Opinion
Civil Action No. 13270.
Submitted: February 2, 1994.
Decided: April 6, 1994.
Kenneth J. Nachbar, Esquire and William M. Lafferty, Esquire, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; Attorneys for Plaintiffs.
M. Duncan Grant, Esquire and Sean P. McDevitt, Esquire, of PEPPER, HAMILTON SCHEETZ, Wilmington, Delaware; Attorneys for Defendant.
MEMORANDUM OPINION
This is an action brought by Marc C. Ostrow and James J. Fuld, Jr., who together own 32% of the issued and outstanding common stock of the defendant Bonney Forge Corporation ("Bonney Forge" or the "Company"), a Delaware corporation. They seek to require Bonney Forge to allow them to inspect and copy corporate books and records (1) pursuant to Section 12(f) of a Stockholders' Agreement to which the Company and its stockholders are signatories, and (2) under Section 220 of the Delaware General Corporation Law.
The plaintiffs demanded access to Bonney Forge's books and records in a November 12, 1993 letter to Mr. John Leone, Bonney Forge's President and its controlling stockholder. Bonney Forge rejected this demand in a November 22, 1993 letter of its counsel. Plaintiffs filed this action on November 23, 1993, and supplemented their demand in a letter to Bonney Forge on December 17, 1993. Defendant moved to dismiss that portion of the complaint that sought inspection under the Stockholders' Agreement. After expedited discovery, the case was tried on January 3 and 7, 1994. At trial, defendant's pretrial motion to dismiss was denied. At the conclusion of plaintiffs' case, a motion for involuntary dismissal under Chancery Court Rule 41(b) was denied as well. The parties completed post-trial briefing on February 2, 1994.
The core issue of this case, with respect to the contractual claim, is whether defendants may condition access to the Company's books and records under Section 12(f) upon the Company's being satisfied that plaintiffs will not use the information contained in those records in a way that the Company regards as inappropriate. With respect to the statutory (Section 220) claim, the core issue is whether plaintiffs have met their burden of establishing a proper corporate purpose for that inspection. Plaintiffs advance two purposes principally: the valuation of their shares, especially in connection with a possible exercise of a contractual right to put those shares to the Company; and secondly, the investigation of possible fraud or breach of duty on the part of Mr. Leone.
Defendant has met this request with an aggressive defense, claiming that under neither the parties' Stockholders' Agreement nor under Section 220 do plaintiffs have the rights they assert. Among other defenses, it urges that any inspection could serve no proper purpose because: (1) in no event is it financially possible for the Company to repurchase any of its stock at this time; (2) affording plaintiffs access to company information would, in the judgment of the company, risk commercial injury; and (3) there is no basis shown to assert any breach of fiduciary duty claims.
Having considered the evidence adduced at trial and the legal arguments of counsel, I conclude for the reasons set forth below that plaintiffs have fully satisfied their burden under both the statutory and contractual bases that they present and that therefore, prompt access to all of the Company's books and records shall be afforded to plaintiffs and their attorneys or designated agents, pursuant to an order of this court.
I.
Bonney Forge is a manufacturer of forged steel valves and fittings for the petrochemical market with its principal place of business in Allentown, Pennsylvania. The steel valve market in which Bonney Forge operates is concentrated and highly competitive, featuring mature products with little differentiation. Plaintiffs Ostrow and Fuld collectively own 32% of the outstanding common stock of the defendant corporation. The remaining two-thirds are owned by Mr. Leone, with 52.7%; Mr. Keith Winterson, the chief financial officer, with 10%; and other members of management with the balance.
Messrs. Ostrow and Fuld own about 32%; Mr. Fuld's secretary, Freida Rosenberg owns another approximately 1%, which she apparently obtained from Messrs. Ostrow and Fuld. Tr. at 238; Dx. 1.
A. Background: The Leveraged Buyout and the Stockholders' Agreement
In April 1983, James Fuld approached Mr. Leone and raised with him the possibility of Leone's participation in a management buyout of Bonney Forge from Gulf Western Manufacturing Company. Fuld offered the services of his firm, Pennwood Capital Corporation, in structuring, arranging financing for, and negotiating such a transaction. Dx. 56. Leone would supply the necessary management expertise. After some negotiation, Messrs. Ostrow, Fuld and Leone executed a Memorandum of Agreement in January 1984 regarding the formation of a joint venture for the purpose of acquiring Bonney Forge. Dx. 5.
The LBO was arranged with an absolute minimum of equity investment. After the successful completion of the management buyout, Bonney Forge had a debt to equity ratio of greater than 100 to 1. Tr. at 36. (Its current debt to equity ratio is about .7 to 1. Id. at 348.) After the transaction, Mr. Leone and Lloyd Holland, then Bonney Forge's chief financial officer, owned 35.7% and 4% respectively of the common stock of the new corporation. Managers of Bonney Forge's Italian subsidiary, Bonney Forge Europe S.p.A. ("BFE") owned 27%, and Ostrow and Fuld in the aggregate held 33%. See Dx. 5.
The investor group contributed only about $100,000 of the $10 million purchase price.
Upon accomplishment of the management buyout, all of the shareholders and Bonney Forge itself, became parties to a Stockholders' Agreement executed in October 1984. With respect to this dispute, the key provisions of the Stockholders' Agreement are: (i) the shareholders' rights to inspect corporate books and records; and (ii) the conditional option granted to Ostrow and Fuld to put all or a part of their shares back to Bonney Forge, and their related right, subject to veto, as described below, to arrange financing to enable such repurchases.
