IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
GREG de VRIES, an individual, and )
RAYMOND MURRAY, )
an individual, )
)
Plaintiffs, ) C.A. No. 9782-ML
)
v. )
)
)
DIAMANTÉ DEL MAR, L.L.C. )
)
Defendant. )
MASTER‟S REPORT
(Plaintiffs‟ Motion to Compel)
Date Submitted: March 11, 2015
Final Report: June 3, 2015
Stamatios Stamoulis, Esquire and Richard C. Weinblatt, Esquire of STAMOULIS
& WEINBLATT, L.L.C., Wilmington, Delaware; Steven R. Main, Esquire and
Christopher T. Hill, Esquire of HILL, RUGH, KELLER & MAIN, P.L., Orlando,
Florida; Attorneys for Plaintiffs.
Joanna J. Cline, Esquire and James G. McMillan, III, Esquire of PEPPER
HAMILTON, L.L.P, Wilmington, Delaware; OF COUNSEL: Thomas McC.
Souther, Esquire of PEPPER HAMILTON, L.L.P., New York, New York;
Attorneys for Defendant.
LEGROW, Master
The operating agreement of a limited liability company requires the
managing member to prepare and provide to the other members certain quarterly
and annual reports. In the last five years, the managing member has ignored that
obligation. During that same period, the managing member caused the company to
surrender its only asset to satisfy a debt with a balance approximately one-
twentieth the value for which the asset previously appraised. The managing
member had personally guaranteed that debt and the property transfer extinguished
that personal guarantee.
Shortly after the transfer, two members of the limited liability company
demanded to inspect the company‟s books and records to value their investment
and investigate possible mismanagement. At the time, the members were unaware
the asset had been surrendered. The company granted the inspection, but withheld
privileged documents. It is undisputed that the company‟s non-privileged
documents do not provide any information about the events or decision-making
process that ultimately led to the surrender of the company‟s only asset. The
plaintiffs therefore moved to compel the production of privileged documents under
the fiduciary exception to the attorney-client privilege. Because they have shown
good cause to inspect some of the documents on the privilege log, I recommend
that the Court grant in part the motion to compel. This is my final report.
BACKGROUND
Diamanté Del Mar, LLC (“DDM”) is a limited liability company organized
under the laws of Delaware with its principal place of business in Danbury,
Connecticut.1 DDM was formed in September 2002 along with its wholly-owned
Mexican subsidiary for the purpose of acquiring the rights to approximately 10,000
acres of undeveloped land, including three miles of Pacific coastline in El Rosario,
Baja California, Mexico (the “Property”).2 DDM‟s managing member is Baja
Management, LLC (“Baja”).3 Kenneth A. Jowdy (“Jowdy”) serves as Baja‟s
President and sole managing member and, as such, has control over the day to day
operations of DDM.4 Baja owns a 93% interest in DDM.
DDM expected to develop the Property in three phases. The initial phase
would include construction of a hotel and residential properties, as well as roads, a
golf course, and a club house, and was estimated to cost $65 million.5 A report
prepared by KPMG in 2005 indicated DDM was seeking a $20 million loan to
fund this phase of the development.6 Phases two and three would produce
1
Pls.‟ Verified Compl. ¶ 3.
2
Id. at ¶¶ 4, 9.
3
Id. at ¶ 5.
4
Id.
5
Id., Ex. B (“KPMG Report”) at 4-6.
6
Id.
2
additional recreational facilities such as a spa, tennis complex, fitness centers, a
winery and vineyards, and an equestrian center.7
The plaintiffs, Greg deVries and Raymond Murray, each invested $500,000
in DDM pursuant to subscription agreements dated April 14, 2004 and March 29,
2005 respectively, and each received a 0.5% class A membership interest in the
company.8 At the time, the plaintiffs were professional ice-hockey players in the
National Hockey League.9 In all, 14 individuals invested $500,000 each in DDM.
Under DDM‟s operating agreement (the “Operating Agreement”), Baja was
required to prepare annual and quarterly reports and transmit to DDM‟s non-
managing members unaudited financial statements and quarterly business reports.10
The quarterly business reports never were prepared and the plaintiffs have not
received any reports or statements since at least 2010.11
DDM obtained clear title to the Property and permits to complete the
aforementioned renovations, but the Property remains largely undeveloped.12 An
appraisal performed by KPMG in April 2005 valued the Property at $68.9 million
and reported that DDM had:
7
Id.
