CHANCERY COURT GRANTS MOTION TO DISMISS SECTION 220 DEMAND MADE DURING A PENDING PLENARY CLAIM DUE TO LACK OF SPECIAL CIRCUMSTANCES

Mar 21 2019

In CHC Investments, LLC v. FirstSun Capital Bancorp, C.A. No. 2018-0610-KSLM (Del. Ch. January 24, 2019), the Court of Chancery (the “Court”), in a motion to dismiss, found that CHC Investments, LLC’s (“CHC” and “Plaintiff”) pending plenary claims rendered CHC’s purpose for demanding inspection corporate books and records pursuant to Section 220 of the Delaware General Corporate Law (“Section 220”) improper, and granted FirstSun Capital Bancorp’s (“FirstSun” and “Defendant”) motion to dismiss.

Before bringing a Section 220 claim against Defendant, Plaintiff filed a direct plenary action in the Court against Defendant and certain former directors, officers, and stockholders of Strategic Growth Bancorp, Inc. (“SG Bancorp”), which had merged into Defendant after Plaintiff became a shareholder in SG Bancorp”) in 2013. In 2014, Plaintiff invested an additional $25 million dollars in SG Bancorp securities to fund SG Bancorp’s national mortgage platform and real estate investment trust operations. Within months after the additional investment, SG Bancorp announced its intention to spin-off the mortgage unit through an exchange offer transaction in which Plaintiff declined to participate. In May 2015, SG Bancorp released financial statements, which Plaintiff alleged, contained information that was previously concealed from Plaintiff. The plenary action complaint alleged that SG Bancorp’s investment solicitation disclosures contained material misrepresentations or omissions regarding SG Bancorp’s mortgage business, asserted claims of fiduciary duty breach, fraud, and related causes of action, and sought damages, rescission, and costs and attorney’s fees.

After filing the plenary action, Plaintiff served the Defendant with a demand to inspect company books and records, pursuant to Section 220. The Plaintiff’s stated purpose was to investigate the facts behind SG Bancorp’s disclosures, corporate management in association with the mortgage unit spin-off, and alleged improprieties regarding the exchange offer transaction. The Defendant denied the demand for inspection. In response, Plaintiff commenced an action to compel inspection. The Defendant responded, and moved to dismiss.

The Court applied Court of Chancery Rule 12(b)(6) (“Rule 12(b)(6)”) to the Defendant’s motion to dismiss. Under Rule 12(b)(6) the Court will grant a motion to dismiss only if “the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof.” Cent. Mortg. Co. v. Morgan Stanley Mortg. Cap. Hldgs. LLC, 27 A.3d 531, 536 (Del. 2011).

In order to inspect corporate books and records pursuant to Section 220, a stockholder must state a proper purpose for inspection. Plaintiff admitted that it designed its inspection request to “give Plaintiff the information necessary to investigate the claims” asserted in the plenary action. The Defendant claimed that investigating claims asserted in a pending action is not a proper purpose.

In support of its Section 220 claim, Plaintiff cited two cases in which the Court held that special circumstances supported ordering enforcement of a stockholder’s Section 220 rights notwithstanding a pending plenary action. First, Plaintiff argued that Khanna v. Covad Communications Group, Inc., 2004 WL 187274 (Del. Ch. Jan. 23, 2004) should be interpreted broadly to permit a stockholder claimant such as Plaintiff to pursue its plenary claims while also seeking to investigate those claims under Section 220 where the stockholder faces statute of limitations or laches pressures. Rejecting this interpretation, the Court instead held that Khanna is limited to circumstances in which timing pressures are caused by the defendant, or at least, not by the plaintiff, and found that Plaintiff alleged no facts suggesting that Defendant was at fault for the timing of the Section 220 claim.

Plaintiff further asserted that King v. Verifone, 12 A.3d 1140 (Del. Supr. 2011) should be interpreted broadly to permit a claimant such as Plaintiff that has filed a plenary action to pursue a Section 220 inspection where the claimant has the opportunity to amend the plenary complaint. The Court ruled that King should be construed narrowly, however, and held that Plaintiff’s right to amend the complaint, standing alone, does not create a proper purpose for a Section 220 inspection while a plenary action is pending, citing in support of this holding decisions in Central Laborers Pension Fund v. News Corporation, 2011 WL 6224538 (Del. Ch. Nov. 30, 2011) and Amalgamated Bank v. NetApp, Inc., 2012 WL 379908 (Del. Ch. Feb. 6, 2012). The Court held that these precedent cases support enforcing Section 220 rights where a court has deemed a pending plenary action complaint insufficient and permitted a stockholder to re-plead, or amend its complaint, but are not applicable to Plaintiff’s Section 220 claim since no judicial action had occurred in Plaintiff’s plenary suit.

In addition, the Court noted that Khanna and King also did not apply to Plaintiff’s Section 220 claim because Khanna and King both involved plenary actions brought as derivative claims, whereas Plaintiff’s plenary action was a direct claim. The Court indicated that derivative and representative claims may be afforded greater leniency since they seek to further the interests of all stockholders and there are greater incentives for preserving their claims. In a direct claim plenary suit such as Plaintiff’s, the Court reasoned, none of the policy considerations affording leniency are implicated.

Because the Court found that no special circumstances or policy considerations were alleged or existed as would be required to support enforcement of Plaintiff’s Section 220 claim, the Court granted FirstSun’s motion to dismiss.