Paraflon Investments, Ltd. v. Linkable Networks, Inc.

Court of Chancery of the State of Delaware · 2020 · Corporations

CorporationsSection 220Books and RecordsStockholder Inspection Rights8 Del. C. § 220proper purposecredible basisnon-exculpated wrongdoing

Facts

Paraflon invested over $7 million in Linkable, which remained unprofitable and eventually sold its assets to Collinson while winding down. Before the sale, Linkable was in desperate need of cash and had a signed Blue Chip term sheet for additional financing, but the company chose not to countersign the final agreement or enforce the term sheet; a Blue Chip affiliate sat on Linkable's board. Paraflon later demanded records concerning possible wrongdoing, including documents about the abandoned Blue Chip financing, the Collinson sale, financial records, and other materials. Linkable produced many documents, but Paraflon sought more, including contracts not mentioned in its original demand.

Issue

Whether Paraflon established a proper Section 220 purpose supported by a credible basis to suspect non-exculpated wrongdoing sufficient to require production of additional records concerning the abandoned Blue Chip financing or the Collinson sale, and whether it could obtain inspection of contracts not requested in its demand letter.

Rule

Under 8 Del. C. § 220, a stockholder may inspect books and records for a proper purpose reasonably related to its interest as a stockholder. Investigating mismanagement or wrongdoing is a proper purpose, but the stockholder must show a credible basis from which the court can infer that mismanagement or wrongdoing may have occurred; where the charter contains a Section 102(b)(7) exculpatory provision, the investigation must target non-exculpated wrongdoing. Even then, the stockholder is entitled only to documents that are necessary, essential, and sufficient to the stated purpose, and inspection generally is limited to requests actually specified in the demand letter.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

Nora Patel owns shares in Cedar Loop Systems, a Delaware corporation headquartered in Austin. The company was weeks from missing payroll when it declined to enforce a signed bridge-financing commitment from Mesa Crest Capital, whose partner Daniel Rowe sat on Cedar Loop's board, and Nora seeks inspection to investigate possible fiduciary misconduct.

If Cedar Loop's charter contains a Section 102(b)(7) exculpatory clause, which is the strongest argument that Nora has stated a proper purpose under Section 220?

Explanation. A stockholder investigating wrongdoing must show a credible basis to infer possible wrongdoing, and where a Section 102(b)(7) clause exists, the investigation must target possible non-exculpated wrongdoing. Some evidence suggesting the board may have favored an affiliated investor over the corporation—especially when the company urgently needed cash and chose not to pursue a signed commitment—supports a possible loyalty-based claim. Poor performance alone is insufficient, and the stockholder need not prove actual misconduct. (Derived from Paraflon Investments, Ltd. v. Linkable Networks, Inc. (n.d.).)