Master in Chancery Reverses Course, Recommends Rejection of §220 Request

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By Michael Greene

Feb. 11 — A Master in Chancery's Feb. 10 report recommended that the Delaware Chancery Court deny a DGCL §220 books and records inspection related to investigating possible waste or mismanagement by ITT Educational Services Inc.'s officers and directors because the plaintiff failed to demonstrate a proper purpose.

The plaintiff stockholder sought to investigate corporate waste and possible breaches of fiducary duty by the ITT's directors, among other claims, but could not any establish any possibility of harm to the corporation even if the alleged misconduct had occurred, according to Master in Chancery Kim E. Ayvazian.

“To allow [plaintiff] to inspect ITT's books and records regarding ITT's cohort default rate management efforts would simply be an indulgence that could lead to mischief and ‘indiscriminate fishing expeditions,'” she opined, though she found evidence of possible wrongdoing.

Books and Records Demand

The plaintiff stockholder made a books and records demand on ITT under 8 Del. C. §220 for the purpose of investigating whether the company was in compliance with federal Title IV eligibility requirements and was not at risk of losing its primary source of revenue—federal Title IV student loans.

As support for his demand, the plaintiff cited ITT's public disclosures and a Majority Committee Staff Report issued by the U.S. Senate Health, Education, Labor and Pensions Committee.

After both parties moved for summary judgment, Ayvazian issued a draft report recommending that the chancery court grant the plaintiff's motion for summary judgment as to four of the five categories of requested books and records.

Subsequently, ITT raised several exceptions to the draft report, including that the plaintiff had demonstrated a proper purpose for the §220 action.

Merits Defense

Ayvazian first rejected ITT's argument that the court had failed to consider that the company's elevated student loan cohort default rates were a result of factors outside the company's control and that the Staff Report could not be considered in the § 220 action.

She noted that loan servicing issues and the economic recession had the same impact on every educational institution during the three-year period in which the plaintiff sought to investigate, yet the Staff Report found that ITT had the sixth-highest default rate among the companies investigated.

Ayvazian also concluded that the Staff Report supported a reasonable inference that ITT was tardy in preparing for new federal regulations and that possible mismanagement was a reason for the higher cohort default rates.

‘Caremark' Claim

However, despite finding this evidence to be sufficiently reliable, Ayvazian determined that the plaintiff failed to demonstrate a proper purpose for bringing his books and records action.

Ayvazian determined that it was evident from the record that the plaintiff was seeking evidence for the purpose of bringing a possible Caremark claim, and one of elements of this type of claim is loss or harm to the corporation.

According to the report, the plaintiff limited the scope of his demands to investigating concerns that ITT was jeopardizing its income stream from federal student loans. Ayvazian found that the company was not at risk of losing this income stream even if the court were to assume possible mismanagement.

“There is no probability at least in the near future, that such harm will occur,” she opined.

Accordingly, she upheld ITT's exception and modified her report to recommend that the chancery court grant ITT's motion for summary judgment.

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