With respect to the first of these rights, the Agreement authorizes the inspection of Bonney Forge's books and records, and requires the company to furnish the shareholders with certain materials periodically. The relevant section, 12(f), provides as follows:
(f) Each [shareholder] shall have the right to examine the books and records of the Company at any time and from time to time, shall promptly and regularly receive copies of all accounting reports and tax returns prepared for or on behalf of the Company and shall be kept duly informed as to the business and affairs of the Company.
Dx. 1 § 12(f) (emphasis added).
As to the second aspect of the Agreement relevant here — Ostrow and Fuld's put — Section 8 of the Agreement, provides that plaintiffs may put their shares to the company, and, subject to its financial ability to do so, the company must purchase them. Dx. 1 § 8(a). The contractual purchase price for the shares, to be determined through a series of investment bankers' appraisals, is to be based on the fair market value of the outstanding shares of the company valued "as a whole assuming it were being sold as a going concern," Id. § 7(c) (emphasis added), rather than with a minority discount. If the company is legally or contractually unable to purchase the shares, then the put may be deemed withdrawn in its entirety, or only partially, to the extent that the company is able to repurchase the shares.Id. § 7(f). In the event that the company is able to purchase only some of the shares offered, it must do so. Id. A further provision embodied in a 1988 amendment enables Messrs. Ostrow or Fuld to arrange financing to enable a repurchase of their shares, if the Company purports to be otherwise unable to do so.
The put became operative after October 18, 1988, the fourth anniversary of the Stockholders' Agreement. Px. 1 § 8(a).
B. The Italian Shares and the Refinancing Amendment to the Stockholders' Agreement
The amendment to the Stockholders' Agreement arose from events following Bonney Forge's sale in 1988 of BFE, its Italian subsidiary. According to the defendant, in connection with this transaction, it acquired from the Italian managers their 27% stock interest in Bonney Forge. Tr. at 62. The Italian managers concurrently received a payment from Bonney Forge assertedly in exchange for a waiver of their severance payment rights under Italian law. Id. at 60, 385-86.
It was later discovered that the Italian managers apparently participated in the purchase of BFE, acquiring a 30% interest in the entity that purchased the subsidiary. Tr. at 377. It appears that Mr. Leone later recouped that 30% interest on behalf of Bonney Forge, sold 20% for $200,000 and retained 10% of that interest. Tr. at 377.
Mr. Leone, however, promptly proposed the sale of those treasury shares to key American managers and personnel as performance incentives. Ostrow and Fuld objected, claiming that they had preemptive rights to buy a pro rata portion of the shares under Section 10 of the Stockholders' Agreement if those shares were to be reissued. Tr. at 64. Leone took the position that no preemptive rights would arise with the sale of shares to key management personnel because no shareholder's percentage interest would be diluted beyond his original position. Px. 7 at 2. After some negotiation, Messrs. Ostrow, Fuld and Leone executed an amendment to the Stockholders' Agreement in May 1988, which acknowledged the right of Bonney Forge to use the treasury shares in an employee incentive compensation plan. In fact, the shares were eventually granted to management. Tr. at 298-99.
The management shareholders include Mr. Leone, Mr. Winterson, and a vice president of engineering, Mr. Benevides. Tr. at 345-46, 357.
Following this incident, Mr. Fuld became suspicious of the financial information he was receiving. According to plaintiffs, Mr. Leone had convinced them that Bonney Forge shares were virtually worthless at that time because of the Company's recent record of poor performance. Tr. at 68. Mr. Fuld testified, however, that about one month later he learned that the Company's fourth quarter earnings for 1987 had nearly equalled the earnings in the whole of the first three quarters of 1987 combined. Id. at 73. Plaintiffs suggest that the defendant manipulated the Company's 1987 earnings to make them appear lower than they actually were in an attempt to thwart plaintiffs' efforts to exercise their preemptive rights. I need not decide if that is correct.
The 1988 amendment to the Stockholders' Agreement addressed the situation that would obtain if Ostrow and Fuld sought to exercise their put right but the Company were to assert its financial inability to comply with its obligation to repurchase the stock. The amendment provides that Ostrow and Fuld will be authorized "as agents of the Company" to arrange financing to enable Bonney Forge to meet that obligation. See Px. 16 § 5(c). The company may refuse to undertake the proposed financing only if a majority of the shareholders not exercising options has determined in good faith that the plan would adversely affect the Company's financial condition or prospects. Id.
C. Plaintiffs' Interest Starting At Least in 1991 to Liquidate Their Holdings
The amendment to Section 8 provides as follows:
(d) In the event that Section 7(f) [governing the company's inability to purchase shares] of this Agreement shall at any one or more times apply to any sale by Ostrow and/or Fuld pursuant to this Section 8, (i)(A) Ostrow and/or Fuld shall be entitled to attempt to arrange, as agents of the Company, financing (including, without limitation, a recapitalization or refinancing by the Company) to raise funds for or otherwise permit the purchase of such Shares and (B) the Company shall enter into such financing arrangement so long as, (x) Purchasers (other than an Electing Purchaser [i.e., shareholders other than Ostrow and/or Fuld]) holding a majority of the Shares then outstanding shall not have reasonably determined in good faith that such financing arrangement would have an adverse effect upon the financial condition or prospects of the Company and provided notice thereof to Ostrow and Fuld. . . .
Px. 16 § 5(c).
