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Boards of Directors Should Be Aware of Potential Defense to Books and Records Demand

Client Alert

Authors: Christopher B. Chuff, Joanna J. Cline, Douglas D. Herrmann and James H. S. Levine

10/11/2017
Boards of Directors Should Be Aware of Potential Defense to Books and Records Demand

Reprinted with permission from the October 11, 2017 edition of the Delaware Business Court Insider. © 2017 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. (ALMReprints.com, 877.257.3382). This article was published on November 7, 2017 in the Harvard Law School Forum on Corporate Governance and Financial Regulation blog.

A recent decision by the Delaware Court of Chancery, Mehta v. Kaazing, C.A. No. 2017-0087-JRS (Del. Ch. Sept. 29), confirms that stockholder demands to inspect corporate books and records based on the need to value a stockholder’s shares may be validly denied if the stockholder is unable to demonstrate that it has a “present” need to value its shares. Indeed, as the court makes clear, simply reciting a proper purpose, such as valuing one’s shares or investigating mismanagement, is not enough. To justify inspection, the stockholder must set forth the circumstances underlying its need for inspection and demonstrate that the stockholder has a need to inspect corporate books and records at the present time.

Section 220 and the Court’s Holding

Under Section 220 of the Delaware General Corporation Law (DGCL), a stockholder seeking to inspect corporate books and records has the burden of proving: that he is in fact a stockholder of the defendant company; that he has complied with the Section 220 requirements concerning form, manner, and making of the demand; and that the inspection is sought for a proper purpose.

It is well settled in Delaware that the valuation of one’s stock can be a proper purpose for the inspection of books and records. In fact, the need to value one’s ownership interest in the corporation is routinely cited as a basis for inspection.

What the Court of Chancery’s Mehta decision makes clear, however, is that simply stating the need to value one’s ownership interest is not sufficient to satisfy a stockholder’s burden to justify inspection. Rather, the court found, the stockholder must identify a particular need or reason to value his membership interests at the time of the request. Without a showing of a present need for a valuation, the mere articulation of that purpose is not sufficient to justify the stockholder’s inspection of corporate books and records.

In Mehta, the stockholder seeking inspection stated that one of the reasons he was seeking inspection was to value his ownership interest in the company. The stockholder did not, however, provide any reason as to why he needed to value his ownership interest at that time. Given that the stockholder failed to identify a present need or reason to value his shares, the Court found that the stockholder was not entitled to inspection on that basis. The court stated that the stockholder “had not demonstrated that valuing his membership interests justifies inspection since he has failed to identify any reason why he needs to value his membership interests at this time.”

Takeaway

Although Section 220 of the DGCL has been liberally construed to enable stockholders to obtain inspection of corporate books and records under various circumstances, boards of directors can resist such demands where the stockholder asserts the need to value its shares as a basis for inspection without explaining why the stockholder needs to value its shares at that time. Instead, the stockholder must explain the factual circumstances underlying its need for inspection and demonstrate that the stockholder has a legitimate need to inspect the corporate books and records at that time. Boards of Directors may consider denying inspection where a stockholder is unable to make that showing.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.