In Wei v. Zoox, Inc., the Delaware Court of Chancery found that an appraisal petition had been filed for the sole purpose of gathering discovery to be used in drafting a fiduciary duty complaint challenging a merger where the former stockholders had lost standing to seek books and records under Section 220 due to the rapid closing of the merger.  Nonetheless, in a novel ruling, the court permitted the appraisal petitioners to pursue some discovery in the appraisal action, limited to what would have been available to them under Section 220 had they not lost standing to seek such records.  The court rejected the petitioners’ request for broader discovery that is normally available in an appraisal action in light of its finding that the petitioners’ true purpose in filing the appraisal action was to seek Section 220-like books and records.

Background

Zoox, Inc. (“Zoox”) is a self-driving vehicle technology company founded in 2014.  Under a merger agreement, dated June 24, 2020, Amazon.com, Inc. (“Amazon”) agreed to acquire Zoox for $1.3 billion.  On June 25, 2020, holders of Zoox’s common and preferred stock approved the merger agreement by written consent.

On August 4 or 5, 2020, petitioners James Wei and Yanxin Zhang, owners of Zoox common stock, made inspection demands on Zoox pursuant to Section 220 of Delaware’s corporate code, seeking to inspect 23 categories of books and records.[1] Petitioners were looking to obtain information to support their belief that Zoox’s board and top executives used the COVID-19 pandemic as a pretext to engineer a $1.3 billion proposed sale to Amazon on self-dealing terms.  On August 12, 2020, Zoox informed petitioners that their demand pursuant to Section 220 was untimely because the merger between Amazon and Zoox had closed on August 12, 2020 and they no longer had standing to inspect documents under Section 220.[2]  On August 13, 2020, petitioners filed a complaint in the Delaware Court of Chancery to enforce their inspection rights under Section 220 (“Section 220 Action”).

In December 2020, petitioners voluntarily dismissed their Section 220 Action and filed a new appraisal action in Chancery Court noting that they “‘would be entitled, at minimum, to discovery of the same material sought’ in the Section 220 Action.”[3] Petitioners served discovery requests on Zoox seeking 53 categories of documents encompassing the 23 categories in petitioners’ Section 220 Action.  In response to the discovery requests, Zoox produced a limited amount of documents which included “all board-level materials concerning the Company’s valuation and financial performance, the Amazon deal, alternative transactions, all non-disclosure agreements entered into with any potential counterparties to an alternative transaction, and a waterfall analysis of the liquidation preferences of the various classes of Zoox stockholders, updated as of July 31, 2019 [and as of closing].”[4]  Zoox refused to produce emails and other electronically stored information.

The Decision

In a decision dated January 31, 2022, Chancellor McCormick found that appraisal petitioners should not be permitted to obtain full discovery in an appraisal proceeding that has been commenced for the purpose of conducting a pre-suit investigation.[5]

Chancellor McCormick acknowledged that the court has broad discretion in determining the scope of discovery, but nevertheless found that public policy weighs against granting appraisal petitioners full discovery where the proceeding is a replacement for an unavailable Section 220 action.[6]  McCormick explained that Section 220 is narrower than Federal Rule of Civil Procedure 26 for obtaining discovery in appraisal proceedings. If permitted as a form of pre-suit investigation, appraisal proceedings could become viewed as a more attractive option than Section 220.  Such a trend would “run contrary to Delaware lawmakers’ efforts to limit appraisal litigation  . . . [and] undermine the work that [the Chancery Court] has done in refining Section 220 law.”[7]

The decision turned on petitioner’s purpose: Chancellor McCormick concluded that if petitioners were using the appraisal action as a substitute for Section 220, then they should only be able to receive the same information they could have obtained in  Section 220 proceeding.  However, if petitioners were using the appraisal action for other legitimate purposes, then the scope of discovery did not need to be limited.[8] In her view, petitioners’ purpose was clearly a pre-suit investigation and as such, they are entitled to no more information through discovery than what they would be entitled through a Section 220 proceeding.[9]

Takeaways

• Petitioners’ Purpose: In its decision, the court made clear (consistent with prior Chancery decisions) that it was not opposed in principle to a stockholder using discovery in an appraisal action as a tool to gather information to use in a potential breach of fiduciary action. However, in a ruling of first impression, the court found that the stockholder’s purpose in seeking appraisal was a relevant factor in considering the scope of that discovery.  In particular, where such purpose is essentially to seek books and records under Section 220, the court ruled that discovery should be limited to what would have been available under Section 220.
• Appraisal Actions Are Not Substitutes for Section 220 Actions: While the outcome Wei v. Zoox, Inc. may encourage some stockholders to use an appraisal action as a substitute for Section 220 when the latter is unavailable, this is not likely to be a common occurrence for a few reasons.
  • First, it is a fairly complex process for stockholders to perfect appraisal rights, and it is comparably simple for them to make a demand for books and records under Section 220. In most cases, particularly involving public deals, there is sufficient time between announcement and closing for stockholders to file Section 220 actions such that they do not lose standing in the manner the stockholders did in this case.
  • Second, for public companies, amendments to the appraisal statute in 2016 provide that appraisal petitions are subject to dismissal unless more than 1% of the shares (or shares worth at least $1 million) seek appraisal.[10]
  • Third, for private companies like the one at issue in this case, stockholders often waive appraisal rights, which the Delaware Supreme Court recently affirmed was valid under Delaware law.[11]
  • Fourth, the decision in this case makes clear that even if a stockholder is entitled to appraisal and elects to pursue discovery in an appraisal proceeding in lieu of a books and records action under Section 220, the stockholder will be limited to the same scope of records as it would have received under Section 220.

ENDNOTES

[1] See 8. Del. § 220 (providing any stockholder certain inspection and access to books and records upon written demand).

[2] Per Section 220 of Delaware’s corporate code, a corporation has five business days to respond to a Section 220 demand. By operation of the merger, petitioners no longer had standing to inspect documents under Section 220.

[3] Wei v. Zoox, Inc., C.A. No. 2020-1036-KSJM (Del Ch. Jan. 31, 2022) at 4.

[4] Id. at 5.

[5] Id. at 24.

[6] Id. at 5, 24.

[7] Id. at 24.

[8] Id. at 25.

[9] Id. at 26-27.

[10] Effective August 1, 2016, the appraisal rights of dissenting stockholders in mergers and certain other transactions under the DGCL were modified.  See 8 Del. § 262.

[11] See Manti Holdings, LLC v. Authentix Acquisition Co., Inc., 261 A. 3d 1199 (Del. Sept. 13, 2021).

This post comes to us from Cleary Gottlieb Steen & Hamilton LLP. It is based on the firm’s memorandum, “A Back-Door Section 220?  Chancery Court Limits Appraisal Petitioners’ Demand for Broad Discovery,” dated February 7, 2022, and available here.