8
Id. ¶ 3.
9
Id. at ¶¶ 1-2.
10
Motion to Compel Production of Documents and Challenging Def.‟s Privilege Log
(Pls.‟ Br.), Ex. C, § 502.
11
Pls.‟ Br. at 3. See also Pls.‟ Br., Ex. D (e-mail from DDM counsel dated November 4,
2014 confirming that the quarterly business reports do not appear to exist).
12
Id. at ¶ 7.
3
[G]ood, clear, marketable, insurable title to three parcels of land that
comprised 8,065 of the 9,727 total acres … [and DDM] expects to
obtain fee simple title on the three parcels that comprise 1,218 acres
three to six months after the date of value. This transfer would bring
the total acreage held in fee simple estate to approximately 9,283
acres.”13
The report also stated that as of June 2005, the Property had no encumbrances.14
On February 21, 2006, DDM secured – with Jowdy‟s personal guarantee – a
loan for $3 million from KSI Capital Corp. (“KSI”), a “hard money lender.”15 The
plaintiffs were not aware of the loan or its terms at the time the Property was
encumbered.16 DDM paid its required interest-only payments on a monthly basis
up to and including July 2009.17 DDM did not, however, obtain any of the
additional funds necessary to develop the Property.18
On June 18, 2009, the plaintiffs, along with DDM‟s twelve other individual
members, filed suit against Jowdy in the Superior Court of California, alleging
claims for breach of fiduciary duty and fraud (the “California Action”).19 The
California Action included allegations that the KSI loan constituted
13
KPMG Report at 4-6.
14
Id.
15
Def.‟s Opposition to Pls.‟ Mot. to Compel (“Def.‟s Br.”) at 4. Hard money loans carry
high interest rates and typically are secured by real estate.
16
Pls.‟ Br. at 9.
17
The total amount DDM paid is approximately $1.5 million.
18
Id. DDM attributes its inability to secure any other financing for the project to the
global financial crisis. Def.‟s Br. at 4.
19
Def.‟s Br., Ex. A.
4
mismanagement by Baja and Jowdy. The suit voluntarily was dismissed in
February 2010.20
In January 2010, KSI sued DDM, the Mexican subsidiaries, and Jowdy in
the United States District Court for the District of New Jersey, alleging claims for
breach of contract stemming from the default on the $3 million loan (the “KSI
Action”).21 The parties settled the KSI Action on November 15, 2010. The
plaintiffs were not aware of the KSI Action or its settlement and dismissal.
Under the settlement agreement, Jowdy and DDM executed confessions of
judgment for the full amount of the loan and interest.22 KSI agreed to hold the
judgments in escrow until April 2011 to allow DDM time to obtain financing to
satisfy the KSI loan. When DDM did not obtain financing, Baja and Jowdy
reached a new agreement with KSI. Under that agreement, DDM executed
documents transferring the Property to KSI in lieu of KSI recording the judgments
against DDM and Jowdy.23 Those transfer documents were held in escrow for a
brief time, to allow DDM a final opportunity to satisfy the loan, but DDM
ultimately surrendered the Property to KSI in September 2013.24
20
Id., Ex. B.
21
Pls.‟ Br., Ex. G; Def.‟s Br. at 6.
22
Pls.‟ Br., Ex. K, L.
23
Id., Ex. M.
24
Id., Ex. E.
5
The plaintiffs were not aware of these agreements or the transfer of the
Property until they made a demand on May 30, 2014 to inspect DDM‟s books and
records (the “Demand”). In the Demand, the plaintiffs stated the purpose of their
inspection was to “conduct a current valuation regarding their respective
ownership interests in DDM, and to further investigate whether there has been any
mismanagement of DDM, especially as it relates to the $3,000,000 loan received
from [KSI] in or around February of 2006.”25 When DDM did not provide the
requested books and records for inspection, the plaintiffs filed this action on June
18, 2014, to enforce their inspection rights under the Operating Agreement and 6
Del. C. § 18-305.
After this action was filed, the parties reached a settlement and DDM
produced non-privileged books and records responsive to the Demand. When they
obtained the records, the plaintiffs learned for the first time about the terms of the
settlement with KSI and the later transfer of the Property. The plaintiffs also
discovered that on June 27, 2014, DDM canceled its status as an active limited
liability company.26 According to the plaintiffs, the books and records produced in
response to the Demand do not answer several key questions, including why the
litigation was settled, why Jowdy entered into revised agreements with KSI in
25
Pls.‟ Verified Compl., Ex. I, at 3.