The plaintiffs first expressed a serious interest in liquidating their holdings in 1990. Dx. 57. At a December 1990 breakfast meeting with Mr. Leone, Messrs. Ostrow and Fuld discussed their proposal that Bonney Forge repurchase their shares through an ESOP to be created primarily for that purpose. Px. 21. In the wake of that meeting, Mr. Leone requested that Mr. Winterson, Bonney Forge's C.F.O., prepare a valuation of Bonney Forge. Px. 22. Winterson's valuation yielded a $444,000 value for Ostrow and Fuld's one-third interest. Messrs. Ostrow and Fuld warmly objected to certain of the assumptions underlying Winterson's valuation; they valued the company nearer to $10 million total (after deducting outstanding debt), and urged Leone to seek a professional valuation. Id. At Mr. Leone's direction, Bonney Forge's accountants performed a valuation which appraised the one-third interest at $585,000, factoring in a minority interest discount. Px. 25; Tr. at 78-80.
The principals met again over breakfast on April 5, 1991. Px. 26. They discussed what plaintiffs viewed as discrepancies in financial figures, the accountants' valuation, and the prospect of going public, to which Mr. Leone expressed a most basic aversion. Id. At this point Messrs. Fuld and Ostrow were exploring ways to sell their shares and thus sought information that could help them value their holdings. In an April 29, 1991 letter to Leone, Dx. 59, the plaintiffs followed up on their April 12, 1991 request for information. They again invoked their rights under Section 12(f) to "examine the books and records of the Company at any time and from time to time. . . ." In the April 29 letter, plaintiffs emphatically refused to sign a confidentiality agreement:
Mr. Leone stated that he would sell his shares immediately were the company to go public, since, he believes, the company's competitive position will be irretrievably injured by the requisite public disclosures. Tr. at 276-77.
Plaintiffs had been instructed by the Company's lawyers to communicate through them with regard to any potential sale of plaintiffs' stock. Px. 30.
We will not sign a confidentiality agreement as such an agreement is NOT required and can inhibit our Rights To Sell Our Shares To Third Parties as provided under the Stockholders' Agreement.
We find incredible the comment of your lawyers that "most of the requested information to be highly confidential."
Information requested included detailed budgets — bank documents — historical monthly summary numbers — real estate loans — equipment appraisals — dollar/lira exchange rates — steel prices — steel scrap prices — legal documents with GW (Paramount) and the owner of Bonney Forge Italy — market share information — list of directors and shareholders — annual meeting minutes — plant vacation time — compensation of officers and directors — analysis of increase in SGA expenses, etc.
Should any item be deemed by you to be both highly confidential and not under our rights to receive, let us know which item and why you feel this way. Please send the other information as soon as possible.
Dx. 59 at 2. At that time plaintiffs were focused upon pursuing an initial public offering of their block or arranging a refinancing of the firm's balance sheet. Leone reacted strongly to what he perceived as plaintiffs' cavalier letter, and has not allowed any information to be disseminated to plaintiffs that he has deemed sensitive to the Company's competitive position. Tr. at 385. As of the trial for example, despite plaintiffs' requests, see Px. 44, Bonney Forge had not sent copies of its tax returns to Messrs. Ostrow and Fuld, notwithstanding the language of Section 12(f) for fiscal years beginning 1990 to the present. Tr. at 315.
Two months later, on June 6, 1991, Ostrow and Fuld each formally put 1400 shares to Bonney Forge. Px. 34. They were advised, however, that Paramount Communications Corporation (Gulf Western's successor), which still held long-term debt and preferred stock with covenants restricting the exercise of the puts, refused to consent to the repurchase. Px. 35, 48; Tr. at 118. The company was therefore contractually unable to purchase the shares, and, as provided in the Stockholders' Agreement, considered the put withdrawn.
That same month plaintiffs began to explore the initial public offering avenue. They contacted the investment bank Ladenburg, Thalmann Co., Inc., which expressed an interest in a public offering of plaintiffs' Bonney Forge shares. That firm estimated gross proceeds of plaintiffs' one-third interest at about $5 to $6 million. Px. 36. This effort was aborted, however, when the Company released disappointing financial results and budgets.
D. Financial Information and the Inspection Demand
There followed a period of relative inactivity in plaintiffs' efforts to obtain detailed information concerning the Company. During this period, however, plaintiffs apparently continued to receive certain monthly financial reports. See, e.g., Dx. 36.
Upon receiving the 1992 audited financial statements Mr. Fuld wrote to Mr. Leone putting a number of questions of a financial and accounting nature and requesting copies of Bonney Forge's prior tax returns. Px. 44. In response, Bonney Forge's attorneys wrote unambiguously that the Company had provided "all of the information required to be provided under applicable law or by agreement and does not intend to provide any additional information in response to your request." Px. 45.
The dispute concerning access to books and records — and, of course, the more basic issue of the resolution of plaintiffs' desire to liquidate their Bonney Forge holdings — continued unresolved. On November 12, 1993, plaintiffs wrote to Bonney Forge formally requesting inspection of its books and records under the terms of the Shareholder Agreement and Section 220 of the Delaware General Corporation Law. They sought a range of information in twenty-three detailed categories. Px. 53. In their letter, the purposes of plaintiffs' demand were stated to include: the valuation of their shares in order to determine whether to put their shares to the company; the investigation of possible specific mismanagement and waste of corporate assets; and the investigation of possible fraud and breaches of fiduciary duty with regard to identified transactions, including the disposition of the Italian managers' shares.
