Summary
holding that the company's directors "were not free to contract away disclosure obligations that they had a fiduciary duty to observe," and that "[n]or could they rely upon a certificate provision prohibiting disclosure to avoid a shareholder's inspection right conferred by statute," and by doing so, the "directors and management made the corporation complicit in their violations of fiduciary, as well as statutory, law."
Summary of this case from Manti Holdings, LLC v. Authentix Acquisition Co.Opinion
Civil Action No. 20092.
Date Submitted: July 31, 2003.
Date Decided: April 28, 2004.
Alan J. Stone, Esquire and Brian J. McTear, Esquire, of MORRIS, NICHOLS, ARSHT TUNNELL, Wilmington, Delaware; Attorneys for Plaintiff.
C. Malcolm Cochran, IV, Esquire, of RICHARDS, LAYTON FINGER, P.A., Wilmington, Delaware; OF COUNSEL, Michael D. Hays, Esquire and Edward J. O'Connell, Esquire, of DOW, LOHNES ALBERTSON, PLLC, Washington, D.C.; Attorneys for Defendant.
MEMORANDUM OPINION
The plaintiff, Robert A. Marmon ("Marmon") brought this action under 8 Del. C. § 220 to inspect the stock list and specified books and records of Arbinet-Thexchange, Inc., a Delaware corporation ("Arbinet" or "the company"). Marmon's stated purposes for seeking the inspection were to value his Arbinet shares and to investigate possible mismanagement at the company. At the conclusion of the post-trial argument held on July 9, 2003, the Court ruled from the bench that Marmon had established his entitlement to inspect (1) Arbinet's stock list and (2) books and records that were essential and sufficient for the limited purpose of valuing his shares. The Court reserved decision on whether Marmon had established his entitlement to inspect Arbinet's books and records for the separate purpose of investigating mismanagement.
That issue presently awaits decision. This is the Opinion of the Court, after trial, on the merits of Marmon's § 220 claim to inspect Arbinet's books and records for the purpose of investigating mismanagement at Arbinet. For the reasons next discussed, the Court concludes that Marmon has established his entitlement to relief on that claim.
I. FACTS
Founded in 1996 by Alex Mashinsky, Arbinet is an online trading exchange that operates an online spot market for voice minutes in which telecommunications companies buy and sell wholesale voice traffic. In the early stages of Arbinet's development, Marmon worked with Arbinet as a consultant and agreed to receive common stock of Arbinet as part of his compensation package. After completing his tenure as a consultant, Marmon served as Arbinet's President and as a member of its board of directors until January 1998.
In May 1999, Arbinet hired Anthony Craig as a consultant. In December 2000, Craig replaced Mashinsky as Arbinet's CEO and Chairman. In June 2000, Craig became the Executive Chairman of the Arbinet Board, and in August 2001, he assumed the title of non-executive Chairman of the Board, a position he currently maintains. During that period when Craig was at the helm, Arbinet engaged in five rounds (Rounds A through E) of financing in the equity capital market to facilitate the company's continued growth.
On January 9, 2002 Marmon and David Katz — Marmon's colleague and fellow Arbinet common stockholder — sent an e-mail message to Curt Hockemeier, Arbinet's current CEO, requesting "the sort of information normally provided in annual reports and at shareholders' meetings." In his e-mail, Katz also notified Hockemeier that Arbinet's Chief Financial Officer had informed him (Katz) that the company did not intend to hold an annual shareholder's meeting.
Hockemeier did not respond to Katz. Chris Reed, Arbinet's Director of Marketing, did respond, however, and instructed Katz to contact Peter Sach, Arbinet's Chief Administrative Officer, about his requests.
Between January 17, 2002 and March 20, 2002, Katz sent three e-mails to Peter Sach, repeating his requests for financial information and also for the date on which the next annual stockholder meeting would be held. Responding to Katz's last (March 20, 2002) e-mail, Sach told Katz that Arbinet's "board will decide as to whether an annual meeting should be held." Sach also advised Katz that the company's "certificate of incorporation and third amended and restated investor rights agreement" prevented Arbinet from furnishing financial information to (i) shareholders that held less than three percent of the "then-registerable securities" and (ii) shareholders that had purchased less than two million dollars of Series E preferred stock.
