King v. Verifone Holdings Inc.

• Decision Date: 28 January 2011
• Docket Number: 2010.,No. 330,330
• Citation: 12 A.3d 1140
• Parties: Charles R. KING, Plaintiff Below, Appellant,v.VERIFONE HOLDINGS, INC., Defendant Below, Appellee.
• Court: Supreme Court of Delaware

12 A.3d 1140

Charles R. KING, Plaintiff Below, Appellant,

v.VERIFONE HOLDINGS, INC., Defendant Below, Appellee.

No. 330

2010.

Supreme Court of Delaware.

Submitted: Dec. 15, 2010.Decided: Jan. 28, 2011.

Court Below: Court of Chancery of the State of Delaware, C.A. No. 5047.Upon Appeal from the Court of Chancery. REVERSED.David A. Jenkins and Michele C. Gott, Esquires, of Smith, Katzenstein & Jenkins LLP, Wilmington, Delaware; Of Counsel: Judith S. Scolnick (argued) and Tom Laughlin, Esquires, of Scott + Scott LLP, New York, New York; for Appellant.Raymond J. DiCamillo and Kevin M. Gallagher, Esquires, of Richards, Layton & Finger, P.A., Wilmington, Delaware; Of Counsel: Robert A. Sacks, Esquire (argued), of Sullivan & Cromwell LLP, Los Angeles, California; Brendan P. Cullen, Laura Kabler Oswell and Ryan J. McCauley, Esquires, of Sullivan & Cromwell LLP, Palo Alto, California; for Appellee.Before STEELE, Chief Justice, HOLLAND, BERGER, JACOBS and RIDGELY, Justices, constituting the Court en Banc.JACOBS, Justice:

The sole issue on this appeal is whether a stockholder-plaintiff who has brought a stockholder's derivative action without first prosecuting an action to inspect books and records under 8 Del. C. § 220 is, for that reason alone, legally precluded from prosecuting a later-filed Section 220 proceeding. Charles R. King (“King”), the plaintiff-below appellant, brought this Section 220 action for a court-ordered inspection of certain books and records of the corporate defendant-below, appellee VeriFone Holdings, Inc. (“VeriFone”). The Court of Chancery dismissed King's complaint, holding that King lacked a proper purpose under Section 220, because he had previously elected to prosecute a derivative action in the United States District Court for the Northern District of California (the “California Federal Court”). On appeal, King claims that the Court of Chancery erred as a matter of law in concluding that the prior filing of his California derivative action constituted an “election” that precluded him from seeking relief in a later Section 220 books and records proceeding. We agree and, therefore, reverse the judgment of the Court of Chancery.

FACTUAL AND PROCEDURAL BACKGROUND ¹

VeriFone, a Delaware corporation whose principal place of business is in San Jose, California, designs, markets, and services electronic payment transaction systems. On November 1, 2006, VeriFone acquired the Israeli-based Lipman Electronic Engineering Ltd. (“Lipman”), which was then the world's fourth-largest point-of-sale terminal maker. That acquisition made VeriFone the world's largest provider of electronic payment solutions and services.

On December 3, 2007, VeriFone publicly announced that it would restate its reported earnings and net income for the prior three fiscal quarters. Both sets of numbers had been materially overstated due to accounting and valuation errors made while Lipman's inventory systems were being integrated with VeriFone's.² After that restatement announcement, VeriFone's stock price dropped over 45%, and the company was subjected to litigation and regulatory investigations. One day after the announcement, several VeriFone shareholders filed a class action in the California Federal Court, asserting various federal securities fraud claims against VeriFone, its Chief Executive Officer, and its Chief Financial Officer. The United States Securities and Exchange Commission (“SEC”) also launched an investigation and filed a civil complaint in the California Federal Court, charging VeriFone with federal securities law violations.³

A. The California Derivative Complaint

King beneficially owns 3000 VeriFone shares, of which he has held at least 500 since December 11, 2006. On December 14, 2007, King filed a stockholder derivative action on behalf of VeriFone against certain of its officers and members of its board of directors (“Board”) in the California Federal Court. Three other federal derivative actions followed. All four cases were consolidated, and the California Federal Court appointed King as lead plaintiff.