To summarize, these include:
(1) Federal and state income tax returns, 1987-1993;
(2) Employment, severance and key man life insurance contracts for employees earning greater than $50,000 annually;
(3) Financial records relating to salaries, bonuses and benefits paid to any officer or director, or to any employee earning greater than $50,000 annually;
(4) Financial records and agreements relating to loans made to officers and directors and their relatives;
(5) Financial records relating to salaries, bonuses and benefits paid to any employee related to any officer or director;
(6) Board and committee meeting minutes relating to the declaration of dividends;
(7) Board meeting agendas and minutes, 1987-1993;
(8) Shareholders' meeting agendas and minutes, 1987-1993;
(9) All agreements with BFE;
(10) BFE financial statements, 1989-1993;
(11) Articles of incorporation, by-laws and corporate purpose of Cedar Investments;
(12) Cedar Investment's financial statements since its inception;
(13) All documentation regarding outstanding loans, balances due, notices of default, mortgages and correspondence;
(14) All documentation of equipment leases or loans with respect to equipment;
(15) Certain historical financial information, 1985-1993;
(16) Certain current and forward-looking financial information, 1994-1999;
(17) Capital expenditure plans, 1990-1996;
(18) Correspondence regarding the replacement of Ernst Young, and management letters from them, 1987-1992;
(19) All documents relating to the new valve manufacturing plant;
(20) Specific company operations data;
(21) Specific company manufacturing data;
(22) Specific company product line data;
(23) Specific company industry data.
Px. 53.
In a December 17, 1993 letter to Mr. Leone, plaintiffs supplemented their earlier demand and notified the company that they intended to exercise their rights under Section 8(d) of the Stockholders' Agreement to arrange financing to enable the Company to repurchase some or all of their shares. Px. 54. Plaintiffs further stated their intention to explore a sale of their shares to a third party, if they were unable to arrange refinancing. They explained that they required the requested information in order to value their shares.
E. Bases Asserted for Denial of the Inspection Demanded
Bonney Forge denied the request for inspection in a November 22, 1993 letter of its counsel, claiming that the plaintiffs lacked a proper purpose under the Stockholders' Agreement and Delaware law. Px. 55. The letter cites four bases for denying the request. First, it refers to a negative covenant in a Loan Agreement. Prior to receiving the inspection demand at issue here, Bonney Forge entered into refinancing agreements with PNC Bank, N.A. ("PNC") on August 6, 1993 to replace financing with Fidelity Bank. The Loan Agreement between Bonney Forge and PNC includes terms that I take to be standard in loan agreements with small private companies: a negative covenant prohibiting the repurchase of shares, the redemption of options, and the payment of dividends, without prior approval of the lender. Tr. at 122, 394-96; Px. 52 § 7.12.
The defendant apparently did not respond to the December 17 supplementary letter.
The refinancing covered four types of loans: debt to take out Paramount (Gulf Western); a construction loan for a facility in Mt. Union, Pennsylvania, a revolving line of credit and financing for the expansion of the Mt. Union plant. Tr. at 397-99. The bank was additionally involved in a $1 million dollar standby letter of credit associated with workers' compensation and forward foreign exchange contracts for Italian Lira.
The second stated basis for the company's denial of the request for access to books and records was the asserted fact that a majority of the non-exercising shareholders had purportedly made a good faith determination that any attempt to refinance Bonney Forge's indebtedness would have an adverse effect on the financial condition or prospects of the company. For these first two reasons, defendants stated that the valuation purpose was invalid since it would be a mere "academic" exercise. Third, the information requested was said to constitute harassment of the Company, since, it was said, the plaintiffs already had all the information to which they were entitled. Fourth, the letter stated that the plaintiffs had no basis to assert possible mismanagement sufficient to warrant any investigation.
II. The Litigants' Positions
The primary right asserted is that under Section 12(f) of the Stockholders' Agreement, plaintiffs have an unconditional right to inspect all Bonney Forge's books and records, whether or not the Company agrees with their purpose in doing so. This position, it should be noted, is not inconsistent with the expressed willingness of plaintiffs to agree to certain prudent steps designed to protect confidentiality. One may stand on legal rights while volunteering to accommodate the demands of another.
At trial, Mr. Fuld stated his willingness to sign a reasonable confidentiality agreement, yet the defendant remains doubtful of his sincerity. Tr. at 109; Bonney Forge Post Trial Brief at 19.
Defendant denies this claim of an unconditional right. It counters that there is an implied condition to the Section 12(f) right that is conceptually similar to the implied covenant of good faith and self-dealing that has frequently been recognized.See, e.g., Wilgus v. Salt Pond Investment Co., Del. Ch., 498 A.2d 151, 159 (1985); 3 Farnsworth on Contracts § 7.17a (1990). According to the Company, that condition "requires plaintiffs, as a condition to the exercise of their right under Section 12(f), to agree to keep whatever information they learn through Section 12(f) confidential." Bonney Forge Post Trial Brief at 17. Defendant asserts that plaintiffs have refused to satisfy this condition and have indicated their belief that they may disclose confidential information in their discretion in the pursuit of their effort to liquidate their holdings of Bonney Forge. Defendant asserts that this alleged breach of the implied condition excuses its performance under Section 12(f). Secondly, the Company contends that even if the plaintiffs do have a contractual inspection right, that right is limited to the plaintiffs themselves and to an inspection that is reasonable in scope. Thus, the Company asserts that the minority shareholders have no contractual right to use attorneys or other agents in their inspection.