Marmon and Katz claim they were informed by a reliable source that there was pervasive mismanagement of the company. They received that information in conversations they had with Mashinsky, Arbinet's current Vice Chairman, during the summer of 2002. Marmon and Katz testified that Mashinsky contacted them and expressed his concerns that: (i) unauthorized loans had been made to company officers and that (ii) the Series E round of financing had been structured to benefit certain large shareholders and to dilute down and/or "squeeze out" the common stockholders of Arbinet.
The record shows that in March 2001, Craig requested and received from the company a loan of between $200,000 and $300,000 to enable Craig to exercise 3.5 million options to purchase Arbinet stock. Craig then requested, and Arbinet granted a loan in the amount of $750,000 to pay the construction costs for his home in Florida. The loan was secured by the 3.5 million shares Craig had just purchased. According to Marmon and Katz, the loan was made at a time when Arbinet was running out of cash. Arbinet claims that the loan was made to compensate Craig for his past services during his employment with Arbinet, which was for only eight months. That loan, plaintiff claims, was later recharacterized by Arbinet as a "bonus" to Craig.
Marmon claims that there is credible evidence that the $750,000 loan was unauthorized. According to Marmon, the Compensation Committee that approved the loan was not properly formed, and that Committee held no formal meetings or kept any minutes of the discussions among its members. Moreover, Marmon says, the testimony of Paul Theunissen, who was at all relevant times a Compensation Committee member, suggests that that Committee lacked any authority to act unilaterally on behalf of the Arbinet board. That is relevant (Marmon claims), because the full board never considered or formally approved the loans to Craig. Based upon information that Mashinsky told Marmon, the board did not even know of the loan's existence until almost one year after the loan was made.
Marmon also claims that there is credible evidence that the Series E Round of financing had been orchestrated to benefit certain stockholders at the common stockholders' expense. Based upon information received by Marmon, Craig advised the board that because of cash flow problems, the board should either shut the company down or agree to accept additional financing at unfavorable rates from venture capitalists, including EnerTech Capital. Marmon claims that that recommendation by Craig was a self-interested act, because Craig was the President and CEO of Safeguard Scientifics, a firm that owns an approximately 5% interest in EnerTech Capital.
Marmon also claims that Mashinsky told him that certain venture capital investors favored the Series E financing Round because those investors had previously agreed to waive certain anti-dilution and preference rights that they held in anticipation of Arbinet's planned IPO in March 2000. When that IPO was abandoned, the venture capitalists' position became vulnerable, and they then proposed a later curative round of financing to enable them to reacquire their anti-dilution and preference rights. Put differently, Marmon claims that (1) Craig and Arbinet conducted the Series E Round of financing to protect the venture capitalists, by enabling them to invest in preferred securities with a superior liquidation preference and anti-dilution rights at a substantially reduced valuation, and (2) the financing was accomplished without the knowledge or approval of the common stockholders.
Marmon claims that after the Series E Round of financing closed in July 2001, Craig received 8.5 million options to purchase Arbinet common stock as compensation for arranging for the Series E Round financing. Craig received those options in August 2001, nearly one year after he had stepped down as Arbinet's CEO, although the options were supposedly granted in order to "incentivize management."
Marmon also claims that after the close of the Series E Round, ComVentures, an Arbinet investor, purchased the entire interest in Arbinet of another venture capitalist, at a fifty percent discount, without the knowledge of the common shareholders. One partner of ComVentures, Roland Van der Meer, is a member of the Arbinet Board of Directors and Compensation Committee. Van der Meer (it is claimed) was primarily responsible for the approval of Craig's $750,000 loan. That transaction is also claimed to have been highly favorable to Van der Meer, because it further diluted the value of Arbinet common stock, and resulted in ComVentures becoming Arbinet's largest shareholder. Thereafter (according to what Mashinsky told Marmon) a scheme was hatched to issue yet another round of securities that would effectively marginalize, if not eliminate, the common shareholders.