26
Pls.‟ Br. at 4-5.
6
2012, or why the Property, which once appraised for more than $60 million in its
undeveloped state, was transferred to KSI to satisfy a $3 million debt.
In addition to producing non-privileged books and records, DDM also
provided the plaintiffs a privilege log listing the documents DDM had withheld or
redacted on the basis of privilege. The log included 95 documents, 41 of which
were withheld in their entirety and 54 of which were redacted.27 The documents
on the privilege log all were created between 2010 and 2012, aside from seven
redacted documents relating to this litigation. The privileged documents involved
communications between Jowdy, William Najam (“Najam”), Jowdy‟s brother-in-
law and the former Vice President and General Counsel of DDM, and several
outside counsel representing DDM and Jowdy on a variety of matters. The
plaintiffs do not dispute that the documents on the log are privileged. They argue,
however, that they should be entitled to inspect all those documents under the
Garner doctrine.
The plaintiffs filed this motion to compel asserting they should be allowed to
inspect all the documents on the privilege log. The plaintiffs argue that the specter
of mismanagement and self-dealing hangs over Jowdy‟s agreements with KSI
because of Jowdy‟s personal guarantee of the loan, the surrender of the Property to
27
Ltr. to the Court from J. Cline, Esq. dated Mar. 11, 2015, Ex. A (hereinafter “Privilege
Log”). Although there are other versions of the privilege log in the record, this version is
the most recent and reflects updated descriptions for some of the redacted documents.
This is the version of the privilege log that I will refer to in this report.
7
satisfy a loan representing less than 5% of the appraised value of the Property, and
the failure to provide any information to DDM‟s non-managing members since at
least 2010. The books and records DDM previously produced in response to the
Demand do not answer those questions, and the plaintiffs contend that the
documents on the privilege log represent the best – and possibly only – way they
may investigate possible mismanagement.
DDM vigorously disputes the plaintiffs‟ right to inspect the privileged
documents, contending that the plaintiffs have failed to demonstrate both that the
records are essential to their stated purpose and that there is good cause to apply
the fiduciary exception to the attorney-client privilege. DDM argues there is no
evidence of any possible mismanagement of the company, and that the surrender of
the Property is nothing more than a reflection of the fact that the initial estimates of
the value of the Property and its potential for development did not pan out, due at
least in part to the financial crisis that began in 2008 and its affect on the
availability of real estate financing.
During argument, one of the disagreements between the parties involved
Jowdy‟s personal guarantee of the KSI loan, and whether – despite that guarantee –
Jowdy‟s interests were aligned with the other members of DDM. Specifically, the
plaintiffs contend that Jowdy had a personal incentive to allow DDM to forfeit the
property, so KSI would not collect its judgment against Jowdy. DDM argues that
8
Baja owns 93% of DDM‟s membership interests and therefore was incentivized to
maximize the value of the Property. The plaintiffs, however, contend the record is
not clear regarding Baja‟s interest or what it stood to gain in the event of a sale of
the Property and dissolution of the company. Under DDM‟s operating agreement,
upon dissolution of DDM and payment of its third party obligations, DDM‟s net
assets are to be distributed to “all of the Members in accordance with the positive
balances in their respective Capital Accounts after giving effect to all
Contributions, distributions and allocations for all periods.”28 According to the
plaintiffs, the balance in each of the non-managing members‟ capital accounts is
nearly $500,000 each, while Baja‟s is near zero.29 Therefore, if – as DDM argued
– the Property was not worth anything close to its 2005 appraised value, Baja
would not have received any of the proceeds from a sale of the property unless the
net proceeds – after payment of DDM‟s obligations – exceeded $7 million. DDM,
on the other hand, argues that the plaintiffs misunderstand the operating agreement,
because upon a sale of the Property the net proceeds first would have gone to repay
any “net losses” to Baja‟s capital account, after which the members of DDM would
have received their percentage interest in the proceeds.30 Oddly, although DDM‟s
28
Pls.‟ Br., Ex. C.
29
Ltr. to Court from S. Stamoulis, Esq. dated Mar. 10, 2015.
30
Ltr. to Court from J. Cline, Esq. dated Mar. 11, 2015.
9
argument assumes there were net losses to Baja‟s capital account, there is no
documentation or explanation of those losses in the record.
