Sims and Venuti Discuss 'Zoox' and the Intersection of Stock Appraisal and Section 220 Demands in Delaware
In Zhang v. Zoox, C.A. No. 2020-1036-KSJM (Del. Ch. Jan. 31, 2022), the Delaware Court of Chancery ruled that, when stockholders use an appraisal proceeding under 8 Del. C. Section 262 (Section 262) solely to investigate follow-on claims, the scope of discovery to which appraisal petitioners are entitled should be limited to what they would receive in the books and records context under 8 Del. C. Section 220 (Section 220). The court’s ruling in Zoox has implications and raises questions both in and outside the context of appraisal proceedings.
Zoox, Inc. (Zoox or the company) is a private company that developed self-driving cars for ride-hailing services. After learning Zoox would be acquired by Amazon.com, two Zoox stockholders (the petitioners) sought appraisal of their shares and later served Section 220 inspection demands. Under Section 220, the petitioners had to wait five days before filing suit to enforce their inspection rights, but the merger closed during that waiting period.
Despite losing standing, the petitioners filed a Section 220 lawsuit. The petitioners later filed an appraisal suit and voluntarily dismissed the Section 220 action, stating in the dismissal notice their belief that, in the appraisal action, they “would be entitled, at a minimum, to discovery of the same material sought” in the Section 220 action. In the Section 262 proceeding, the petitioners sought appraisal of a total of 2,000 shares of Zoox stock, collectively worth less than $2,000 at the merger price. The court observed that, even accepting the petitioners’ allegations as true, the fair value of the petitioners’ stock was likely no more than $20,000.
The petitioners served broad discovery requests on Zoox in the appraisal action. The company produced the documents known in the Section 220 context as “formal board materials,” and filed a motion for a protective order as to all other documents sought by the petitioners. Zoox advanced two arguments in support of the motion.
First, Zoox argued under Court of Chancery Rule 26 that the discovery the petitioners sought was disproportional to the amount in controversy, noting a full production would cost Zoox at least $50,000. The court rejected this argument, determining that Rule 26’s proportionality requirement alone does not limit the scope of discovery to which appraisal the petitioners are entitled based on the size of their stakes. Relying on prior cases, the court reasoned that allowing fulsome discovery facilitates the court’s ability to fulfill its statutory mandate to determine a company’s fair value, regardless of the size of a petitioner’s stake.
Second, Zoox argued that, because any potential recovery would likely be offset by the petitioners’ litigation costs alone, the petitioners were employing the appraisal proceeding solely as a means to gather evidence supporting future breach of fiduciary duty claims. The petitioners disputed this assertion, but conceded that gathering information was one of their goals.
The court noted that Section 262 proceedings can be effective information-gathering tools, given that appraisal actions are generally not susceptible to case-dispositive motions and that the scope of discovery under Section 262 is broad. However, the court stated that permitting stockholders to use appraisal proceedings as an alternative to Section 220 could result in appraisal actions supplanting Section 220 as the favored pre-suit information-gathering tool. That outcome, the court stated, would run contrary to the Delaware legislature’s and courts’ recent efforts to limit appraisal litigation and to direct stockholders to Section 220 as the primary means for pre-suit investigation.
After discussing the various policy considerations, the court struck a balance by holding that stockholders can use appraisal proceedings solely as information-gathering tools when Section 220 is unavailable, but that the scope of discovery will be limited to what they would be entitled to obtain under Section 220. The court noted that the scope of discovery need not be so limited when the petitioners use an appraisal proceeding for other legitimate purposes. Relying on objective facts, the court found that the petitioners’ purpose for pursuing the appraisal litigation was to use the broad scope of discovery permitted under Section 262 as a substitute for Section 220 to gather information to support follow-on claims, and therefore ruled that the petitioners were only entitled through discovery to the information they could obtain under Section 220.
The court’s decision in Zoox has implications and raises questions, three of which are discussed below. First, it is unlikely that Zoox will broadly result in stockholders using appraisal proceedings exclusively as a substitute for books and records demands. Section 220 offers stockholders an expedited mechanism to obtain a narrow swath of information that is necessary and essential to the stockholders’ stated purposes. Appraisal actions, on the other hand, are nonexpedited plenary proceedings that often take years to litigate. Stockholders will likely use appraisal proceedings as a substitute for Section 220 only when Section 220 is unavailable (as was the case in Zoox) or when there is no need to obtain information quickly.
Second, the court’s decision in Zoox begs the question whether the scope of discovery, in appraisal and other actions, could ever be limited based solely on Rule 26’s proportionality principle and the amount in controversy. If there is a point where proportionality principles mandate limiting the scope of discovery, other limiting principles, such as undue burden and expense and unreasonable duplication, would also likely come into play.
Third, although the court’s holding was limited to its “unusual” facts, Zoox shows that a plaintiff’s motivations (when objectively discernable) for filing suit can have real-life consequences in the context of the litigation. It remains to be seen how far, if at all, Zoox’s holding will be extended both in and outside the context of appraisal litigation. For example, if it is objectively discernible that a petitioner commences an appraisal proceeding solely to prompt a nuisance-value settlement by driving up costs for the respondent company, Zoox could potentially support an argument that the scope of discovery should be limited. We might never know the answer to this and other similar questions, given that the court cautioned that Zoox should not be read to suggest that it is “open season on appraisal petitioners’ purposes.” In all events, appraisal petitioners will from now on likely be less blatant about their motivations for filing suit.
Reprinted with permission from the February 16, 2022 edition of the Delaware Business Court Insider © 2022 ALM Media Properties, LLC. All rights reserved.