As a result of the information provided by Mashinsky, Katz wrote to Chi K. Eng, Esquire, Arbinet's General Counsel, on October 3, 2002, asking Eng to confirm in writing that the company and its officers and directors were not engaging in any improper activity. Mr. Eng did not respond. Thereafter, on October 14, 2002 and November 1, 2002, Katz again contacted Eng in an effort to receive information about the company. By letter dated November 5, 2002, Eng notified Katz that Arbinet did not intend to provide the requested information.
By letter dated November 7, 2002, Marmon advised Eng that he had reason to believe that Arbinet had made unauthorized loans to its officers or directors, and that some of those directors were involved with an entity that was supplying financing in the Series E Round. Marmon identified the specific books and records that he desired to inspect, and advised Eng that if he did not receive an adequate response, he would seek relief under 8 Del. C. § 220. On December 11, 2002, after Arbinet had failed to provide the information requested, Marmon served a § 220 demand letter on the company. Arbinet did not respond to the demand letter, and Marmon filed this proceeding on December 20, 2002.
II. THE CONTENTIONS
Marmon prosecuted this action under 8 Del. C. § 220(c) to inspect the books and records of Arbinet for the purpose of investigating waste, mismanagement, and breach of fiduciary duty by the officers and directors of the company. Marmon contends that the information he received from Mashinsky, Arbinet's current Vice Chairman, is sufficient to establish his entitlement to inspect books and records under § 220.
As noted above, Marmon's separate purpose was to value his shares.
Arbinet concedes that Marmon has satisfied the procedural requirements of Section 220, and it does not dispute that Arbinet has refused to provide the information Marmon requested. Arbinet's defense is that Marmon has failed to demonstrate a proper purpose because he has not presented credible evidence sufficient to support his allegations of mismanagement. More specifically, Arbinet contends that at trial Marmon presented only hearsay evidence that was not admissible to establish the truth of the matters Marmon relies upon to support his allegations of wrongdoing and waste. Moreover, Arbinet urges, the admissible evidence conclusively establishes that there was no mismanagement at Arbinet.
III. ENTITLEMENT TO INSPECTION
Under Delaware law, stockholders seeking to inspect a corporation's books and records to investigate waste and mismanagement, has the burden to establish the propriety of his purpose. To satisfy that burden, the plaintiff stockholder must provide "some credible basis from which the court can infer that waste or mismanagement may have occurred." Although that burden requires the stockholder to present specific and credible allegations of waste and mismanagement, it does not require proof by a preponderance of the evidence that waste and mismanagement actually occurred. A stockholder may satisfy his burden by providing credible testimony that issues of wrongdoing exist within the company.
Thomas Betts Corp. v. Leviton Mfg. Co., Inc., 681 A.2d 1026, 1031 (Del. 1996).
Id.
Id.
At trial, Marmon was unable to secure the appearance of his informant, Mashinsky, as a witness to testify in support of his claims. Accordingly, Marmon presented Mashinsky's allegations of wrongdoing through the testimony of other witnesses. To avoid the bar of the rule against hearsay, Marmon did not offer those witnesses' testimony for the truth of the matters asserted, but rather, to establish that there existed credible evidence to support a finding that issues of waste and mismanagement existed within Arbinet.
Arbinet contends that the Court cannot consider testimony about what Mashinsky told Marmon or Katz as evidence of possible mismanagement, because that testimony is inadmissible hearsay. In support of its position, Arbinet relies upon Thomas Betts Corp. v. Leviton Mfg. Co., which (Arbinet argues) holds that a statement that is not offered for its truth may not be used as substantive evidence for any purpose in a Section 220 proceeding. Arbinet misreads Thomas Betts. In that case, this Court admitted testimony from the plaintiff's witness describing out-of-court statements allegedly made by an employee of the defendant company. The Court refused to credit those statements as evidence of possible mismanagement, however, because it concluded that the out-of-court testimony was not credible. Because the non-testifying employee had a significant financial interest that was tied to the plaintiff, the Court did not believe that the out-of-court statements attributed by the employee were "sufficiently reliable to create a credible inference of waste and mismanagement."
681 A.2d 1026, 1031 (Del. 1996).
Id.