The dispute between the parties is relatively narrow. DDM does not contend
that the plaintiffs are not entitled to inspect books and records or that the plaintiffs
have not stated a proper purpose for the inspection. The only issue before the
Court is whether DDM may withhold as privileged the documents listed on the
privilege log, or whether the “fiduciary exception” to the attorney-client privilege,
first articulated by the Fifth Circuit in Garner v. Wolfinbarger31 and expressly
adopted by the Delaware Supreme Court, permits the plaintiffs to inspect DDM‟s
privileged documents.
I. ANALYSIS
In Garner, the Fifth Circuit Court of Appeals confirmed that the attorney-
client privilege may be claimed by a corporation, even against its stockholders.
The court recognized, however, that in suits between the corporation and its
stockholders involving charges that corporate fiduciaries acted “inimically to
stockholder interests, protection of those interests as well as those of the
corporation and of the public require that the availability of the privilege be subject
to the right of the stockholders to show cause why it should not be invoked in the
31
430 F.2d 1093 (5th Cir. 1970).
10
particular instance.”32 This fiduciary exception attempts to strike a balance
between the privilege‟s purpose of encouraging open communication between
counsel and client, and the right of a stockholder to understand what advice was
given to fiduciaries who are charged with breaching their duties.33 To balance
those competing interests, the Fifth Circuit in Garner adopted a “good cause” test
that stockholders must meet to avoid a corporate claim of privilege.34 In its recent
decision in Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Fund
IBEW, the Delaware Supreme Court for the first time expressly held that the
Garner exception may apply in both plenary actions and in books and records
actions, although the exception continues to be one that “is narrow, exacting, and
intended to be very difficult to satisfy.”35 In a books and records action, this Court
must first consider whether the records at issue are necessary and essential to the
stockholder‟s stated purpose for inspection. Only if the Court determines the
records meet that standard should it consider the “good cause” factors articulated
32
430 F.2d at 1103-04.
33
In re lululemon athletic, inc., 2015 WL 1957196, at *10 (Del. Ch. Apr. 30, 2015).
34
Garner, 430 F.2d at 1104.
35
Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, 95
A.3d 1264, 1278 (Del. 2014). On several previous occasions, this Court had applied the
Garner doctrine, including in actions to inspect books and records. See, e.g. Saito v.
McKesson HBOC, Inc., 2002 WL 31657622 (Del. Ch. Nov. 13, 2002); Grimes v. DSC
Communications Corp., 724 A.2d 561 (Del. Ch. 1998); Sealy v. Sealy Inc., 1987 WL
12500 (Del. Ch. Jun. 19, 1987).
11
in Garner.36 DDM argues that the books and records listed on the privilege log are
not necessary and essential to the plaintiffs‟ purpose, and, alternatively, that the
plaintiffs have not met the burden of showing “good cause” to invade DDM‟s
privilege. I will address each argument in turn.
A. Certain of the records are necessary and essential to the plaintiffs’
purpose.
Determining whether the documents listed on the privilege log are
“essential” to the plaintiffs‟ stated purpose is a threshold question that must
precede any inquiry into the application of the Garner good cause analysis.37 A
document is “„essential‟ … if, at a minimum, it addresses the crux of the
shareholder‟s purpose, and if the essential information the document contains is
unavailable from any other source.”38 This inquiry depends on the context of a
particular case.39 It is the plaintiffs‟ burden to demonstrate that a document is
“essential” to the inspection.
DDM argues that the plaintiffs have not met that burden because they only
contend that the privileged documents would provide “additional insight” into the
events that led to the surrender of the Property. DDM also asserts that the
plaintiffs‟ stated purpose is to investigate the KSI loan and the encumbrance of the
36
Wal-Mart Stores, Inc., 95 A.3d at 1278; Espinoza v. Hewlett-Packard Co., 32 A.3d
365, 374 (Del. 2011).
37
Wal-Mart Stores, Inc., 95 A.3d at 1278.
38
Espinoza, 32 A.3d at 371-72.
39
Id. at 372.
12
Property, which occurred in 2006, while the privileged documents were created
between 2010 and 2014. The plaintiffs, on the other hand, argue that the non-
privileged books and records produced by DDM do not address in any way the
events that transpired after the settlement of the KSI Action, including the critical
decisions that led to the loss of the Property and the associated loss of the
plaintiffs‟ investment. The plaintiffs therefore argue that, unless they are permitted
to inspect the privileged documents, they will have no way to assess whether
Jowdy surrendered the Property (a) to advance his personal interests in satisfying
the KSI debt, (b) because of mismanagement, or (c) as DDM contends, because
outside factors associated with the economy generally and the real estate market
particularly left DDM no alternative.