See Ostrow Dep. at 29-30.
The issues with respect to plaintiffs' second claim — its Section 220 claim — relate principally to the propriety of its purposes and the scope of the examination sought. The principal purposes stated include the purported need to value plaintiffs' shares in anticipation of the exercise of their put option, with or without refinancing; and second, to investigate possible mismanagement and waste of corporate assets, citing particular circumstances.
Defendant counters that plaintiffs have no proper purpose. It claims that under the PNC Loan Agreement (see p. 15 supra) it is currently contractually unable (and is in any case financial unable) to purchase any shares that might be put to it. It is therefore urged that valuation of the plaintiffs' stock would be a mere "academic" exercise, since the put cannot now be exercised. Bonney Forge further asserts that the company is not obligated to undertake alternate financing that might be arranged by the plaintiffs since it claims that Mr. Leone, with a majority of non-exercising shares, has made a good faith determination that any refinancing at all would have an adverse impact on the company's financial condition and prospects. Thus, in the Company's view the valuation and refinancing purposes of plaintiffs are "academic." In its argument an "academic" purpose is not a proper purpose under Section 220. Finally, defendant asserts that plaintiffs have not alleged sufficient facts to warrant further investigation of their potential claims of fraud, corporate waste and breach of fiduciary duties.
In addition, defendant claims that the plaintiffs have all the information to which they are entitled. This position is patently circular and requires no extended consideration. The evidence shows there is much information that plaintiffs have not seen that may relate to one or more of their stated purposes. Whether they are entitled to see that information is, of course, the issue in the case.
III. The Contractual Claim
I turn first to plaintiffs' claim that they are entitled to inspection of the books and records under Section 12(f) of the Stockholders' Agreement. I agree.On its face, Section 12(f) plainly confers a right upon the plaintiff to inspect Bonney Forge's books at any time. That right is subject to no express conditions precedent. The defendant posits that this clear contractual right is nevertheless subject to an implied condition that has been satisfied in defendant's reasonable judgment. That implied condition is apparently that plaintiffs provide adequate assurance to defendant that they will keep sensitive company information confidential. According to defendant, plaintiffs have not done so and indeed have made statements consistent with a willingness to violate that condition. Thus it is said that plaintiffs have repudiated their obligations under Section 12(f). This, claims the Company, is a most grievous matter, sufficient to excuse its performance under Section 12(f),
Yet the factual record that the Company cites in support of its purported concern with confidentiality is slight. It relates largely if not entirely to the refusal in 1991 of plaintiffs to agree that they were required to sign a confidentiality agreement. See pp. 10-11 supra. Equally notable, the Company failed to assert any concern it now says that it has about plaintiffs' injuring it through disclosure of Bonney Forge information, in the Company's November 23, 1993 letter that stated four grounds for the denial of the request to inspect documents. Thus plaintiffs may be expected to conclude that the concern that these 32% shareholders would intentionally or negligently risk injury to the Company through disclosure of its financial information is, in this instance, not a legitimate concern but a tactical ploy.
In all events the issue is resolved at one level, in my opinion, by the testimony of Mr. Fuld. Fuld testified that the plaintiffs are willing to be bound to reasonable confidentiality restrictions on the use of Company information. Tr. at 109. To this, in effect, the defendant in its post-trial briefing says only that it does not trust Mr. Fuld. I accept Fuld's testimony as truthful. His expressed agreement at trial to be voluntarily bound to take appropriate steps to preserve confidentiality, even if he had not so stated in the past, is a sufficient basis to resolve any issue that might otherwise be raised concerning the existence or scope of implied conditions on access to confidential Company information under the Stockholders' Agreement.
Fuld testified that he had communicated that willingness in the past.
At a more basic level, however, I conclude that no fairly litigable claim has been presented with respect to the Company's assertion that plaintiffs have breached or failed to satisfy any implied term of the Stockholders' Agreement, with respect to the use to which they may put information disclosed in Bonney Forge's books and records. It is utterly clear that they have not done so. Surely it is possible that a covenant of some sort with respect to use of Company information may meet the test for implied contractual covenants. I have earlier stated my view of an appropriate legal test for determining whether such an implied contractual obligation has been breached. That test focuses, as of the time of contracting, upon the interests of the parties and the course of negotiation. It places the burden on the party asserting the violation of an implied contractual provision and asks:
[I]s it clear from what was expressly agreed upon that the parties would have agreed to proscribe the act later complained of as a breach of the implied covenant of good faith — had they thought to negotiate with respect to that matter[?] If the answer to this question is yes, then, in my opinion, a court is justified in concluding that such act constitutes a breach of the implied covenant of good faith.Katz v. Oak Indus. Inc., Del. Ch., 508 A.2d 873, 880 (1986). This test is consistent with the articulation of the legal test in the Restatement (Second) Contracts § 205. See also 3Farnsworth, supra, at 7.17(a).
I suppose that under this test an implied covenant not to injure the Company gratuitously or affirmatively to exercise care not to do so unintentionally might, for example, be implied. But there is no evidence that any implied covenant of that sort would have been threatened by plaintiffs. To the contrary, the plaintiffs have stated that they do not intend to disseminate the information they receive haphazardly. When, for example, Messrs. Ostrow and Fuld provided the investment bank Ladenburg, Thalmann Co., Inc. with information in connection with a possible public offering, they required that the information be kept confidential, and the bankers complied. Px. 36. Plaintiffs, of course, have an interest in seeing that confidential Company information does not fall into unfriendly hands.