In its affirming opinion, the Supreme Court indicated that, had this Court found the disputed testimony reliable, it could properly have considered the hearsay testimony to determine whether there was a credible basis to infer that mismanagement had occurred. The relevant point is that in Thomas v. Betts the Supreme Court did not endorse a categorical rule of law (as Arbinet claims) that "hearsay statements not offered for their truth fail as a matter of law to meet Section 220's evidentiary requirements."
Id. at 1032-33; see also Skoglund v. Ormand Indus., Inc., 372 A.2d 204, 208-13 (Del.Ch. 1976).
Defendant's Post-Trial Brief, pg. 17.
In this case, the testimony concerning Mashinsky's information is admissible and establishes a credible basis to infer that mismanagement may have occurred. Mashinsky, unlike the witness in Thomas Betts, had no significant financial ties to Marmon. Moreover, Mashinsky as the founder and the current Vice Chairman of Arbinet, was in a unique position to know that information. For these reasons, the information Mashinsky is said to have provided is (in this Court's view) sufficiently reliable that it may be considered in determining whether a credible basis exists to conclude that waste or mismanagement may have occurred within Arbinet.
Arbinet points out that in his deposition, Mashinsky denied making any of the mismanagement-related statements attributed to him by Marmon. That argument is neither accurate nor dispositive. Mashinsky did not disavow the statements that Marmon and Katz attributed to him. Rather, in his deposition Mashinsky testified that he spoke with Marmon and Katz on several occasions, but could not recall the specifics of those conversations. There could be several reasons for Mashinsky's failure of recollection, at least two of which do not favor the company's position. Mashinsky could have experienced a genuine loss of memory. Equally plausibly, Mashinsky, who still is employed at Arbinet, could have concluded that his position and livelihood would be threatened if he testified that he (Mashinsky) was the source of Marmon's information. Mashinsky's deposition cannot, therefore, operate to obviate or defeat Marmon's trial testimony, which (the Court finds) is credible evidence that Mashinsky was a reliable information source.
But the result reached here does not rest solely on that technical evidentiary ruling. To the contrary, reasonable suspicions that something may have been amiss at Arbinet are also fueled by both the defendant company's pre-litigation course of conduct and by its litigation tactics in this case.
The company has had no annual stockholders' meeting for over three years. That alone constitutes a violation of Delaware statutory law. Nor has Arbinet disclosed to its shareholders any information about itself or its activities, as would normally occur in connection with a shareholders' meeting. Yet, during this three-year "blackout" period, the company engaged in several rounds of financing, the information about which was purposefully withheld from Marmon and certain other Arbinet stockholders. When asked why there had been no disclosure, Marmon was told that the company was contractually barred by its certificate of incorporation and by its agreement with venture capital providers, from disclosing this information to shareholders who held less than specified levels of ownership.
8 Del. C. § 211. There is evidence that directors were not elected by written consent.
That response, if truthful, is difficult to characterize in neutral terms. The directors of a Delaware corporation have a duty to disclose material facts to all of the corporation's shareholders. The directors are not free arbitrarily to pick and choose the shareholders to whom they will or will not make disclosure. Nor can the corporation be heard to defend such a practice on the basis that it has bound itself contractually not to make such disclosures. Arbinet's directors were not free to contract away disclosure obligations that they had a fiduciary duty to observe. Nor could they rely upon a certificate provision prohibiting disclosure to avoid a shareholder's inspection right conferred by statute. By so doing, Arbinet's directors and management made the corporation complicit in their violations of fiduciary, as well as statutory, law.
Lynch v. Vickers Energy Corp., 383 A.2d 278 (Del. 1977).
See Paramount Communications v. QVC Network, 637 A.2d 34, 51 (Del. 1994).
A charter provision that conflicts with a statute is void. See Maddock v. Vorclone Corp., 147 A. 255 (Del.Ch. 1929); Gow v. Consolidated Coppermines Corp., 165 A. 136 (Del.Ch. 1933); State ex rel. Cochran v. Penn-Beaver Oil Co., 143 A. 257 (Del. 1926) (invalidating charter provisions restricting shareholder right to inspect books and records). If any such charter provision limiting disclosure exists in this case, it is void to the extent that it abridges or limits shareholder inspection rights under § 220. Id.
