Chancery Court Partially Grants Books and Records Request
By David Forney and Jonathan Miner
In Mehta v. Kaazing Corporation, C.A. No. 2017-0087-JRS (Del. Ch. Sept. 29, 2017), the Delaware Court of Chancery partially granted and partially denied a plaintiff shareholder’s books and records inspecting demand under Section 220(c) of the Delaware General Corporation Law (“DGCL”). Although valuation of equity is usually a proper purpose, here the shareholder did not identify any reason why his equity needed to be valued, so this purpose was deemed improper. The shareholder’s other purposes, including alleged wrongdoing and mismanagement, were deemed proper notwithstanding the shareholder’s open employment litigation action against the company, but the scope of his requests were limited only to those documents that addressed the crux of those purposes.
The plaintiff, Vikram Mehta (“Mehta”), served as the CEO of Kaazing Corporation (“Kaazing”) from October 2013 to April 2015 when he was terminated from that position by Kaazing’s board of directors. Mehta is also a stockholder of Kaazing. At that time, Kaazing had two large investors, Columbus Nova Technology Partners (“CNTP”) and New Enterprises Associates (“NEA”), both of which had participated in prior financing rounds. CNTP had two representatives on the Kaazing Board of Directors. Following Mehta’s termination, a managing director from CNTP became Kaazing’s Executive Chairman and a new CEO and COO were appointed. Prior to Mehta’s termination in April 2015, he was negotiating an extension of Kaazing’s existing credit line and a new Series C equity financing round. The extension of the credit line and Series C financing, however, failed to close under the new leadership, who Mehta alleged had compensation packages that were overly generous.
In February 2016, Kaazing contacted its shareholders and reported that it had “ended 2015 with a very strong Q4” and noted that existing investors would be able to participate in an upcoming Series C financing. Mehta did not receive this communication until he specifically asked for it, well after other shareholders had already invested. On March 25, 2016, Kaazing delivered its shareholders a much different message – that the company was in dire need of a $1 million bridge loan.
Over the next few months, Kaazing closed a bridge loan with CNTP as a lead investor, and then closed a Series 1 financing, also with CNTP as lead investor, which lead to a reverse stock split and recapitalization of all shares into common stock. Mehta asserted that the Series 1 financing was overly favorable to CNTP and that he and other shareholders were required to waive certain shareholder rights before they were allowed to participate in the fundraising. Kaazing’s new financing arrangements resulted in a dilutive conversion of Mehta’s shares of Series B-1 preferred stock to shares of common stock.
On January 10, 2017, Mehta sent a demand to Kaazing pursuant to Section 220 of the DGCL (the “Demand”) in which he sought inspection of certain books and records to “(i) ascertain the value of his stock; (ii) ascertain whether there has been mismanagement, waste, or wrongdoing by the Company’s agents and representatives; (iii) determine what impact if any this mismanagement, waste, or wrongdoing, has had, or might have, on the value of Plaintiff’s shares of the Company; and (iv) communicate with other shareholders of the Company. Kaazing offered to provide some responsive documents if Mehta signed a confidentiality agreement. Mehta rejected the offer from Kaazing and filed this action.
Under Section 220 of the DGCL, a shareholder seeking to inspect books and records has the burden of proving (1) that he is in fact a stockholder of the defendant company, (2) that he has complied with the Section 220 requirements concerning form, manner and making of the demand and (3) that the inspection is sought for a proper purpose. Kaazing did not contest the first two prongs, so the Court’s analysis turned on whether Mehta’s inspection request was sought for a “proper purpose.”
The Court noted that a proper purpose is one that is “reasonably related to such person’s interest as a stockholder”, and that the stockholder has the burden of proving the proper purpose by a preponderance of the evidence for each item sought. Kaazing asserted that Mehta’s true purpose was to gather documents not otherwise accessible to him through the discovery process which he would use in employment litigation that he had also initiated against the company.
Considering Mehta’s purpose of valuation of his stock, the Court noted that it is settled law that valuation of stock can be a proper purpose, but that in Mehta’s case he had not identified any reason why his stock need to be valued at that time. Accordingly the Court dismissed the portion of Mehta’s demand relating to valuation of his equity.
The Court looked more favorably on Mehta’s purpose of investigating mismanagement, waste or wrongdoing at Kaazing. To prevail on such a request, a plaintiff must merely present some evidence that provides a credible basis for the court to infer possible mismanagement. The Court noted that this is a low burden of proof. Mehta’s evidence of contradictory statements regarding the financial condition of Kaazing, the preferential treatment of certain investors, including CNTP, and excessive compensation of new executives was sufficient to meet the standard.
After determining that Mehta’s purpose of investigating mismanagement, waste or wrongdoing at Kaazing was proper, the Court turned to the scope of Mehta’s document requests. The Court noted that Delaware law provides that once a plaintiff has established a proper purpose he is only entitled to the documents that “address the crux of the shareholder’s purpose.” The Court analyzed a number of specific document categories and document requests and denied several items, including Mehta’s requests for the general ledger of the company and a record of all changes in the composition of the board and its committees and reasons for such changes. Mehta’s request for the general ledger was related to a desire to investigate “how and where Kaazing was spending money”, which the Court reasoned was related to general curiosity and not an investigation of mismanagement. The Court granted most of Mehta’s other documentary requests.