Wei, et al. v. Zoox, Inc., C.A. No. 2020-1036-KSJM (Del. Ch. Jan. 31, 2022) (McCormick, C.)
In this memorandum opinion, the Court of Chancery granted in part a motion for a protective order sought by appraisal respondent Zoox, Inc. (“Zoox”), relying on the Court’s broad discretion over the discovery process to hold that policy considerations militate against granting a stockholder seeking appraisal of a privately held company the full breadth of discovery typical in appraisal proceedings where the stockholder’s clear purpose is to investigate a follow-on breach of fiduciary duty claim.
In connection with the merger of Zoox with and into Amazon.com, Inc., announced in June 2020, petitioners each served demands for appraisal pursuant to 8 Del. C. § 262 for their shares of stock of Zoox and also made inspection demands on Zoox pursuant to 8 Del. C. § 220 to investigate possible wrongdoing in connection with the merger. Zoox rejected the books and records demands because, at the time of the company’s demand response, the merger had closed, and the petitioners no longer had standing to pursue such demands under Section 220. On August 13, 2020, petitioners filed a complaint to enforce their inspection rights under Section 220 (the “Section 220 Action”).
In October 2020, petitioners withdrew their appraisal demands as to more than 95% of their collective shares, with each continuing to demand appraisal as to 1,000 of their shares, leaving 2,000 shares total subject to appraisal. The 2,000 shares are worth less than $2,000 at the merger price. Petitioners filed the appraisal action in December 2020 (the “Appraisal Action”), and voluntarily dismissed the Section 220 Action three days later, noting in the notice of voluntary dismissal that, in the Appraisal Action, they “would be entitled, at minimum, to discovery of the same material sought” in the Section 220 Action. Petitioners served 53 document requests that encompassed the 23 requests included in the 220 demands. While Zoox provided certain materials responsive to the requests that overlapped the requests in the 220 demands, Zoox objected to producing emails and other electronically stored information and ultimately moved for a protective order.
The Court rejected Zoox’s first argument that petitioners’ discovery requests violated the proportionality requirement of Rule 26. In addressing this argument, the Court assumed that petitioners actually intended to appraise their shares and analyzed whether the proportionality requirement alone should limit the scope of discovery in an appraisal proceeding based on the size of the petitioner’s stake. The Court followed its earlier ruling in Kaye v. Pantone, Inc., holding that the Court’s obligation in an appraisal proceeding is to value the corporation itself, “tak[ing] into account all relevant factors,” regardless of the size of the petitioner’s stake. The Court further stated that a party’s financial stake is not dispositive in a Rule 26 proportionality analysis because the “amount in controversy” is only one of six enumerated factors of Rule 26.
Next, Zoox argued that discovery should be limited because petitioners were improperly using discovery in the Appraisal Action as a means of investigating a future claim for breach of fiduciary duty. While acknowledging that Delaware courts have allowed appraisal petitioners to use discovery adduced in appraisal proceedings in parallel or later-filed actions, the Court evaluated the policy considerations underlying Sections 220 and 262 and concluded that appraisal petitioners should not be permitted to obtain full discovery in an appraisal proceeding initiated solely for the purpose of conducting a pre-suit investigation. Doing so would allow stockholders seeking to conduct a pre-suit investigation to do so under the Rule 26 standard for obtaining discovery in appraisal proceedings rather than the narrower standard for obtaining books and records under Section 220. That would make appraisal proceedings more attractive than Section 220, contrary to the Court’s guidance that stockholders employ Section 220 for such pre-suit investigations. The Court reasoned, however, that where, as here, an appraisal proceeding is pursued because the Section 220 path is blocked, a trial court has discretion to limit discovery to the scope of what the petitioner could have obtained under Section 220. The Court concluded the petitioners filed the appraisal action as a substitute for Section 220 on the grounds that “objectively discernable facts reflect” that seeking appraisal was “an economically irrational investment” given the small dollar amounts at stake, and the petitioners did not deny that such an investigation was one of their aims. The Court thus granted Zoox’s protective order in part, limiting petitioners to the discovery that they would have obtained in a Section 220 proceeding.
Importantly, that the respondent was a private company limits the applicability of the ruling in two respects. First, as the Court observed, federal securities laws ensure stockholders of public companies have enough notice and time to pursue books and records under Section 220, meaning they would not be forced to pursue books-and-records like discovery through an appraisal proceeding. Second, for most public company mergers, Section 262(g) requires the appraisal petitioners to obtain at least 1% of the outstanding shares eligible for appraisal or shares worth $1 million. In practice, that would most likely prevent petitioners from using “economically irrational” appraisal petitions to pursue books and records concerning most mergers involving publicly traded companies.