At his deposition, Mr. Ostrow stated that he had told Bonney Forge that he would be "discreet" with confidential information, and would share it with an appraiser or underwriter, "with an appropriate assurance of confidentiality." Ostrow Dep. at 27-30.
Ladenburg's chairman wrote: "As discussed in our conversation, we will hold all information in confidence." Id.
But accepting arguendo the existence of a very general implied covenant of this sort — which plaintiffs acknowledge and have not repudiated — there is, nevertheless, in my opinion, no ground to support a claim that plaintiffs have a duty to satisfy any precondition to access to the Company's books. This statement means to point out the difference between a condition to access to books and a covenant with respect to how information will be used. There is a logical and a practical difference. Even if one could fairly imply a covenant of some sort, that does not mean that a condition to access to Company information would necessarily follow. Whether the subject of an implied covenant (whatever it might be specifically) would give rise to an implied condition to access is a separate and, in the circumstances, more difficult implication.
A consideration of the nature of the contract provision, the parties' course of dealings, and their relative positions is completely inconsistent with a conclusion that any condition on access of the minority shareholders to the Company's books and records can be inferred from the contract's silence on the point. Section 12(f) is obviously a provision for the benefit of plaintiffs, who as very substantial minority shareholders sought contractual protections from possible majority shareholder oppression. Under the express language used, they are given complete and unconditional access to information. This access serves several purposes: to permit them to keep fully informed to the extent they want to be; to try to arrange alternative financing to enable Bonney Forge to satisfy its put obligation; and to arrange a public offering of its shares. See, e.g., Dx. 1 § 7(c) (valuation), § 9 (public offering). These contractual guarantees are unimportant if the controlling shareholder is supportive of the minority shareholders' efforts to sell their stock publicly or to arrange financing to permit Bonney Forge to buy it. It is only when the controlling shareholder is not inclined to cooperate in these efforts that the right to access to the Company's books for these purposes becomes significant. Recognizing the purpose of Section 12(f) of the Stockholders' Agreement requires one to conclude that to construe any implied condition on the rights it creates that would give the majority shareholder or the entity itself, a way to impede access to or use of the information is entirely inconsistent with the basic purpose that provision serves.
With respect to implied covenants as distinguished from implied conditions, I need not inquire into the existence or specific contours of any implied covenant in the Stockholders' Agreement to respect the confidentiality of company information. As indicated above I suppose there may be such a thing, but I am in no position now to define it for future occasions. I am of the opinion that any such covenant cannot be inconsistent with the intended purposes of Section 12(f) to afford complete access to Company information "at any time and from time to time." Thus, I conclude that there is no implied condition upon plaintiffs' contractual right to inspect Bonney Forge's books and records. Defendant is contractually obligated to grant plaintiffs complete access to all of its books and records, including documents in its possession relating to any other entity or investment in which it has an interest.
* * *
The remaining issue with respect to plaintiffs' contractual right to access to the Company's books and records is whether plaintiffs may employ agents such as attorneys or accountants or clerks in accomplishing that inspection. The Company further contends that there is no right to make copies of any document.
The contract itself is silent on both of these issues. With respect to them there is no testimony concerning negotiation of Section 12(f) or of any person's subjective understanding of the legal meaning of the provision. Thus, in construing what the legal meaning of Section 12(f) is, the court is required to ask what is the most reasonable meaning to ascribe to the operative words, given the objective circumstances of the negotiation and the purposes the provision was designed to serve.
In that connection, one important background circumstance is the fact that the plaintiffs for whose protection Section 12(f) was created are sophisticated businessmen. They understood, or I presume that one in their position would understand, that, independent of any negotiated provision, the formal corporation law itself supplied certain rights to access to Bonney Forge's books and records. Obviously the contractual right was designed to afford rights beyond those already existing. By the time the Stockholders' Agreement was executed, however, the baseline statutory rights afforded by Section 220 had long been interpreted to permit shareholders to exercise those rights through agents. For example, in 1942 the Delaware Supreme Court stated with respect to the right to inspect a stocklist as follows:
The stockholders' right to examine corporate records is a personal one in the sense that it is not transferable for the benefit of a stranger. But a stockholder may, of course, exercise his right through a duly constituted agent. 5 Fletcher Cyc. Corp. # 2230; 18 CJS Corporations § 508 p. 1185.State v. Sentry Safety Control Corp., Del. Supr., 24 A.2d 587, 590 (1942) (emphasis added).
It had similarly been judicially determined that a shareholder's rights of inspection of corporate books includes the right to make copies for a proper purpose. See, e.g.,State v. Superior Oil Corp., Del. Super., 13 A.2d 453, 454 (1940) ("If there be a right to examine the list of stockholders, there is a corresponding right to make the examination beneficial by taking copies thereof.").
Given the fact that the Section 12(f) rights were additional rights beyond those created by statute it is entirely unreasonable to conclude that those additional contract rights are to be strictly constrained with respect to agents and copies as Bonney Forge contends. The purposes of Section 12(f) include the facilitation of other rights (the put right and the refinancing option) created by the Stockholders' Agreement. It is most unlikely that these rights could be pursued at all without making some copies of Company books available to bankers, lawyers, accountants or other persons involved in such a proposed transaction and it is equally impractical to think that such transactions can feasibly or efficiently be undertaken without the use of agents. Thus, the extremely cramped reading of the rights created by Section 12(f) that the Company seeks to impose is inconsistent with a reasonable attempt to exercise the substantive rights created by the Agreement and cannot be accepted.
