225 to invalidate the Board’s instruction.

[For a general discussion of Section 225 of the DGCL, which permits challenges to an election of directors of a Delaware corporation, click here.]

As a threshold matter, CCSB argued that the Court should apply the highly deferential business judgment rule as its standard of review, primarily based on a provision in its charter that states any application by the board of the Voting Limitation “‘shall be conclusive and binding upon the Corporation and its stockholders.’”  (Mem. Op. at 4-5.)  Chancellor McCormick denied this reasoning on the grounds that a corporation cannot alter its directors’ fundamental fiduciary obligations unless such alteration has been authorized by statute—which it has not.  Therefore, the Court applied the well-established standard of review under Delaware corporate law that requires the Board’s actions to be tested twice—first, to determine whether the action was legally compliant and, second, to determine whether the action was equitable.

Applying this two-step analysis, the Court of Chancery found that the Voting Limitation does provide a basis for the Board to exclude stockholder votes when acting in concert, but found that the Plaintiffs had not, in fact, acted in concert.  A simple agreement that stockholders vote similarly is insufficient to prove an action in concert—there must be an agreement, arrangement or understanding of the alignment, which was not present here.

Finally, the Court of Chancery also found that the Board’s vote instruction did not satisfy the equitable test articulated under Blasius Industries, Inc. v. Atlas Corp.  According to Chancellor McCormick, Defendant’s argument that it must protect its shareholders from Plaintiffs’ alleged effort to take control of the company assumed that the directors knew better than the shareholders, which is not a legitimate reason to limit stockholder votes.  Therefore, the Court of Chancery found that the Board’s exercise of the Voting Limitation was both legally invalid and failed under Blasius’s equitable test.

Key Takeaway: An application of a voting limitation will be assessed under the “twice-tested” standard of review to assess legality and equitability.  Directors should remember that the shareholders have a fundamental right to exercise their voting power—a right that the Court of Chancery will be hesitant to curtail without a compelling, legitimate reason.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.

In the recent decision of Oklahoma Firefighters Pension and Retirement System v. Amazon.com, Inc., C.A. No. 2021-1484-LWW (Del. Ch. Jun. 1, 2022) (Mem. Op.), the Court of Chancery denied Plaintiff’s Section 220 request to demand additional inspection of Amazon’s books and records, finding that Plaintiff had not set forth a proper purpose for its investigation and that Amazon had adequately responded to Plaintiff’s demand.

Plaintiff filed its demand under 8 Del. C. § 220 to inspect Amazon’s books and records to examine potential corporate mismanagement and determine the independence and disinterestedness of Amazon’s directors.  The demand sought nineteen different categories of documents spanning eleven years.  Although Amazon questioned the legitimacy of Plaintiff’s purpose, it agreed to produce a targeted set of responsive materials, including relevant Board or committee meeting minutes and redacting any non-responsive content.  Plaintiff, in turn, filed this litigation to demand production of all documents responsive to its Section 220 demand.

The Court found that Plaintiff had not, as a threshold matter, stated a proper purpose for its investigation.  First, Plaintiff’s reference to closed or pending investigations and litigation failed to establish a credible basis for its desire to investigate possible mismanagement at Amazon.  The investigations and litigation had either closed without any adverse findings or were pending, and the only evidence of wrongdoing—a fine issued to Amazon from Italy—was irrelevant as Plaintiff only sought to investigate potential U.S. antitrust violations.  The Court found that Plaintiff had also failed to provide a credible basis for its desire to investigate the directors’ independence—stockholder curiosity is insufficient under Delaware law, and any evidence presented by Plaintiff was more speculative than reliable.

Perhaps more importantly, though, the Court of Chancery found that Plaintiff’s request for additional document production pursuant to 8 Del. C. § 220 failed because Amazon had already complied with Plaintiff’s demand.  Specifically, the Court found that Plaintiff had not shown that investigation of the additional books and records sought was essential to its investigation.  The Court also found that Amazon had produced all reasonably responsive documents, stating: “[f]ormal board-level documents are often the beginning and end of a Section 220 production where a plaintiff aims to investigate whether directors exercised proper oversight.”  (Mem. Op., at 30-31.)  In fact, the Court went so far as to commend Amazon for its effort to cooperate with Plaintiff by not outright rejecting its demand, but instead producing the core board materials that typically satisfy a Section 220 request.  Plaintiff had not justified its need for any specific documentation past what Amazon had already produced and, therefore, was overreaching.

Key Takeaway: When issuing a Section 220 demand to inspect corporate books and records, a plaintiff should first heed this Court’s decision by including a proper purpose for its investigation with a credible basis for the suspected misconduct.  Additionally, the responding company may be able to restrict its production to only those board and committee minutes that are relevant to the plaintiff’s stated purpose for inspection.

Carl D. Neff is a partner with the law firm of Pierson Ferdinand LLP, and practices in Delaware. You can reach Carl at (302) 482-4244 or at carl.neff@pierferd.com.