Rock Solid Gelt Ltd. v. SmartPill Corp.
| Decision Date | 10 October 2012 |
| Docket Number | C.A. No. 7100-VCN |
| Parties | Rock Solid Gelt Limited v. The SmartPill Corporation |
| Court | Court of Chancery of Delaware |
VICE CHANCELLOR
Jeremy D. Anderson, Esquire
Fish & Richardson P.C.
David E. Ross, Esquire
Seitz Ross Aronstam & Moritz LLP
Dear Counsel:
Plaintiff Rock Solid Gelt, Ltd. ("Rock Solid"), a shareholder of Defendant The SmartPill Corporation ("SmartPill"), a Delaware corporation, has brought a books and records action under § 220 of the Delaware General Corporation Law. This is the Court's decision after trial.
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In November 2006, Rock Solid purchased 374,531 shares and 74,906 warrants of SmartPill, for $999,997.77, as part of SmartPill's Series F Preferredfinancing.1 As a holder of Series F Preferred stock, Rock Solid had certain rights and preferences, including dividends, liquidation preferences, voting rights, protective provisions, conversion rights, anti-dilution provisions, and redemption rights.2
In March 2008, SmartPill conducted another round of financing (the "Series 2 Preferred financing").3 It proposed to issue 37,486,886 newly authorized shares of Series 2 Preferred stock at a price of $0.6352903 cents per share, or up to an aggregate of $20 million.4 Further, existing Series F Preferred stock would be converted into newly authorized shares of Series 1 Preferred stock. Rock Solid's existing rights and preferences remained intact, and it was not diluted relative to its position before the financing.5
In 2010, SmartPill conducted yet another round of financing (the "Series B financing").6 At the time, Psilos Group Partners III, L.P. ("Psilos"), Oxford Bioscience Partners V L.P. ("Oxford"), Kimberly Clark Ventures LLC ("KimberlyClark"), High Peaks Ventures L.P., and High Peaks Ventures NY L.P. (collectively, "High Peaks") were SmartPill's Controlling Stockholders.
On April 6, 2010, Psilos presented to SmartPill's board a proposed initial term sheet for a preferred stock financing in which Psilos would be the lead investor.7 The pre-financing valuation of SmartPill in the Series B financing was $16.8 million, in contrast with the pre-financing valuation of $30 million and post-financing valuation of $50 million in the Series 2 Preferred financing. 8 The proposed term sheet provided for the automatic conversion of all outstanding shares of Series 1 Preferred and Series 2 Preferred into common stock, "eliminating the preferences and many of the other rights enjoyed by holders of those shares."9
The proposed term sheet also acknowledged that six out of the seven members of SmartPill's Board of Directors (the "Board") had potential conflicts ofinterest with respect to this round of financing.10 The Board then established a Special Committee, consisting of Austin Broadhurst, Jr., the sole remaining member of the Board, whom the Board determined to be independent and without any personal interest in the proposed financing.11
The Board authorized the Special Committee to negotiate with Psilos on behalf of SmartPill with respect to the Psilos term sheet and the proposed financing, to engage its own independent legal counsel and independent financial advisor, and to seek alternative financing on more attractive terms than the terms of the financing described in the Psilos term sheet. It also delegated to the Special Committee the full power and authority of the Board with respect to such matters.12
On May 19, 2010, following the Special Committee's approval of the preferred stock financing contemplated in Psilos's revised term sheet, SmartPill circulated an information statement and subscription documents to its stockholders.13 SmartPill then realized that the preferred stockholders who had expressed their intention to consent to the conversion of all of the outstanding existing preferred stock to common stock did not own sufficient shares to effect such conversion.14
On June 18, 2010, SmartPill issued 11,000,000 additional shares of Series 2 Preferred stock to be purchased by the Controlling Stockholders.15 The sale of such shares was contingent on the receipt by SmartPill of sufficient shareholder consents to effect the automatic conversion of all shares of existing preferred stock, and the Controlling Stockholders consented to the conversion. 16 SmartPill amended its Certificate of Incorporation to increase total authorized common andpreferred stock in order to facilitate the Series B financing.17 The Controlling Stockholders increased their pro rata ownership of SmartPill's stock.18
On July 2, 2010, SmartPill circulated a Confidential Information Statement (the "July Information Statement") in which it provided a detailed account of the background and approval of the transactions described therein, including a discussion of the April 6, 2010 term sheet proposed by Psilos and of the results of negotiations by the Special Committee.19
On January 7, 2011, SmartPill sent a notice to shareholders pursuant to 8 Del. C. § 228,20 which described the Stock Purchase Agreement it had entered into with Alan Fox (the "Fox SPA"),21 a minority stockholder with whom Rock Solid was similarly situated. Fox, like Rock Solid, had initially refused to participate in the Series B financing. Fox directed a demand to SmartPill for books and records concerning the valuation of his interest in SmartPill and the valuationof SmartPill generally. That request was granted,22 and, soon thereafter, the Fox SPA was executed.
