Delaware Ch. Master Allows Inspection, But Declines to Enforce Federal Law

Bloomberg BNA’s Corporate Law & Accountability Report is available on the Corporate Law Resource Center. This news service keeps corporate practitioners informed of legal developments of...

By Yin Wilczek

March 4 — A master Feb. 26 recommended that the Delaware Chancery Court allow a hedge fund stockholder to inspect certain of a delisted company's books and records subject to a confidentiality agreement.

Among other arguments, Master in Chancery Abigail LeGrow rejected the hedge fund's argument that because the sought-after financial records were required by the federal securities laws to be publicly disclosed, there was no basis upon which to conclude that they were confidential.

LeGrow also rejected the argument that the court should order public disclosure of the documents, so that the hedge fund could trade in the company's shares without violating the Securities and Exchange Commission's Regulation FD proscription against selective disclosure.

The master said that both arguments would give the stockholder a “mechanism under Delaware law” to enforce federal securities requirements.

Separate Regimes 

“The inspection right afforded to stockholders under Section 220 is an important feature of the Delaware General Corporation Law, but it is a right entirely separate from the complex overlay of rights and regulations created under the federal securities laws,” the master wrote. “Although I sympathize with [the stockholder] that it may need to devise a way to inspect the records and value its shares without violating Regulation FD, or alternatively choose not to inspect the books and records because of that regulation, I do not believe it is either necessary or appropriate for this Court to remedy that issue.”

Southpaw Credit Opportunity Master Fund LP, the hedge fund in question, bought stock of Advanced Battery Technologies Inc.—a China-based company listed on Nasdaq—in March 2014. The company was delisted in 2011 after its stock price dropped steeply.

While acquiring the stock in March 2014, Southpaw sent ABAT a books and records demand asking for certain financial records so that it could determine the “financial risks associated with” maintaining its current position or buying a bigger stake in the company.

ABAT told the hedge fund it could visit the company's office in China to view the requested records. However, to do so, the hedge fund had to confirm that it would keep the information confidential and not trade in ABAT stock until after the information was publicly disclosed.

Failing to come to an agreement, Southpaw filed its case in court asking to inspect two categories of documents: those for “risk assessment” purposes and those for “valuation.”

ABAT, however, asserted that the sought-after records are confidential until they are converted to U.S. generally accepted accounting principles, audited and provided to the SEC.

A week before trial, the company also raised the defense that the records were barred under Chinese law from being produced beyond the country's borders.

Risk Assessment 

The master found that Southpaw had not sustained its burden regarding materials it sought for “risk assessment” purposes, which she described as a “veiled effort” to obtain information that the hedge fund would have been entitled to had ABAT still been listed and subject to SEC reporting requirements.

However, Southpaw was entitled to inspect documents that are “necessary and essential to valuing its stock in ABAT” pursuant to its “valuation” purpose, the master said.

The master also concluded that ABAT had not sufficiently shown that it was precluded by Chinese law from producing the materials for inspection. Moreover, the company did not show that there was no other way to make the materials available for inspection, she said.

“Although not typical of Section 220 inspections, it may be necessary under these unusual circumstances for ABAT to make the records available in China and bear Southpaw’s associated travel expenses,” LeGrow said. “Although that option seems best reserved as a `last resort,' it is at least preferable to excusing ABAT altogether from its obligations under Delaware law.”

The master added that the nature of the information sought and ABAT's treatment of it as confidential was sufficient for the court to require Southpaw to execute a confidentiality agreement. Because it is “doubtful” that all the records at issue truly are confidential, she directed the parties to include in their agreement “clauses regarding good faith designations and a process to challenge such designations.”

To contact the reporter on this story: Yin Wilczek in Washington at ywilczek@bna.com

To contact the editor responsible for this story: Kristyn Hyland at khyland@bna.com

The decision is available at http://courts.delaware.gov/opinions/download.aspx?ID=220170.