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Chancery Dismisses Section 220 Case Due to Improper Purpose of Circumventing Stay of Discovery in Separate Securities Suit

By Francis G.X. Pileggi

King v. Verifone Holdings, Inc., C.A. No. 5047-VCS (Del. Ch. May 12, 2010), read opinion here. This is a case involving a demand under DGCL Section 220 seeking books and records.

Overview
The Court of Chancery denied the demand for books and records under Section 220 and dismissed the suit.

Background
The procedural history of this case began with a separate securities lawsuit filed in federal court. A Motion to Dismiss for failure to make a pre-suit demand was filed in that case and the federal judge in California both allowed that complaint to be amended and at the same time suggested that the plaintiff file a Section 220 action--apparently to assist the plaintiff in obtaining data to amend the complaint in the separate securities action, or so one could surmise.

The Court of Chancery in this decision spent much of the opinion discussing the public policy reasons why it would be an improper purpose to use Section 220 to circumvent the prohibition against discovery in securities suits at the Motion to Dismiss stage. The Court of Chancery also schooled the federal judge in the related California case regarding why Section 220 was not appropriately used  in the instant circumstances based on the procedural posture and history of this case and the related federal securities litigation.

Analysis
The Court of Chancery explains over the course of many pages why a Section 220 case needs to be filed prior to a derivative suit or a class action, and why it cannot be used to obtain discovery in separate lawsuits.

Importantly, the Court  also rejected the argument that the corporation waived the proper purpose defense by providing documents prior to the filing of this suit in an attempt to resolve the Section 220 demand that was made prior to the suit being filed. See footnote 21.

The Court spent a substantial part of the opinion explaining why a Section 220 action needs to be filed prior to a separate derivative suit, and prior to a substantive suit seeking remedies for substantive claims. The Court explained that one reason why due diligence in the form of a Section 220 demand needs to be made before a derivative suit is filed is, for example, to determine whether pre-suit demand would be excused--but after a derivative suit is filed it is too late at that point to use a Section 220 for such due diligence purposes.

A substantial part of the opinion explains the public policy reasons behind the Court's abhorrence of representative suits that are filed without appropriate due diligence, such as using the 'tools' of a Section 220 proceeding.

"Take-Away" from this Case
This case can be cited to support the argument that at least one proper purpose of a Section 220 demand is to perform due diligence prior to filing a derivative suit--for example, in order to determine compliance with Rule 23.1.

Full post as published by Delaware Corporate and Commercial Litigation Blog on May 13, 2010 (boomark / email).