IV. The Section 220 Claim
In addition to their rights under the Stockholders' Agreement, plaintiffs assert rights to inspect the Company's books and records under Section 220 of the General Corporation Law. Their stated purpose includes valuing their stock and the Company in connection with their desire to exercise their put right or find a way to refinance the Company if it cannot buy their stock. A second purpose involves investigation of possible breaches of fiduciary duties. The defendant claims that plaintiffs have failed to state a proper purpose for the inspection and thus have no such right here. In a contested books and records case, the court's first issue is typically whether the shareholder has borne the burden of expressing a proper purpose for the inspection sought. CM M Group, Inc. v. Carroll, Del. Supr., 453 A.2d 788, 792 (1982). A proper purpose within the meaning of the statute is one which is reasonably related to the shareholder's interest as a stockholder. 8 Del. C. § 220(b). Once a shareholder has established a proper purpose for the demanded inspection, any secondary purpose he or she may have is generally considered to be irrelevant. CM M Group, Inc., 453 A.2d at 792. The primary purpose may not, however, be adverse to the corporation's best interests. Skoglund v. Ormand Indus., Inc., Del. Ch., 372 A.2d 204, 207 (1976).
The valuation of shares has long been recognized to be a "proper purpose" within the meaning of Section 220. See CM M Group, Inc. v. Carroll, Del. Supr., 453 A.2d 788, 792 (1982) (citing State ex rel. Brumley v. Jessup Moore Paper Co., Del. Supr., 77 A. 16, 20 (1910)). Inspection for valuation purposes is all the more pertinent when the corporation is closely held, its shares are not publicly traded, and no readily available index of their value exists.
Bonney Forge argues nevertheless that plaintiffs' valuation would be a purely "academic" exercise since the company is financially and contractually unable to purchase any shares put, and because Mr. Leone has made a good faith determination, without having considered any proposals and without having performed any analyses of Bonney Forge, Tr. at 277-284, that any refinancing would have an adverse effect on the financial condition or prospects of the Company. This defense is palpably insufficient. These shareholders are not required to accept non-critically the statement of the controlling shareholder that there is no way in which Bonney Forge can repurchase its shares under the Stockholders' Agreement. They very obviously are entitled to value their shares presently and to have access to information to test defendant's positions and to try to arrange financing to enable the firm to buy some or all of their stock. Finally and independently, the prospect of an initial public offering presents a proper corporate purpose for shareholder access.
Even Mr. Winterson, the Company's CFO, stated that he was uncertain of the effect that mezzanine financing would have on the company's balance sheet, not being an expert in structured financing. Tr. at 463-64.
Defendant's repeated reliance upon Helmsman Management Servs., Inc. v. A S Consultants, Inc., Del. Ch., 525 A.2d 160 (1987) to support the "academic exercise" defense is dust thrown in the air. In Helmsman, the valuation purpose of a 25% shareholder, customer and contractual partner (Helmsman) was characterized as "somewhat academic," but the inspection was nevertheless permitted. A quotation from that authority demonstrates that it is a far stronger precedent for plaintiffs in this case than for defendant:
It is not sufficient for Helmsman merely to assert that it would like to value its A S stock. Without a showing of a present need for such a valuation, a mere statement of that purpose, though valid in law, might not be bona fide in fact. At this point Helmsman has made no decision to dispose of its A S stock, has taken no steps to market that stock, and has no potential buyer for it. On the other hand, this court has recognized that there may be situations where a shareholder in a closely-held corporation needs to value his stock to enable him to decide whether or not to sell, and if so, on what terms. . . . There is a very limited market for Helmsman's A S stock; indeed given the corporation's right of first refusal, the only potential buyer may be A S. For that reason, Helmsman must necessarily resort to A S's books and records to establish a value as a predicate for deciding whether its stockholdings are marketable and, if so, on what terms. Those considerations, plus Helmsman's interest in extricating itself from a minority stockholder position in a corporation with which it is no longer in a friendly relationship, persuade me that Helmsman's valuation purpose is valid in fact as well as in law.Helmsman, 525 A.2d at 165 (citations omitted).
These 32% owners have shown themselves to be acting in good faith and to have a legitimate need to know the financial condition of the business. Their statutory right to information for a proper purpose cannot be terminated by the controlling shareholder's view of what is financially in the best interest of the corporation or by his view as to whether any effort they undertake will likely prove fruitless or "academic."
I pass over the allegations of fraud or breach of fiduciary duty. I am inclined to think that plaintiffs have not satisfied the significant burden imposed for ordering a books and records inspection on that easily asserted ground. See Skouras v. Admiralty Entertainment, Inc., Del. Ch., 386 A.2d 674, 678 (1978). But as I find that the Stockholders' Agreement gives to plaintiffs plenary access to Bonney Forge's books and records, this issue is moot.
* * *
For the same reason — namely, the breadth of the contractual right to access to the Company's books and records — I need not in this case go through a detailed analysis of what information is necessary or sufficient. Were I to do so, I would certainly conclude that the opinion of defendant's expert Mr. Serrell was entitled to little or no weight. First, Mr. Serrell assumed that management would cooperate in any appraisal exercise by willingly answering fully all questions posed by the valuator; these candid answers would obviate the need to inspect certain documents. Given the postures of the parties in this case, Mr. Serrell's assumption was clearly problematic, and his conclusions must be weighed accordingly.