On October 31, 2008, King filed a consolidated amended derivative complaint in the California Federal Court action, claiming that various VeriFone officers and directors had committed breaches of fiduciary duty and corporate waste. Specifically, King alleged that VeriFone's officers and Board had: (a) made materially false financial statements to the SEC and the public; (b) abdicated their fiduciary duties by allowing VeriFone to operate with material weaknesses in its internal controls over financial reporting, while representing publicly that the company had effective internal controls; and (c) allowed eight VeriFone directors and/or officers, while possessing material insider information, to sell over 12.4 million of their VeriFone shares for a $462 million dollar profit.⁴

VeriFone moved to dismiss King's consolidated complaint for failure to make a pre-suit demand upon its Board, as required by Federal Rule of Civil Procedure (FRCP) 23.1(b)(3).⁵ On May 26, 2009, the California Federal Court granted VeriFone's motion, holding that King's consolidated complaint failed to allege particularized facts that would excuse a pre-suit demand.⁶ That dismissal was without prejudice.⁷ In granting leave to amend the complaint, the California Federal Court suggested that King first “engage in further investigation to assert additional particularized facts” by filing a Section 220 action in Delaware.⁸ In that regard, the California Federal Court observed that: “Since [King's] purpose is to obtain the particularized facts needed to adequately allege demand futility and to show corporate wrongdoing, rather than to investigate new potential claims, [King] should gain access to certain of VeriFone's documents and records for the Relevant Period.” ⁹

On June 9, 2009, King submitted to VeriFone a written demand to inspect specified categories of documents. The parties were able to resolve all of King's requests except one—the Audit Committee Report (“Audit Report”), which contained the results of an internal investigation of VeriFone's accounting and financial controls that had been conducted after the December 3, 2007 restatement announcement.¹⁰

B. King's Section 220 Action

Unable to resolve the dispute through mediation, on November 6, 2009, King filed this Section 220 action in the Court of Chancery for an order permitting him to inspect the Audit Report and any documents relied upon in its preparation. In his Chancery complaint, King referenced an April 2, 2008 press release from VeriFone, which stated that “[a]s a result of the issues identified by [VeriFone's] management and the Audit Committee independent investigation, management has concluded that VeriFone did not maintain effective internal control over financial reporting.” ¹¹ That press release, King alleged, showed that the Audit Report was essential to enable him to plead demand futility in the California Federal action, because the Audit Report would likely show that VeriFone's officers and Board knew of the company's inadequate financial reporting controls, yet consciously disregarded that fact in violation of their fiduciary duty of loyalty.

VeriFone moved to dismiss the Section 220 complaint under Court of Chancery Rule 12(b)(6), claiming that King had “initiated this litigation backwards” by first filing his derivative suit in California. Citing an earlier Court of Chancery decision, Beiser v. PMC–Sierra, Inc.,¹² VeriFone argued that King's Section 220 action violated the long-standing public policy-based rule that derivative plaintiffs should utilize the Section 220 inspection process before commencing a derivative action.

The Court of Chancery agreed and dismissed King's action, holding that King lacked a “proper purpose” for inspection as 8 Del. C. § 220 requires. The Vice Chancellor reasoned that because King had “elected” to file his California derivative action before conducting a pre-suit investigation (including resort to the Section 220 process), King was precluded from using the Delaware courts to obtain discovery that was unnecessary or unavailable in his federal derivative action.¹³ In reaching this result, the Court of Chancery articulated the following bright-line rule:

[S]tockholders who seek books and records in order to determine whether to bring a derivative suit should do so before filing the derivative suit. Once a plaintiff has chosen to file a derivative suit, it has chosen its course and may not reverse course and burden the corporation (and its other stockholders) with yet another lawsuit to obtain information it cannot get in discovery in the derivative suit.¹⁴

To hold otherwise, the Court of Chancery concluded, would offend public policy and encourage an “inefficient race to the courthouse.” ¹⁵

This appeal followed.¹⁶

ANALYSIS

On appeal, King claims that the Court of Chancery erred in dismissing his Section 220 action for lack of a proper purpose solely because he “elected” to file his California federal derivative action before resorting to the Section 220 process. That bright-line rule, King claims, runs afoul of Delaware decisions where this Court and the Court of Chancery expressly permitted similarly-situated derivative plaintiffs to bring Section 220 actions to uncover facts that could enable them to plead demand futility with particularity in amending their (earlier-dismissed) derivative complaints.

We review a trial court's conclusions of law de novo.¹⁷ We will not, however, disturb the trial court's factual findings so long as those findings are sufficiently supported by the record and are the product of an orderly and logical reasoning process.¹⁸

We conclude that the Court of Chancery's bright-line rule barring stockholder-plaintiffs from pursuing inspection relief under 8 Del. C. § 220 solely because they filed a derivative action first, does not comport with existing Delaware law or with sound...