Delaware Court of Chancery Finds Valuation of Stock Alone is Sufficient to Support Books and Records Request
In Avery L. Woods Trust v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020), the Delaware Court of Chancery (the “Court”) granted an inspection of books and records to Avery L. Woods (“Woods”), the trustee of the Avery L. Woods Trust (the “Trust” ) finding that the Trust’s stock valuation and investigation of possible mismanagement reasons for inspection sufficient and proper.
Sahara Enterprises, Inc. (“Sahara” or “the Company”) is a privately held investment fund that holds a 99% member interest in Sahara Investments, LLC which holds various securities and is managed by SMCO, Inc. (“SMCO”), a sister company of Sahara. When SMCO was created, Sahara represented that the reorganization would not impact the ability of stockholders to obtain information from the Company.
The Trust owns 278 shares of Sahara common stock. There is no ready market for Sahara shares and transfer is restricted by stockholder agreements. Woods grew displeased with the performance of Sahara investments against market indices and sought to value the Trust’s interest in Sahara and to investigate whether the Company’s underperformance was due to mismanagement or lack of oversight.
Woods served a demand for books and records under Section 220 of the Delaware General Corporation Law (“Section 220”) on the Company indicating that the purpose of the demand was to ascertain the value of the Trust’s interest in Sahara and investigate whether the Company’s underperformance was due to mismanagement or insufficient oversight. Sahara refused to provide any documents other than the Bylaws, list of stockholders, and summary of directors’ fees. Woods filed an action seeking to compel the inspection. Sahara responded with seven affirmative defenses including that Woods did not have a proper purpose because the Trust did not actually intend to use the requested books and records to value the shares. Sahara argued that Woods needed to provide some reason for valuing the shares. Sahara also argued that the demand should have been served on SMCO and Sahara did not have the right or ability to obtain books and records held by SMCO.
The Court noted that a plaintiff seeking to obtain books and records under Section 220 must establish a proper purpose for conducting the inspection and must demonstrate that each category of books and records is essential to the accomplishment of the articulated purpose. Under Section 220, a proper purpose is any purpose reasonably related to the stockholder’s interest. Citing precedent, the Court held that valuation of a stockholder’s investment, particularly where the corporation is privately held and no public disclosures are made, is a proper purpose. Once a valid purpose has been identified by the plaintiff, the burden shifts to the corporation to prove that the avowed purpose is not the actual purpose and that the actual purpose is improper. The Court held that while valuation as a purpose must be bona fide, the stockholder need not provide a reason why it seeks to value the stock.
In this case, Woods stated valuation of the stock was a purpose, and the Company failed to provide any evidence that Woods had some ulterior and improper purpose other than valuation of the stock. The Court concluded that there is no requirement under Delaware law that a stockholder demonstrate what it plans to do with the valuation of its shares in the corporation and held that Woods proved a proper purpose for inspection and did not need to provide a reason for the valuation.
The Court also rejected Sahara’s argument that it could not provide books and records held by SMCO because it had no control over SMCO and noted that this argument “bolstered” Wood’s basis to suspect that Sahara’s “directors ha[d] abdicated their statutory responsibilities.” The Court noted that underperformance alone would not have been enough to establish a credible basis to suspect wrongdoing sufficient to conduct an inspection. Sahara’s position that it had no control over SMCO steered the Court toward finding a credible basis to suspect that the Company’s directors abdicated their statutory oversight responsibilities with regard to SMCO’s management of Sahara assets. Additionally, the Company had misrepresented the impact that transferring management to SMCO would have on stockholder ability to access books and records. Sahara’s own arguments established a credible basis to suspect wrongdoing leading the Court to conclude Woods established another proper purpose for an inspection.
When discussing the scope of the inspection, the Court found that formal board materials such as minutes and consents were likely necessary and essential to satisfy the Trust’s proper purposes. Requests for formal board materials related to financial information about the Company were tied to the valuation purpose but requests for informal Board materials and officer level materials concerning financial forecasts were not necessary and essential to the valuation purpose. The Trust also requested to know who the Company’s senior officers are, how much compensation they receive, and whether the Company has entered into related-party transactions with officers or directors. The Court held that desire to know this information was itself another proper purpose.
The Court also rejected Sahara’s assertion that it could not produce SMCO documents noting that the companies had the same directors and share office space, email addresses, and are even audited and reported on a combined basis. Books nominally held by SMCO were within Sahara’s possession, custody or control and Sahara was ordered to produce all documents nominally held by SMCO or Sahara that human controllers can access in the ordinary course of business.
The Court granted the Trust’s books and records request for the purposes of valuing the stock and investigating possible mismanagement but limited the scope to books and records essential to satisfying these purposes.