Compounding the suspicions generated by Arbinet's pre-litigation conduct is the company's chosen manner of litigating this case. In effect, Arbinet has defended its refusal to grant Marmon access to its books and records by attempting to prove at trial, through live witnesses, that the conduct that Marmon claims may constitute mismanagement was in all respects substantively lawful and in no sense improper. The pretext under which the company sought to litigate a "merits" defense to this claim to inspect books and records in order to investigate possible mismanagement, is that there can be no "credible" evidence of mismanagement if, in fact, no mismanagement ever occurred.
This gambit, if allowed, would turn on its head both § 220 and the case law upholding a books and records inspection for the purpose of investigating mismanagement. In such a case, the issue is whether the evidentiary showing is sufficient to justify a court-ordered books and records inspection to uncover evidence (if any exists) of mismanagement. Under Arbinet's view of the law, a demanding shareholder under § 220 would first have to prove actual mismanagement in order to become entitled to conduct the predicate books and records inspection that would uncover (if it exists) evidence of such mismanagement. Besides being circular and conceptually wrong, that litigation approach, is inequitable and subversive of § 220.
For these reasons, the Court concludes that Marmon has presented sufficient credible evidence that mismanagement may have occurred, to entitle him to inspect the company's books and records. The issue then becomes, what books and records Marmon is entitled to inspect. The Court turns to that issue.
IV. RELIEF
Following post-trial argument, the Court concluded that Marmon's stated purpose of valuing his shares was bona fide. Accordingly, the Court ordered Arbinet to permit Marmon to inspect Arbinet's Federal tax returns for tax years 2000-2002, audited financial statements and auditors' notes for that period, appraisals and evaluations of the company as a whole or of divisions of specific assets, offering memoranda or prospecti, financial statements from the date of the last audit to the present, management prepared projections and capital expenditure plans. The inspection was made subject to a confidentiality stipulation the parties entered into. An inspection of the foregoing items having been granted, this Opinion need address only those books and records, excluding those listed above, that pertain to Marmon's purpose of investigating mismanagement.
Marmon's mismanagement claims encompass essentially three areas: (i) unauthorized loans made by Arbinet to Craig, (ii) bonuses and options paid to Craig, and benefits received by Van der Meer, and (iii) the effects of the five rounds of financing engaged in by Arbinet, particularly Round E, to the detriment of the common shareholders and to the corresponding benefit of Series E preferred shareholders.
The Court concludes that the following books and records are essential and sufficient to investigate allegedly improper loans made by Arbinet: all documents evidencing any loans or guarantees made by Arbinet for the benefit of Craig; and all agendas, minutes, and resolutions of meetings of the Board of Directors and the Compensation Committee of the Board from 2000 to the present, that address loans made to officers or directors. Marmon's inspection right is limited to these documents, because Marmon did not furnish evidence that any other officer or director may have been involved in allegedly making or receiving unauthorized loans. Nor did Marmon provide any evidentiary support for his demand to inspect books and records evidencing payments to relatives of officers or directors of the company.
Next, the Court finds that the following documents are essential and sufficient to investigate bonuses and options paid to Craig and benefits received by Van der Meer: all employment contracts, termination or severance agreements, and any key man life insurance policies relating to Craig and Van der Meer; and ledgers and financial records from 2000 to the present, that record the salaries and bonuses, including stock options, paid to Craig and Van der Meer.
Third, the Court concludes that the following books and records are essential and sufficient to investigate the alleged dilution of common stock and the preferential treatment given to senior security holders in any or all of the five rounds of financing: the identity of members of the Board of Directors from 2000 to the present; Arbinet's Certificate of Incorporation, and Bylaws; all financial statements of the company and its subsidiaries; and the agendas and minutes of stockholders' meetings of Arbinet from 2000 to the present; and all stockholder agreements, voting trusts, voting proxies and/or agreements; agendas, resolutions, and all minutes of the Board of Directors or Committees thereof that address any of the rounds of financing.
Any document categories that are not described above in this Opinion have been excluded from the scope of the relief granted because Marmon did not establish an evidentiary basis to support an inspection of the excluded books and records. Marmon's inspection of Arbinet's books and records shall be subject to the parties' previously executed confidentiality stipulation.
V. CONCLUSION
Counsel shall confer upon, and submit, an agreed to form of implementing order.