The documents on the privilege log – all of which the plaintiffs contend are
necessary and essential to their stated purpose – fall within three general
categories: (1) the documents relating to the KSI Action and its settlement, (2) the
documents relating to post-settlement events, including the post-settlement
negotiations and the transfer of the Property, and (3) the documents relating to this
litigation. In my view, the plaintiffs only have demonstrated that the documents in
the second category are essential to their stated purpose.
As to the first category, the plaintiffs‟ argument in their briefs exclusively
focused on the necessity of inspecting documents regarding the events “following
13
[Jowdy‟s] settlement of the KSI [Action].”40 Although the plaintiffs retreated from
that position during oral argument, and contended the documents relating to the
KSI Action also are essential to their purpose, it is not apparent how those records
address the crux of the plaintiffs‟ purpose, which is to investigate whether Jowdy‟s
actions were self-interested or otherwise constituted mismanagement. The
plaintiffs concede that issues regarding the initial KSI loan in 2006 are not the
focus of their investigation, and have not articulated a single reason why the
settlement of the KSI Action constituted self-dealing or mismanagement. Put
another way, the plaintiffs do not contend that the KSI debt was not genuine or that
Jowdy engaged in misconduct by settling the KSI Action. Jowdy personally
executed a confession of judgment in connection with the settlement, so there can
be no contention he used the settlement to remove his personal liability for the KSI
loan. Plaintiffs have access to the settlement agreement to understand its terms.
Accordingly, the plaintiffs have not made the threshold showing that the privileged
40
Pls.‟ Reply Br. in Supp. of Mot. to Compel (“Reply Br.” at 4). See also id. at 4
(privileged documents are the most essential to evaluating whether Jowdy breached his
duties “following the settlement of the KSI [Action] in November of 2010.”); id. at 5
(“Plaintiffs are still completely in the dark as to why Jowdy ultimately chose to surrender
DDM‟s sole asset over a debt that represented less than 5% of its previously appraised
value.”); id. at 6 (“Frankly, in the absence of any actual evidence to support the
conclusory assertion in DDM‟s Opposition, there are myriad of other possible reasons
and explanations regarding why Jowdy ultimately surrendered the [P]roperty.”); id. at 6
(explaining the plaintiffs do not know what efforts were made to refinance the $3 million
loan or the pursue alternative options to protect the investments of DDM‟s members).
14
records created before the KSI Action was settled in November 2010 are essential
to their purpose of investigating mismanagement.
Similarly, the privileged documents relating to this books and records action
are not essential to the plaintiffs‟ purpose. There is no suggestion on the privilege
log that those records relate to the issue of what happened after the settlement of
the KSI Action or why the Property ultimately was surrendered to satisfy the KSI
loan. Because how DDM chose to defend this action is unrelated to the plaintiffs‟
purpose, those records are not essential to the inspection.
In contrast, the plaintiffs have shown that the privileged documents created
after the settlement of the KSI Action, other than those specifically related to this
litigation, are essential to the inspection and in fact may be the only records that
address the issue of what occurred after the settlement and why the Property was
surrendered. Tellingly, DDM does not argue that the plaintiffs have access to this
information from non-privileged documents. Notwithstanding the obligation to
create and disseminate to DDM‟s members quarterly business reports, which likely
would have kept the plaintiffs apprised in near-real time of the KSI Action and the
issues regarding the KSI loan, DDM concedes that those reports were not provided
or even prepared. The plaintiffs therefore have no other way to determine what
efforts Baja or Jowdy undertook to save the members‟ investment, or whether
Jowdy‟s interest in extinguishing his personal guarantee may have factored into the
15
decision to surrender the Property, which extinguished the value of the plaintiffs‟
interest in DDM.
DDM argues, however, that the plaintiffs have no legitimate complaint
regarding Jowdy‟s potential conflict of interest, because Jowdy‟s interest in
preserving Baja‟s stake in DDM would have substantially outweighed his interest
in avoiding his obligations under the guarantee. This argument assumes too much
based on the record before me. DDM argues without a sufficient record that a sale
of the Property and dissolution of the company would result in a substantial
payment to Baja based on its percentage ownership and losses to its capital
account. DDM‟s argument, however, depends on its contention that there were net
losses to Baja‟s capital account, a “fact” for which DDM provided no support.