Under the Fox SPA, SmartPill (i) issued to Fox 1,190,140 shares of Series B Preferred stock for $0.0263 per share, (ii) issued to him warrants to purchase up to an additional 11,406,844 shares of Series B Preferred stock for $0.0263 per share, and (iii) exchanged Fox's common stock for Series A Preferred stock.23 This was at a significant discount to previous financings. Instead of being required to invest $281,877 to maintain his pro rata ownership, Fox only had to invest approximately $50,000.24 Fox also received a commitment from SmartPill that he would be able to participate in the next round of financing, regardless of whether the Controlling Stockholders allowed the minority stockholders to participate in the subsequent offering.25
On October 26, 2011, Rock Solid sent SmartPill a formal written demand (the "Demand"), requesting access to twenty-two categories of SmartPill's booksand records.26 On October 31, 2011, SmartPill rejected the Demand.27 On November 14, 2011, Rock Solid sent a follow-up letter to SmartPill (the "Supplemental Demand").28 On November 21, 2011, SmartPill again refused to allow Rock Solid to inspect the demanded documents.29
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The Delaware General Corporation Law expressly provides shareholders with the right to inspect the books and records of the corporations in which they have an ownership interest.30 This right, however, is not absolute. A shareholder seeking access to a corporation's books and records must demonstrate that "(1) he, she, or it is a stockholder, (2) he, she, or it has complied with the section respectingthe form and manner of making demand for inspection of such documents, and (3) the inspection such stockholder seeks is for a proper purpose."31
In this case, SmartPill has not disputed that Rock Solid's demands, both in October and in November, were proper both as to form and manner. Instead, SmartPill disputes the propriety of the purposes advanced by Rock Solid and the ultimate scope of any court-ordered inspection of its books and records.
As noted above, shareholders seeking to inspect a corporation's books and records pursuant to § 220 must articulate a proper purpose for demanding an inspection. A "proper purpose" means "a purpose reasonably related to such person's interest as a stockholder."32 The shareholder "has the burden of showing, by a preponderance of the evidence, a proper purpose entitling the stockholder to an inspection of every item sought."33 In addition to stating a proper purpose, theshareholder must also "state a reason for the [proper] purpose, i.e. what it will do with the information, or an end to which that investigation may lead."34
In the Supplemental Demand—elaborating on the Demand—SmartPill advanced the following purposes:
These purposes roughly map the four categories of books and records requested by Rock Solid in its post-trial papers.35
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First, valuation of one's shares is a proper purpose for the inspection of corporate books and records.36 Thus, Rock Solid may legitimately request books and records relating to the valuation of Rock Solid's shares before and after the Series B financing.
Second, because Rock Solid must show a proper purpose for every item sought, it is necessary to turn to its requests for books and records to investigate whether the Board committed breaches of fiduciary duties and whether the SpecialCommittee was indeed independent with regard to the Series B financing. To meet its burden of proving a proper purpose, "a stockholder must present some credible basis from which the court can infer that waste or mismanagement may have occurred"37 and that "[t]here must be some evidence of possible mismanagement as would warrant further investigation of the matter."38 Rock Solid therefore has the burden of presenting some credible basis—some evidence that would warrant further investigation of the Series B financing.
Rock Solid, however, does not have to conclusively establish...
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