Chancery Court Rejects Stockholder’s Demand for Books and Records
By: Whitney Smith and Kevin Szu-Tu
In Haque v. Tesla Motors, Inc., C.A. No. 12651-VCS (Feb. 2, 2017), Vice Chancellor Slights declined to compel the defendant, Tesla Motors, Inc. (“Tesla”), to produce certain books and records demanded by Plaintiff stockholder in an action brought under Section 220 of the Delaware General Corporate Law (“Section 220”). Applying well settled Delaware law that a stockholder’s right to inspect books and records under Section 220 is broad but not unlimited, Vice Chancellor Slights denied Plaintiff’s demand, ruling that the Plaintiff failed to demonstrate a credible basis from which the Court could infer wrongdoing.
Tesla is a public Delaware corporation with headquarters in Palo, Alto California. Its main business is the design, development, production, and sale of luxury electric vehicles.
Plaintiff, Shahid Haque, has continuously held Tesla’s common stock since April 24, 2014. On June 15, 2015, and again on July 18, 2016, he sent Tesla demands to inspect its books and records. In the case of the first demand, Tesla provided Plaintiff with limited records, and in the case of the second demand, it provided no official response. After receiving no response from Tesla, Plaintiff filed an action to compel production of corporate books and records under Section 220.
Section 220 permits a stockholder whose request to inspect corporate books and records has been denied to apply to the Court of Chancery for an order to compel inspection. Under Section 220, the stockholder has the burden of establishing by a preponderance of the evidence that: “(1) such stockholder is a stockholder; (2) such stockholder has complied with [Section 220] respecting the form and manner of making demand for inspection of such documents; and (3) the inspection such stockholder seeks is for a proper purpose.”
In the instant case, the Plaintiff’s stated purpose for seeking Tesla books and records was to further investigate his allegations of possible breaches of fiduciary duty and mismanagement by the officers and directors of the company in order to determine whether a derivative action was warranted. Plaintiff alleges that the company manipulated its production capacity figures in order to mask a lack of demand for its vehicles. The Court acknowledged that use of corporate records to investigate potential wrongdoing or mismanagement at a company is a proper purpose under Section 220. However, before compelling production of records in such cases, the Plaintiff must present evidence to establish a “credible basis” from which the Court can infer that mismanagement, waste, or wrongdoing may have occurred. This is the lowest burden of proof and may be satisfied by a credible showing, through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing. By requiring a credible basis to infer mismanagement, the Court seeks to balance a stockholder’s access to corporate records that may provide some evidence of possible wrongdoing against the corporation’s right to deny requests for inspection based solely upon suspicion and curiosity.
The Plaintiff alleged that the company hid low consumer demand for its vehicles by constantly blaming production issues for low sales figures (i.e., deliveries). In particular, Plaintiff pointed to instances when the company was unable to meet its production targets, but was able to meet its delivery goals as evidence to support his allegation. The Court found ironic the premise that Tesla would prefer to tell the market that there are flaws in its production processes and capacity rather than admit that demand was lower than forecasted. Nevertheless, the Court analyzed the evidenced proffered by Plaintiff.
The Plaintiff cited five Tesla reports occurring between Q3 2014 and Q2 2016 as examples of the company covering up low consumer demand with purported production issues. In Q3 2014, Tesla extended a planned two-week factory shutdown to conduct upgrades, and the company subsequently met its production targets while missing its delivery targets. On the assumption that the extended downtime would impact production and delivery targets equally, Plaintiff argued that this discrepancy showed that Tesla made only enough vehicles to meet its delivery targets, even though it had the capacity to produce more. The Plaintiff argued that his theory was also supported by the company’s 61% increase in production of vehicles to meet a milestone target coupled with a missed delivery target in Q4 2014. He argued this showed that Tesla’s true production capabilities outstripped market demand for its vehicles. The Plaintiff also held up reduced production targets in Q1 2015, Q1 2016 and Q2 2016 as examples of Tesla manipulating production targets, purportedly for production issues, in order to hide low demand. The Plaintiff refused to believe the company’s stated reasons for these target adjustments, arguing instead that Tesla was using convenient excuses to obscure actual production capacity. In each of the five reports, the Plaintiff hoped to show that Tesla was capable of manipulating and, in fact, actually was manipulating its production statistics.
Analyzing each of the Plaintiff’s examples in turn, the Court found no credible basis to infer wrongdoing in any instance. In the Court’s view, many of the Plaintiff’s arguments did not take into account the company’s complex manufacturing process and at times were logically deficient. For example, the Court was unconvinced that the Q4 2014 production spike proved any sort of manipulation by Tesla, instead indicating that it would expect a company’s production capabilities to have improved after a factory shutdown made to make improvements. The Court also found that the Plaintiff simply misconstrued Tesla’s reports to bolster his arguments. In one instance the Plaintiff had argued that Tesla had stated that it had resolved production issues, when the company had merely stated that it was “seeing improvement”. Generally, the Court found the company’s explanations for variations in production and delivery targets clear and convincing. After reviewing all of the evidence, the Court found no support for a credible basis to infer that Tesla had been hiding low demand for its vehicles by blaming production issues. The standard of “credible basis” for Section 220 actions, while low, is not a free pass for stockholders to inspect corporate records on mere suspicion and without a factual basis.
Haque v. Tesla Motors, Inc., C.A. No. 12651-VCS (Del. Ch. Feb. 2, 2017)