Given the posture of this case and the limited showing the plaintiffs must make to
permit inspection, it is at least possible that Jowdy‟s interest in extinguishing his
personal liability would outweigh the value of preserving Baja‟s interests in DDM.
In so concluding, it also is significant that Jowdy took these actions without
apprising DDM‟s members about them. This prolonged secrecy over a period of
years lends credence to the plaintiffs‟ concerns about mismanagement. As
explained below in connection with the “colorable claim” factor of the good cause
analysis, I do not believe it is proper in an inspection action to weigh the strength
of the plaintiffs‟ claims of mismanagement against other possible explanations for
16
the conduct, particularly because of the informational divide that separates the
parties at this procedural stage.
Finally, DDM also argues that investigation of the post-settlement events
and the ultimate surrender of the Property exceeds the scope of the purpose
plaintiffs stated in the Demand. This game of “gotcha” comes with ill grace.
Having effectively eliminated the informational rights of DDM‟s non-controlling
members by failing to provide the regular updates required under the Operating
Agreement, DDM now attempts to take advantage of that informational gap by
criticizing the plaintiffs for failing to be more specific in their stated purpose. The
plaintiffs were unaware when they made their Demand that the Property had been
surrendered to satisfy the KSI loan. In my view, they should not be required to
make a second demand to more specifically state an intent to investigate those
actions, when their stated purpose of investigating possible mismanagement
relating to the KSI loan and the encumbrance of the Property fairly may be read to
include an investigation into how the loan and encumbrance ultimately caused
DDM to surrender its only asset.
B. The plaintiffs have shown good cause to inspect the post-settlement
privileged books and records.
When the Delaware Supreme Court expressly adopted the Garner doctrine,
it also adopted the factors identified in Garner as contributing to the analysis of
17
whether a stockholder has shown “good cause” to examine privileged documents.
The factors identified in Garner include:
the number of shareholders and the percentage of stock they represent;
the bona fides of the shareholders; the nature of the shareholders'
claim and whether it is obviously colorable; the apparent necessity or
desirability of the shareholders having the information and the
availability of it from other sources; whether, if the shareholders'
claim is of wrongful action by the corporation, it is of action criminal,
or illegal but not criminal, or of doubtful legality; whether the
communication is of advice concerning the litigation itself; the extent
to which the communication is identified versus the extent to which
the shareholders are blindly fishing; the risk of revelation of trade
secrets or other information in whose confidentiality the corporation
has an interest for independent reasons.41
Of those factors, this Court historically has given the least weight to the percentage
of a stockholder‟s ownership, reasoning that the “ownership factor” only will come
into play when no other factor supports good cause.42 In contrast, the most
important factors in the analysis often are the nature of the claim and whether it is
obviously colorable, the apparent necessity or desirability of the stockholder
having the information and the availability of it from other sources, and the extent
to which the communication is identified as opposed to whether the stockholders
are fishing blindly.43
41
Wal-Mart Stores, Inc., 95 A.3d at 1276 n.32 (quoting Garner v. Wolfingarger, 430
F.2d 1093, 1104 (5th Cir. 1970)).
42
Saito v. McKesson HBOC, Inc., 2002 WL 31657622, at *13 (Del. Ch. Nov. 13, 2002).
43
Sealy Mattress Co. of New Jersey, Inc. v. Sealy Inc., 1987 WL 12500 (Del. Ch. Jun. 19,
1987). See also In re lululemon athletic, inc., 2015 WL 1957196 (Del. Ch. Apr. 30,
2015); Grimes v. DSC Communications Corp., 724 A.2d 561, 570 (Del. Ch. 1998).
18
Of the eight factors identified in Garner as relevant to the good cause
analysis, I view the first two factors (percentage of ownership and the “bona fides”
of the stockholders) and the eighth factor (risk of revelation of trade secrets or
other independently confidential information) as irrelevant to the analysis in this
case. With respect to the remaining five factors, I believe all the factors are neutral
or favor application of the fiduciary exception for the post-settlement privileged
documents, other than those documents related to this litigation.
First, in an inspection action, the “colorable claim” factor considers whether
the stockholder has stated an “obviously colorable” claim that justifies inspection.
