Georgia Notes 18, LLC v. Net Element, Inc., C.A. No. 2021-0246-JRS (Del. Ch. Nov. 18, 2021) (Slights, V.C.)
In this post-trial letter opinion, the Court of Chancery held that a plaintiff who was both a stockholder and creditor of the defendant had failed to prove a proper purpose that would justify inspection of the defendant’s books and records pursuant to Section 220 of the General Corporation Law of the State of Delaware. In so ruling, the Court found that the plaintiff’s primary purpose in making the demand was to obtain information to pursue claims as a creditor against the defendant, which were unrelated to the plaintiff’s legitimate interests as a stockholder.
In January 2014, the defendant executed a promissory note in favor of the plaintiff for the sum of $13.268 million (the “Note”). Pursuant to a debt-for-equity exchange later that year, the defendant agreed to sell its debt to a third party, at which time the plaintiff agreed to cancel the Note for a discounted payment of $10 million. The plaintiff’s manager later testified that he was induced to accept the discount because the defendant’s chief executive officer had informed him that a third party would not pay more than $10 million for the Note. The defendant ultimately received total proceeds from the debt-for-equity exchange of $13.533 million (the “Proceeds”), of which $10 million was distributed to the plaintiff and the balance was distributed to third parties.
The plaintiff made a demand to inspect the defendant’s books and records concerning these matters, expressing that its purpose was to investigate alleged misconduct by a director and officer of the defendant regarding the Proceeds. But the plaintiff’s representative testified that he had two purposes for issuing the demand: first, to obtain information to support a claim by the plaintiff against the defendant as a former creditor (the “Creditor Purpose”); and second, to obtain information to support a claim for a breach of fiduciary duty against an officer and director of the defendant in a derivative action (the “Stockholder Purpose”). The Court found that the Creditor Purpose was the primary purpose of the demand because the plaintiff’s representative specifically admitted that the demand was issued as a result of the plaintiff’s belief that it was defrauded when the defendant remitted the balance of the Proceeds to the third parties rather than using the Proceeds to satisfy the full value of the plaintiff’s Note.
In entering judgment for the defendant, the Court found that the plaintiff was seeking the defendant’s books and records as pre-litigation discovery to support the plaintiff’s Creditor Purpose and to enhance the plaintiff’s claims as a creditor with respect to the Note, and that any Stockholder Purpose was secondary to the plaintiff’s Creditor Purpose.