Mr. Serrell is the owner of Compass Capital Advisors, an investment banking firm to middle market companies (those with sales of between about $5 and $100 million), located in Radnor, Pennsylvania.
The plaintiffs successfully undermined Mr. Serrell's capacity to testify as an expert on this matter. In preparing his testimony, Mr. Serrell consulted Dr. Shannon Pratt's Valuing a Business, the text considered a "bible" in the business. Tr. at 473. Plaintiffs pointed out however, that on a number of occasions, Mr. Serrell's testimony and opinion differed widely from the more conservative stance expressed in selections from Pratt's text.
In addition, Mr. Serrell considered the valuation of Bonney Forge from two viewpoints, first with a minority discount, and second, on a pro rata basis. He testified generally that an appraiser would need fewer documents to value the company if a minority discount were to be applied, since a minority shareholder would have a weak voice in corporate management. Given that the plaintiffs have a right to exercise their puts at a purchase price without a minority discount, according to the Stockholders' Agreement, the plaintiffs have a right to inspect a rather broad set of documents, even based on the defendant's own expert witness.
* * *
Based on the facts and analysis set forth above, I reach the following conclusions. The plaintiffs have a contractual right under Section 12(f) of the Stockholders' Agreement to inspect the books and records, without limitation, of Bonney Forge at its corporate headquarters in Allentown, Pennsylvania. They may designate their agents to facilitate the inspection, and they may make photocopies of extracts of the documents inspected. Plaintiffs and their agents are not obligated to sign a confidentiality agreement in advance of such inspection, but they will be expected to refrain from disclosing any proprietary or confidential information of the Company to any person except one who has a need to know in connection with assisting them with respect to their investment in Bonney Forge. The defendants are not justified in withholding copies of documents required under Section 12(f) to be furnished periodically to plaintiffs, and must send plaintiffs all such material, including back copies, promptly.
Plaintiffs have a statutory inspection right under 8 Del. C. § 220 as well. Under either of these legal basis for their claim, plaintiffs are entitled to inspect all the documents set forth in the twenty-three categories of their November 12, 1993 letter.
V.
Plaintiffs seek the award of their attorney's fees. Ordinarily, of course, attorney's fees are not part of the costs awarded to a prevailing party under the American practice. Although the "American Rule" that parties must pay their own litigation expenses is a basic feature of our legal system, see Maurer v. International Re-Insurance Corp., Del. Supr., 95 A.2d 827, 830 (1953), nevertheless, a court of equity, in its discretion, may award attorney's fees in appropriate cases. CM M Group, Inc. v. Carroll, Del. Supr., 453 A.2d 788, 795 (1982). An exception to the general rule arises when the losing party has acted in bad faith, vexatiously, wantonly, or for oppressive reasons. Slawik v. State, Del. Supr., 480 A.2d 636, 639 n. 5 (1984); Weinberger v. UOP, Inc., Del. Ch., 517 A.2d 653, 656 (1986). Such an award will be made where the court concludes that the litigation process was misused; where, for example, plaintiff had no litigable claim but proceeded nevertheless in bad faith for reasons of tactical advantage. Here the tempting reason to award reasonable attorney's fees is the suspicion, which the evidence in the case has formed in my mind, that defendant not only had no reasonable basis to interpret Section 12(f) of the Stockholders' Agreement as justifying its demands, but that indeed those demands were themselves not put forward in good faith.
I approach this attorney's fee issue as one principally of contract law. With respect to the statutory Section 220 action, I find that the opinion in Stroud v. Grace, Del. Supr., 606 A.2d 75, 89 (1992) (sustaining confidentiality agreement as condition for disclosure of confidential information to shareholders), supplies sufficient ground to make defendant's legal position on that issue a litigable one. The rights under Section 12(f), however, present somewhat firmer ground upon which to base an attorney's fee award. Generally in the litigation of contract disputes there will of course be fairly litigable issues. In actions seeking damages arising from breach this will be the case because, at the least, the dollar amount of damages will be something over which reasonable minds might disagree. In actions seeking specific performance it may be less inevitably the case that room for good faith litigation will exist. There are no doubt cases in which shifting markets have made it economic for a seller simply to refuse to perform and to pay instead the promisee's expectancy damages. 3 Farnsworth on Contracts § 12.1 (1990). But where the law has recognized a promisee's right to the performance itself there is no "privilege" or "right" to repudiate the promise and pay damages. Most typically that is the case when the performance is the granting of a deed. Section 12(f) of the Stockholders' Agreement is a specifically enforceable contract provision. Thus, in looking for precedent to guide decisions with respect to this attorney's fees application I consider the fact that generally attorney's fees are not awarded to a prevailing plaintiff in such an action. See 81A C.J.S. Specific Performance § 223 (1977); but see Loretto Literary Benevolent Inst. v. Blue Diamond Coal Co., Del. Ch., 444 A.2d 256, 260-61 (1982) (Hartnett, V.C.) (awarding fees to successful plaintiffs in suit to require corporation to register a transfer of its stock).
See generally MacNeil, Efficient Breach of Contract: Circles in the Sky, 68 Va. L. Rev. 947 (1982).
The absence of strong authority in the contract area supporting the awarding of attorney's fees, the holding of Stroud v. Grace, with respect to the Section 220 claim and the general dominance of the "American Rule" regarding attorney's fees, persuades me that in this instance the sounder course is to deny the request for attorney's fees.
Plaintiffs may present an implementing form or order on notice.