In Wal-Mart, the Supreme Court concluded the stockholder had stated an
“obviously colorable” claim for bribery; in lululemon this Court considered
whether the stockholder had stated an obviously colorable Brophy claim or claim
for mismanagement. In my view, the consideration of whether the claim is
obviously colorable must take into account the procedural posture and the
relatively low showing necessary in an inspection action, which only requires a
stockholder to state a “credible basis” from which the Court may infer possible
mismanagement or wrongdoing.44 Here, the plaintiffs have shown that DDM and
44
In re lululemon athletic, inc., 2015 WL 1957196, at * 11 & n.75; Saito, 2002 WL
31657622, at *13 (“plaintiff‟s purpose is to recoup any investment loss that may have
been the result of breaches of fiduciary duty. Plaintiff seeks books and records to
determine if there was wrongdoing involved with the merger, which is a colorable
claim.”)
19
Jowdy ignored the obligation under the Operating Agreement to provide quarterly
and annual reports to the members, effectively leaving the plaintiffs in the dark for
years while the KSI loan went unpaid and the company‟s only asset ultimately was
surrendered to satisfy the loan. The balance on the loan was less than 5% of the
value for which the Property appraised several years before it was surrendered, and
the transfer of the Property had the effect of extinguishing a personal guarantee
Jowdy made on the loan. Although DDM has articulated plausible alternative
explanations for these events, the question of whether the plaintiffs have stated a
“colorable” claim should not turn on whether the facts might ultimately
demonstrate the absence of wrongdoing.45 Rather, the plaintiffs have stated a
credible basis from which the Court may infer possible mismanagement or
wrongdoing, the plaintiffs have inspected non-privileged documents and have not
found anything addressing the issues of what occurred after settlement that
prompted Jowdy to surrender the Property, and it would be unfair on that record to
require a more detailed showing of colorability.
The fourth factor, regarding the necessity of the plaintiffs‟ access and the
availability of this information from another source, is addressed at length in the
previous section. Suffice to say it weighs in favor of granting the plaintiffs access
to the privileged documents. The fifth and sixth factors neither favor nor disfavor
45
See Khanna v. Covad Communications Group, Inc., 2004 WL 187274, at *6 (Del. Ch.
Jan. 23, 2004).
20
granting the plaintiffs leave to invade DDM‟s privilege. Although the wrongful
conduct alleged by the plaintiffs likely was not criminal, plaintiffs do contend that
Jowdy acted in a manner inconsistent with his fiduciary obligations to DDM‟s
members. Likewise, although the plaintiffs‟ motion to compel sought advice
concerning this litigation, I already concluded those records are not necessary and
essential to the stated purpose.
Finally, I do not believe inspecting the limited subset of documents on the
privilege log that I concluded are necessary and essential – i.e., those created after
settlement of the KSI Action and not related to this litigation – would amount to a
fishing expedition by the plaintiffs. Although the plaintiffs ideally would be able
to further limit their inquiry to those communications specifically addressing the
post-settlement negotiations and the surrender of the Property, the descriptions on
DDM‟s privilege log do not allow the plaintiffs to more accurately pinpoint the
documents they seek.46 Nothing in the record allows the plaintiffs to more
narrowly tailor their inquiry, but the records they seek fall within a limited number
of documents and production will not be overly burdensome or require additional
searches by the company.
46
The log obliquely describes the documents at issue as relating to the “transfer of
ownership of property with attorney comments,” “legal advice re negotiations with KSI,”
or similar descriptions. See Privilege Log, Entry Nos. 22-39 and redactions from Aug.
2011 through 2012. Although these are not facially inadequate descriptions, they also do
not lend themselves to a more targeted application of the Garner exception.
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In sum, I conclude that the third, fourth, and seventh factors of the Garner
analysis support allowing the plaintiffs to inspect the privileged documents, while
the other factors either are irrelevant to the inquiry or are neutral as between the
parties‟ positions. I therefore conclude the plaintiffs have met their burden of
showing good cause to invoke the fiduciary exception to DDM‟s attorney-client
privilege for those particular documents.
CONCLUSION
For the foregoing reasons, I recommend that the Court grant in part the
plaintiffs‟ motion to compel and order DDM to allow the plaintiffs to inspect the
documents identified on the privilege log and created after the settlement of the
KSI Action, excluding those documents created in connection with this litigation.
This is my final report and exceptions may be taken in accordance with Court of
Chancery Rule 144.
/s/ Abigail M. LeGrow
Master in Chancery
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