Delaware’s top court has ruled that a shareholder can have access to VeriFone Holdings Inc.’s books and records even though he had already filed a derivative complaint against the company, reversing a lower court’s interpretation of the state’s record review rule.
The Friday decision by an en banc panel of the Supreme Court of the State of Delaware overturned a bright-line rule barring shareholders from exercising their rights to inspect a company’s records under Section 220 of the Delaware General Corporation Law if they have already filed a derivative complaint against the company.
In May, Vice Chancellor Leo Strine denied a Section 220 request filed by Charles King, a shareholder who was part of a derivative suit against VeriFone in the U.S. District Court for the Northern District of California.
Judge Marilyn Hall Patel dismissed the derivative complaint filed by King and a group of other plaintiffs in May 2009. At the center of the suit are allegations that VeriFone, a Silicon Valley company that provides automation systems for electronic payments, knowingly overstated its earnings.
In 2009, the company settled a U.S. Securities and Exchange Commission suit over allegations that a former employee, Paul Periolat, altered accounting records, leading the company to overstate its income by more than $37 million in 2007.
According to the SEC, VeriFone altered its records in three consecutive quarters in 2007 to make up for an unexpected decline in gross margins, overstating its operating income by 129 percent. When those misrepresentations were unearthed in December 2007, VeriFone’s stock price plummeted 46 percent.
Judge Patel dismissed King’s complaint in 2009 without prejudice, suggesting King and his fellow plaintiffs exercise their Section 220 rights and review VeriFone’s books, according to the Delaware Supreme Court ruling.
King did just that, entering into negotiations for a document handover with VeriFone. The two sides reached agreement on all but one document – a report by the audit committee of VeriFone’s board of directors – resulting in King’s November 2009 complaint.
Vice Chancellor Strine ruled that any shareholder who files a derivative complaint without first exercising a Section 220 inspection loses the right to request such an inspection.
“Once a plaintiff has chosen to file a derivative suit, it has chosen its course and may not reverse course and burden the corporation (and its other stockholders) with yet another lawsuit to obtain information it cannot get in discovery in the derivative suit,” Vice Chancellor Strine wrote.
The Delaware Supreme Court threw out that bright-line test, however, saying that Delaware courts had long allowed a shareholder to file for a Section 220 review to gather new information and replead their derivative complaints if their complaint is dismissed without prejudice.
“The result we reach here reaffirms long-standing Delaware precedent which recognizes that it is a proper purpose under Section 220 to inspect books and records that would aid the plaintiff in pleading demand futility in a to-be-amended complaint in a plenary derivative action, where the earlier-filed plenary complaint was dismissed on demand futility-related grounds without prejudice and with leave to amend,” the Delaware Supreme Court said. David Scott, the managing partner of Scott & Scott LLP representing King, cheered the Supreme Court’s reversal of a “draconian rule.”
“The Delaware courts have, for years now, justified applying unreasonably high pleading standards to shareholder derivative actions by telling plaintiffs they can ‘use the tools of the trade’ and make these shareholder inspection demands to make very detailed factual allegations without the benefit of formal discovery – and in the Verifone derivative action, that is precisely what we tried to do,” he said.
King’s victory may be short-lived, though. In August, Judge Patel threw out an amended derivative complaint against VeriFone. That decision is currently on appeal to the U.S. Court of Appeals to the Ninth Circuit.
Counsel for VeriFone declined to comment.
King is represented by Scott & Scott LLP and Smith Katzenstein & Jenkins LLP.
VeriFone is represented by Sullivan & Cromwell LLP and Richards Layton & Finger PA.
The case is King v. VeriFone Holdings Inc., case number 5047, in the Supreme Court of the State of Delaware.
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