COURT OF CHANCERY ANALYZES BOOKS AND RECORDS CLAIM UNDER THE LLC ACT
By: Scott Waxman and Zack Sager
In Riker v. Teucrium Trading, LLC, the Delaware Court of Chancery granted in part and denied in part a member’s demand for books and records under Section 18-305 of the Delaware Limited Liability Company Act (the “LLC Act”). The Court also denied the member’s request for attorneys’ fees.
Plaintiff Dale Riker (“Riker”) owned a limited liability company interest in Defendant Teucrium Trading, LLC (the “Company”) and served as its CEO from September 2011 until September 2018 when he was removed by a vote of the Class A members of the Company. After Riker’s removal, Riker made a demand on the Company to inspect fifteen categories of books and records pursuant to Section 18-305 of the LLC Act (the “Demand”). The Demand stated multiple purposes for the books and records, including the following: (i) to investigate improprieties in the Company’s governance, regulatory compliance, reporting, and controls, including, but not limited to, improperly noticed and conducted meetings to remove or appoint officers and the concerted action of a control bloc of Class A members to remove Riker as an officer and freeze Riker out as a Class A member of the Company (the “Governance Purpose”); and (ii) to value Riker’s limited liability company interest in the Company (the “Valuation Purpose”).
Although the Company told Riker that it did not believe that he had stated a proper purpose, it, nonetheless, produced many of the requested documents. Thereafter, Riker sent a letter to the Company demanding that the Company produce numerous additional documents. The Company failed to produce all of the desired documents, and Riker filed a complaint asserting two claims for the production of the Company’s books and records. After a mediation and a subsequent trial, six document requests in the Demand remained in dispute. Two of these requests related to Riker’s Valuation Purpose (the “Valuation Requests”) and the other four related to the Governance Purpose (the “Governance Requests”).
Under Section 18-305 of the LLC Act, members of a Delaware limited liability company (an “LLC”) have the right, subject to such reasonable standards as may be set forth in a limited liability company agreement or otherwise established by management, to obtain certain records upon reasonable demand for any purpose reasonably related to the member’s interest as a member of the LLC. After a proper purpose has been established, the scope of a member’s inspection is limited to those books and records that are necessary and essential to accomplish the stated, proper purpose.
The Court first addressed Riker’s Valuation Requests. It is well established that valuing one’s ownership interest is a proper purpose for seeking books and records. The issue before the Court, therefore, was whether the records Riker sought were necessary and essential to value his interest. Riker identified numerous types of information that he needed to complete his analysis, including information relating to the Company’s gross expenses, contingent assets and liabilities, and cash projections.
With respect to the Company’s gross expenses, Riker sought the Company’s allocation model, an Excel-based workbook with granular details concerning each specific expense of the Company and its funds. The Court denied Riker’s request finding that it exceeded the scope of the Demand and was not necessary for Riker’s stated purpose. Further, the Court found that all of the necessary and essential expense information could be found in the Company’s audited financial statements, which the Company had supplied, or was in the process of supplying, to Riker.
With respect to the Company’s contingent assets and liabilities, Riker sought certain memoranda, which set forth this information. The Court held that it was unnecessary for the Company to provide these memoranda (which were filled with details irrelevant to valuing Riker’s interest) because such information was already set forth in financial statements previously provided to Riker. Further, given the insignificant amount of contingent assets and liabilities, this information was not necessary and essential for the Valuation Purpose.
With respect to the cash projections, Riker sought the Company’s full budget and business plan for 2020, not just portions of it that were provided to him. Specifically, Riker wanted to see the Company’s plans and projections for expanding the outstanding shares in its funds, increasing assets, and/or restoring the Company to profitability. The Court held that such plans and projections would be important to valuing Riker’s interest because an investor cannot replicate management’s inside view of a company’s prospects. Accordingly, the Court ordered the Company to produce the other parts of its budget and business plan to the extent it addressed these matters.
The Court then addressed Riker’s Governance Requests, which sought (i) documents relating to the actual or potential appointment or removal of any company officer, (ii) all communications among the control bloc of the Company’s Class A members (the “Control Bloc”) regarding any action taken or mentioned by the Control Bloc regarding any Company-related matter, (iii) any materials that were made available to any governing group of the Company, and (iv) any materials regarding any decision taken by any governing group of the Company.
Under Delaware law, an investor seeking to inspect documents for the purpose of investigating potential mismanagement need only show, by a preponderance of the evidence, a credible basis from which the Court of Chancery can infer there is possible mismanagement that would warrant further investigation.
With respect to Riker’s request for documents regarding the appointment or removal of officers, the Court was satisfied that the Company had already provided all of the responsive, non-privileged documents relating to Riker’s removal. The Court then stated that Riker failed to identify any evidence of record to establish a credible basis that the actual or potential removal of any other officer of the Company involved any wrongdoing. The Court also held that Riker failed to identify any evidence to demonstrate that credible or legitimate issues of wrongdoing existed concerning any actions taken or considered by the Control Bloc or involving any other governing group of the Company.
Lastly, Riker sought attorneys’ fees for the Company’s allegedly vexatious litigation tactics. Delaware follows the American Rule whereby the prevailing party is generally expected to pay its own attorneys’ fees and costs unless the losing party has acted in bad faith. While the Court found that the Company was aggressive in its litigation defense, it did not find that this was one of those extraordinary circumstances where the Company’s conduct warranted fee shifting. In reaching this conclusion, the Court cited the Company’s efforts to resolve the issues amicably by producing some documents within weeks of it receiving the Demand and many more throughout the course of the mediation.