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Sanders v. Ohmite Holding, LLC, C.A. No. 5145-VCL (Del. Ch. Feb. 21, 2011) (Laster, V.C.)

February 21, 2011

In this opinion, the Court of Chancery granted summary judgment in favor of the plaintiff, a member of Ohmite Holding, LLC (the “Company”) seeking books and records of the Company. The Company is a Delaware limited liability company based in Illinois. Through a series of transactions, the plaintiff acquired his membership interest in the Company by purchasing from a member of the Company “units” in the Company that the plaintiff understood represented 7.75% of the total membership interests in the Company.

After receiving a Schedule K-1 from the Company reflecting a .000775% interest in the Company, the plaintiff requested an explanation for the dilution of his membership interest to one ten-thousandth of what he understood to be its value. The Company explained that prior to the time that the plaintiff was admitted as a member additional units were issued to raise capital. The Company further explained that it presented the member from whom the plaintiff acquired his membership interest the opportunity topurchase more units but the former member declined. As a result of such unit issuance, the Company said, the percentage interest of the member from whom the plaintiff acquired his membership interest declined  to  .000775%.

The plaintiff made a written demand for specific books and records of the Company for the purposes of evaluating the value of his interest in the Company, its financial condition, management’s performance and the legitimacy of the dilution of his interest. The Company denied his request, writing that he did not offer a “proper purpose” for the demand as required by Section 18-305 of the Delaware Limited Liability Company Act (the “LLC Act”), and that he did not have the power to make such a demand because he was not a member of the Company at the time of the additional unit issuance that led to the dilution of the interest he acquired. To bolster its argument regarding the plaintiff’s lack of power to make a books and records demand, the Company pointed to a section of the Company’s operating agreement providing that assignees of membership interests who are not members are not entitled to receive information regarding Company transactions or to inspect the Company’s books.

Section 18-305 of the LLC Act provides members of a Delaware LLC the right, subject to any standards set forth in an LLC’s operating agreement or as otherwise established by the manager or members of the LLC, to obtain certain records of such LLC “upon reasonable demand for any purpose reasonably related to the member’s interest as a member.” The Company’s operating agreement did not place any limit on members’ rights to inspect the Company’s books and records, nor did the Company members or any manager establish any standard governing such rights.

The Court held that because the plaintiff was already a member at the time he made the demand forthe Company’s books and records, and no standards or limitations were placed on his inspection rights under the operating agreement or otherwise, the plaintiff’s rights to inspect the Company’s records were as broad as permissible under the LLC Act. Drawing from cases interpreting similar Delaware statutes in the context of corporations and partnerships, the Court also held that the plaintiff established by a preponderance of the evidence that he has a “proper purpose” for inspection. In other words, as required by the LLC Act, the plaintiff’s purpose is “reasonably related” to his “interest as a member.” The Court supported this part of its holding by citing cases in which a proper purpose was found in investigating (i) potential wrongdoing by management, (ii) potentially wrongful dilution, and (iii) possible breaches of fiduciary duty.

In books and records actions such as this one, the plaintiff’s burden also includes establishing that each category of the books and records sought is essential and sufficient to the plaintiff’s stated purpose. Put differently (i) are the documents and information sought reasonably required to satisfy the purpose of the demand, and (ii) does the party making the demand already have from another source of information sufficient to satisfy the stated purpose such that the volume of records to be turned over may be reduced, or the demand wholly denied? In granting summary judgment for the plaintiff, the Court answered the first of the foregoing questions in the affirmative, and the second in the negative, ordering the Company to provide its member with all of the books and records requested.

The full opinion is available here