In Grand Acquisition LLC v. Passco Indian Springs DST, C.A. No. 12003-VCMR (Del. Ch. Aug. 26, 2016) the Delaware Court of Chancery found that under the Delaware Statutory Trust Act (the “Act”), the governing instrument of a Delaware statutory trust (DST) does not need to affirmatively disavow the preconditions and defenses applicable to inspection rights related to a DST’s books and records under Section 3819 of the Act in order to create a separate and distinct contractual right that can, in some circumstances, render statutory preconditions and defenses inapplicable to such requests.
This case arose from a demand letter that Grand Acquisition, LLC, a Nevada limited liability company (“Grand Acquisition”), which owns 0.185874 percent of the Class A interests of Passco Indian Springs DST, a Delaware statutory trust (the “Trust”), sent to the Trust demanding the right to inspect and make copies of the current list of the Trust’s beneficial owners, along with such beneficial owners’ current contact information and ownership interests in the Trust (collectively, the “Requested Information”). The Trust denied Grand Acquisition’s request on the basis that Grand Acquisition had not provided a “reasonable basis” for the request, as required under Section 3819 of the Act. Rather than provide such a basis, Grand Acquisition filed a complaint with the Chancery Court asserting that the governing instrument of the Trust (the “Trust Agreement”) includes language granting its beneficial owners an inspection right that is not qualified by the default preconditions and defenses included in Section 3819 and, therefore, the Trust Agreement effectively modifies or eliminates the reasonable basis requirement for such requests.
In its response, the Trust countered that Section 3819’s prefatory phrase “[e]xcept to the extent otherwise provided in the governing instrument” requires that a governing instrument affirmatively disavow such preconditions and defenses in order to render the default rules of the Section inapplicable. The Trust also argued in the alternative that Grand Acquisition’s request was (a) outside the scope of the term “books and records” as used in the applicable section of the Trust Agreement and (b) for an improper personal purpose adverse to the Trust’s interests. The parties agreed to resolve the case through cross motions for summary judgment.
With respect to whether a DST’s governing instrument must affirmatively disavow default rules contained in the Act, Vice Chancellor Montgomery-Reeves found that, while no such case has been decided regarding a DST, it is appropriate for the Court to cite to decisions involving Delaware limited liability companies (LLC’s) and limited partnerships (LP’s) when interpreting the Act on the same basis that the Court’s decisions involving LLC’s and LP’s often cite one another. Drawing upon the Court’s precedent in those contexts, the Vice Chancellor found that the Chancery Court has consistently found that a books and records inspection right shall be treated as a separate and independent contractual right unless such agreement “explicitly state[s] that the provision is merely clarifying or placing additional conditions on the other statutory and contractual right if in fact that is the provision’s intended purpose.” (citing Bond Purchase, L.L.C. v. Patriot Tax Credit Props., L.P., 746 A.2d 842, 853 (Del. Ch. 1999) Moreover, the Court noted that “providing an entity’s owners with an unconditional contractual right to inspect that entity’s books and records has the practical impact of rendering the relevant statutory preconditions and defenses inapplicable to that independent contractual right.” (Id. At 855)
Because the Trust Agreement contained such an unqualified right, the Court concluded that the Trust cannot deny Grand Acquisition’s request to inspect such books and records on the basis of Grand Acquisition failing to state a reasonable basis or lacking a proper purpose. Similarly, the Court found that the Trust may not deny Grand Acquisition’s request on the basis of statutory defenses under Section 3891 such as (1) that the Requested Information is subject to third-party confidentiality agreements or (2) that the Trust has a good faith belief that revealing the Requested Information to Grand Acquisition is not in Trust’s best interests.
Regarding whether the Requested Information falls outside the scope of the term “books and records” as used in the Trust Agreement, the Trust noted (i) the Trust Agreement does not define the term “books and records” and (ii) it does, however, define the term “Ownership Records” in a separate section of the Trust Agreement, which is equivalent to the information that Plaintiff is requesting. The Trust therefore argued that the doctrine of expressio unis dictates that the Trust Agreement intentionally excluded the Requested Information from the scope of “books and records.” The Court rejected this reasoning, finding that the two sections appear to be “wholly unrelated.” Additionally, the Trust Agreement indicates that the term “books and records” should be defined by their “customary meaning,” which the Vice Chancellor noted must certainly include the Requested Information as such information is expressly referenced in Section 3819.
Finally, regarding the improper purpose defense asserted by the Trust with regard to the contractual inspection right, the Court noted that no Delaware court has yet addressed whether such a defense applies in the context of a DST, however, it was not necessary to reach that issue in this decision as the Trust failed to prove such a defense would apply in this instance even if it were applicable.
In asserting its improper purpose defense, the Trust alleged that Grand Acquisition’s affiliation with Maxus Realty Trust, LLC (“Maxus”) is problematic, as evidenced by several litigious encounters between Maxus and Passco Companies, LLC (“Passco”), an affiliate of the Trust that owns the management company responsible for operating the apartment complex owned by the Trust. Moreover, the current CEO of Maxus, David Johnson, was the previous owner of an entity that had been described, at the time of his ownership, by the District Court of Douglas County, Nebraska as employing “a business strategy wherein it purchases a small fraction of a company or partnership in order to gain a toehold in the enterprise . . . to gain access to sensitive business information which, if successful, is then used for exploitation of either the business, its less sophisticated shareholders, or both.” As a result, the Trust asserted, it is clear that Grand Acquisition intends to use the Requested Information to “be disruptive and cause stress upon passive investors in order to make financial gains at others [sic] expense.”
In dismissing this defense, Vice Chancellor found that the Trust appeared to confuse the improper purpose defense with the statutory “good faith” defense that would be applicable under Section 3819 of the Act. While the latter would only require a good faith belief that revealing the Requested Information to Grand Acquisition is not in Trust’s best interests, the former requires showing by a preponderance of the evidence that revealing the Requested Information to Grand Acquisition would actually harm the Trust (“in an economic sense”) as a whole, as distinguished from its individual interest holders. “Notably absent,” the Vice Chancellor found, “is any allegation of damage to the ‘value of the joint investment.’ Instead, [Passco] merely describes run-of-the-mill business conflicts between an investor in a real estate asset and that asset’s manager.”
Having found against the Trust on each argument, the Court granted Grand Acquisition’s motion for summary judgement and ordered the Trust to comply with Grand Acquisition’s inspection request regarding the Requested Information.