On February 21, 2011, the Delaware Court of Chancery handed down an opinion regarding an LLC member’s right to conduct a books and records inspection on matters that occurred before the member obtained an ownership interest in the LLC. Max Sanders v. Ohmite Holding, LLC, C.A. No. 51450VCL (Del. Ch. Feb. 21, 2011). In addition to addressing this unique issue, the opinion also touches upon several other matters, such as: (1) The required propriety of a records inspection demand (i.e. whether the demand is being made for a proper purpose); and (2) The scope of the demand (i.e. whether the records sought are sufficiently related to the stated purpose).
In Ohmite Holding, LLC, a relatively new LLC member, Max Sanders, demanded to inspect Ohmite Holding, LLC’s books and records to obtain information relating to actions that transpired before he became a member of the LLC. Sanders’ demand explained that his purpose of inspection was to: “evaluate the value of [his] ownership interest, the status of the business and financial condition of Ohmite, the performance of Ohmite’s management and the legitimacy of the dilution of [his] interests in Ohmite. . .” Opinion at p. 6.
In response to Sanders’ demand, Ohmite denied the request in whole. Specifically, Ohmite refused to provide Sanders with the requested information, contending the requested information related to events that “pre-dated when Sanders formally became a member [in the LLC] and that Sanders had no right to obtain books and records from the pre-membership period.” Opinion at p. 1.
PROPRIETY OF RECORDS INSPECTION DEMAND
The Court of Chancery first addressed the propriety of Sanders’ inspection demand – whether the demand was being made for a proper purpose. The court found Sanders’ demand was valid, that “valuing one’s ownership interest is a proper purpose for seeking books and records.” Opinion at p. 11. The court also opined that “investigating potential wrongdoing is also a proper purpose.” Opinion at p. 12.
The court further concluded inspection was proper because Sanders presented “a credible basis from which the Court of Chancery [could] infer there is possible mismanagement that would warrant further investigation.” Opinion at p. 12. This conclusion illustrates an important point: if you are making a records inspection demand and your sole stated purpose is to investigate wrongdoing, then if the LLC refuses your demand, a Delaware court may likely require you to demonstrate a “credible basis” of mismanagement before ordering the LLC to turn over the records you requested. The court clarified that the “credible basis” standard does not mean a plaintiff must prove misconduct has actually occurred. Opinion at p. 12.
SCOPE OF DEMAND
While the stated purpose of the demand may be proper, the inquiry does not end there. The scope of the demand must be analyzed. A demand may be found improper if it seeks information unrelated to the proper purpose. The court explained, “in addition to the proper purpose requirement, ‘the burden of proof is always on the party seeking inspection to establish that each category of the books and records requested is essential and sufficient to [that party’s] stated purpose.'” Opinion at p. 13 (internal citation omitted). In other words, a plaintiff must show that he / she actually needs a “category of books and records for an identified proper purpose.” Opinion at p. 14.
Further, if a requesting party already has “sufficient” information, whether from other sources or as a result of a prior books and records request, then the inspection can be denied. Opinion at p. 14. Likewise, if the requested books and records are not “essential” to satisfy the stated purpose, then the inspection can be denied “as seeking materials beyond what is need to perform the task.” Opinion at p. 14.
In Ohmite Holding, LLC, the court found that each of the categories of documents sought “is reasonably required for [Sanders] to carry out an inspection for the purposes set forth in his demand.” Opinion at p. 15. As such the court ordered Ohmite to provide Sanders with the books and records he requested. The court also awarded “costs” to Sanders. Opinion at p. 15. Importantly, the court also found that Sanders was “entitled to inspect the books and records . . . regardless of whether they pre-date when he formally acquired member status.
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