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King v. VeriFone Holdings, Inc., No. 330, 2010, C.A. No. 5047 (Del. Jan. 28, 2011) (Jacobs, J.)

January 28, 2011

In King v. VeriFone Holdings, Inc., the Delaware Supreme Court reversed Vice Chancellor Strine’s dismissal of a request, pursuant to 8 Del. C. § 220, by VeriFone Holdings, Inc. (“VeriFone”) stockholder Charles King (“King”), to inspect VeriFone’s books and records related to an internal audit of an earnings restatement. The Court held that the Vice Chancellor erred by finding King lacked a proper purpose, because the U.S. District Court judge for the Northern District of California had dismissed King’s earlier-filed derivative action without prejudice and with leave to amend his complaint. The Court held that “investigating corporate mismanagement—the purpose stated by King—is a proper purpose for seeking a Section 220 books and records inspection,” particularly when the inspection could directly support the amendment of an earlier-filed derivative complaint.

VeriFone restated its reported earnings, after determining that it had made material accounting and valuation errors. The company hired outside advisors to audit its accounting and financial controls, and subsequently issued a press release reporting the results of that audit. King submitted to VeriFone a demand to inspect certain types of documents, related to the restatement, but ultimately the parties resolved all issues in mediation, except for disclosure of the audit report.

King filed a derivative complaint in the Northern District of California against certain VeriFone directors and officers for breach of fiduciary duty and corporate waste. After the judge appointed King as lead plaintiff, he filed a consolidated amended derivative complaint. The defendants then filed, and the judge granted, a motion to dismiss without prejudice for failure to make presuit demand on the VeriFone board of directors. King followed the judge’s suggestion that he file a Section 220 inspection request, in Delaware, to “aid the plaintiff in pleading demand futility in a to-be-amended complaint.” The defendants moved to dismiss, pursuant to Court of Chancery Rule 12(b)(6), the Section 220 complaint, which the defendants asserted would violate a public policy that derivative plaintiffs should institute Section 220 demands before filing derivative actions. Vice Chancellor Strine granted that motion to dismiss, stating a “bright-line rule” precluding a Section 220 inspection after filing a derivative complaint. King appealed to the Delaware Supreme Court.

Justice Jacobs, writing for the Court en banc, stated that “although ill-advised . . . Delaware case law does not support the Court of Chancery’s conclusion that King lacked a proper purpose for bringing a Section 220 action solely because he first ‘elected’ to file a derivative suit.” The Court observed that, when an earlier-filed derivative action was dismissed without prejudice and with leave to amend, Delaware courts have found a proper purpose for a Section 220 inspection related to the derivative claims. See In re Walt Disney Co. Deriv. Litig., 731 A.2d 342 (Del. Ch. 1998); Saito v. McKesson HBOC, Inc., 2001 WL 818173 (Del. Ch. July 10, 2001); Melzer v. CNET Networks, Inc., 934 A.2d 912 (Del. Ch. 2007). The Court distinguished these decisions permitting post-dismissal inspection from decisions denying inspection, because those actions involved dismissal of derivative actions with prejudice or without leave to amend. See Beiser v. PMC-Sierra, Inc., 2009 WL 483321 (Del. Ch. Feb. 26, 2009) (lacking a proper purpose when plaintiff-stockholder’s second amended federal derivative complaint remained pending and the federal had not granted leave to amend that complaint); West Coast Mgmt & Capital, LLC v. Carrier Access Corp., 914 A.2d 636 (Del. Ch. 2006) (lacking a proper purpose when federal judge dismissed without prejudice, but specifically denied plaintiff-stockholder’s request for leave to amend). The Court found that neither the text, nor the underlying policy, of Section 220 support the Vice Chancellor’s “bright-line rule” that a plaintiff-stockholder “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.”

Despite its holding, the Court encouraged stockholder-plaintiffs to use Section 220 before filing a derivative action and “agree[d] with the Vice Chancellor that it is wasteful of the court’s and the litigants’ resources to have a regime that could require a corporation to litigate repeatedly the issue of demand futility.” The Court discussed possible remedies when a plaintiff appears to have ‘raced to the courthouse’ simply to jockey for lead plaintiff status. Although the Court observed that a judge presiding over a plenary action may fashion appropriate remedies, it considered three potential options. First, the judge might deny the plaintiff the lead position in a consolidated action. “More drastically,” the judge might dismiss the complaint with prejudice and without leave to amend. Alternatively, the judge might “grant leave to amend one time, conditioned on the plaintiff paying the defendants’ attorneys’ fees incurred on the initial motion to dismiss.”

The full opinion is available here