February 15, 2022

Appraisal: Chancery Limits Discovery for Lurking Fiduciary Claim

In Wei v. Zoox (Del. Ch.; 1/22), the Chancery Court granted a protective order limiting the discovery that a company would be otherwise be required to provide to petitioners in an appraisal proceeding.  The case arose out of Amazon’s 2020 acquisition of Zoox, a private company.  The petitioners followed their appraisal demand with a Section 2020 inspection demand, but the company refused to comply with it because the merger had already closed.

Subsequently, the petitioners withdrew their appraisal demand for 95% of the shares that they owned, and filed an appraisal action in the Chancery Court.  They subsequently submitted a detailed document request to Zoox, which the company partially complied with.  In arguing that it should not be required to comply fully with the petitioners’ discovery demands, Zoox argued that the petitioners were improperly using the appraisal proceeding as a means to investigate a potential breach of fiduciary duty claim.  Chancellor McCormick agreed, and this Potter Anderson blog summarizes her reasoning:

While acknowledging that Delaware courts have allowed appraisal petitioners to use discovery adduced in appraisal proceedings in parallel or later-filed actions, the Court evaluated the policy considerations underlying Sections 220 and 262 and concluded that appraisal petitioners should not be permitted to obtain full discovery in an appraisal proceeding initiated solely for the purpose of conducting a pre-suit investigation.  Doing so would allow stockholders seeking to conduct a pre-suit investigation to do so under the Rule 26 standard for obtaining discovery in appraisal proceedings rather than the narrower standard for obtaining books and records under Section 220.

That would make appraisal proceedings more attractive than Section 220, contrary to the Court’s guidance that stockholders employ Section 220 for such pre-suit investigations.  The Court reasoned, however, that where, as here, an appraisal proceeding is pursued because the Section 220 path is blocked, a trial court has discretion to limit discovery to the scope of what the petitioner could have obtained under Section 220.

The Court concluded the petitioners filed the appraisal action as a substitute for Section 220 on the grounds that “objectively discernable facts reflect” that seeking appraisal was “an economically irrational investment” given the small dollar amounts at stake, and the petitioners did not deny that such an investigation was one of their aims.  The Court thus granted Zoox’s protective order in part, limiting petitioners to the discovery that they would have obtained in a Section 220 proceeding.

The blog also points out that Zoox’s status as a private company is central to the case, and the issues presented here are unlikely to arise in public company transactions. There are two reasons for that conclusion.  First, the federal securities laws ensure that public company stockholders have enough advance notice of a merger to pursue books and records actions prior to closing, which means they wouldn’t have to use the appraisal mechanism as a substitute.  Second, Section 262(g) of the DGCL requires appraisal petitioners in most public company deals to obtain at least 1% of the outstanding eligible shares or shares worth $1 million. That relatively high filing bar “would most likely prevent petitioners from using ‘economically irrational’ appraisal petitions to pursue books and records concerning most mergers involving publicly traded companies.”

John Jenkins