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holding that the record in that case did not suggest the absence of separate entities because "each of the [subsidiaries] has a separate and functioning board of directors that is not controlled by the [limited liability companies] and . . . each of the [subsidiaries] has a significant shareholder other than the [limited liability companies]."
Summary of this case from DFG Wine Co. v. Eight Estates Wine Holdings, LLCOpinion
C. A. No. 18928
Date Submitted: November 27, 2001
Date Decided: January 29, 2002
Norman M. Monhait, of ROSENTHAL MONHAIT GROSS GODDESS, P.A., Wilmington, Delaware; OF COUNSEL: Paul D. Wexler and Lawrence P. Eagel, of BRAGAR WEXLER EAGEL MORGENSTERN, LLP, New York, New York; Attorneys for Plaintiff
William D. Johnston and John J. Paschetto, of YOUNG CONAWAY STARGATT TAYLOR, LLP, Wilmington, Delaware; OF COUNSEL: Eric Rieder and Eric L. Cohen, of ROBINSON SILVERMAN PEARCE ARONSOHN BERMAN LLP, New York, New York; Attorneys for Defendants.
MEMORANDUM OPINION
This is an action brought by plaintiff Arbor Place L.P. ("Arbor"), an Illinois limited partnership, to inspect the books and records of two Delaware limited liability companies of which Arbor is a common member, Encore Opportunity Fund, LLC ("Encore Opportunity") and Encore Strategic Fund, LLC ("Encore Strategic") (collectively, the "LLCs"). The managing member of each of the LLCs, Encore Capital Management, LLC ("Encore Capital"), a Delaware limited liability company, is also joined as a defendant in this matter.
The purpose of each of the LLCs, as stated in each LLC Agreement, is to invest members' capital in other entities, which in turn invest that capital in securities. Encore Opportunity and Encore Strategic are thus "feeder funds" for, respectively, JNC Opportunity Fund Ltd. ("JNC Opportunity") and JNC Strategic Fund Ltd. ("JNC Strategic") (collectively, the "Funds"), both Cayman Islands corporations. JNC Opportunity and JNC Strategic are described as hedge funds that invest principally in unregistered securities of United States companies issued pursuant to Regulation D under the Securities Act of 1933. There are four investors in the Funds — the two LLCs and Proton Opportunity Fund Ltd. and Proton Strategic Fund Ltd. The LLCs collect capital from investors who are United States taxpayers. Proton Opportunity Fund Ltd. and Proton Strategic Fund Ltd. collect capital from investors who are not United States taxpayers. This arrangement assures compliance with federal tax laws requiring a separation of onshore and offshore invested capital.
Arbor became a common member of Encore Opportunity in April 1997 and a common member of Encore Strategic in March 1998. Arbor ultimately invested a total of $4 million in the LLCs. Under the LLC Agreements, which govern common members' rights, capital could be withdrawn from the LLCs on 60 days notice, subject to Encore Capital's power to suspend withdrawals to avoid liquidity problems. Encore Capital exercised this power in November 1999, suspending withdrawals from Encore Opportunity until March 2000. In March 2000 the suspension on withdrawals was lifted but was reinstated in October 2000. Because a member was required to give notice to the LLCs 60 days before making a withdrawal, however, May 2000 until October 2000 was the actual time period during which it was possible for members to make withdrawals. Some members did make withdrawals of capital from the LLCs during this time period, including Encore Capital which withdrew funds covering its management fees. On October 16, Arbor requested to withdraw a portion of its investment, effective December 31, 2000. By October 2000, however, both LLCs were again suffering liquidity problems and Encore Capital determined that it would be necessary to wind down the LLCs over time. On October 25, Encore Capital informed the members of both LLCs that the LLCs would be embarking on an orderly winding down and termination process and that withdrawals would be suspended during that process. Arbor was thus prohibited from withdrawing its capital pursuant to its October 16 request. Nevertheless, on or about November 21, 2000, Arbor made a new request to withdraw all of its investment. Because of the suspension, this request was denied.
In February and March 2001, Arbor asked to inspect the books and records of the LLCs under Section 9.2 of each LLC Agreement and under 6 Del. C. § 18-305(a), all of which provide some right of access to books and records. In response to these requests, on or about April 2, 2001, Encore Capital produced, on behalf of the LLCs, the LLCs' general ledger accounts transaction histories, continuity schedules, annual reports, bank account ledger cards, and trial balances. Defendants contend that these are all of the documents to which Arbor is entitled under Section 9.2 of the LLC Agreements or under § 18-305(a). Arbor contended that these records were unintelligible and useless to investors and that it was entitled to inspect more records of the LLCs. Encore Capital refused to produce additional records. Arbor then brought this action, which was tried to the Court on November 5, 2001.
Through this action, Arbor is attempting to obtain copies of the federal tax returns of the LLCs and a list of the other members of the LLCs. Arbor is also attempting to obtain certain books and records of the Funds, including a list of portfolio investments. Each of these requests is based both on Section 9.2 of the LLC Agreements and on § 18-305 of the LLC Act. Arbor's stated purposes for these requests are to determine its losses, to evaluate any potential claims against Encore Capital as manager of the Funds, and to communicate with other members concerning matters of common interest.
I. TAX RETURNS OF THE LLCs
Arbor argues that, pursuant to Section 9.2 of the LLC Agreements, it is entitled to view the partnership tax returns of the LLCs. Each LLC Agreement contains an identical Section 9.2 that provides, in its entirety:
Books and Records. At all times during the existence of the Company, the Company shall cause to be maintained full and accurate books of account, which shall reflect all Company transactions. The books and records of the Company shall be maintained at the offices of the Company and/or such other places as the Managing Member may designate. Each Common Member (or such Common Member's designated representative) shall have the right during ordinary business hours and upon reasonable notice to inspect and copy (at such Common Member's own expense) all books and records of the Company.
In post-trial briefing, the defendants argue that Arbor has waived any right to inspect the tax returns by failing to raise the issue at trial and that, in any case, tax returns do not fall within the language of Section 9.2. As a preliminary matter, I note that I am not persuaded by the defendants' argument that Arbor waived its right to inspect the LLCs' tax returns by failing to raise the issue at trial. Were I to deny the claim on these grounds, nothing would prevent Arbor from making another demand to inspect the tax returns, thus forcing the issue once again. In the interest of judicial economy, therefore, I will consider this request.
It is undisputed that the LLC Agreements are contracts to be construed like any other contract. Contract interpretation must begin, of course, with the language of the contract. According to the defendants, Section 9.2 first states what books and records must be maintained, then where those books and records must be maintained and, finally, under what circumstances a member may inspect those books and records. The defendants' argument is that each sentence of Section 9.2 "concerns the same books and records initially referred to in the first sentence — 'the books of account, which shall reflect all Company transactions.'" All other corporate documents, the defendants insist, fall outside the language of Section 9.2.
See, e.g., 6 Del. C. § 18-110 1(b) ("It is the policy of [the LLC Act] to give the maximum effect to the principle of freedom of contract and to the enforceability of limited liability company agreements."); Elf Atochem N. Am., Inc. v. Jaffari, Del. Supr., 727 A.2d 286, 290-91 (1999) ("The policy of freedom of contract underlies both the [LLC] Act and the LP Act.... The basic approach of the [LLC] Act is to provide members with broad discretion in drafting the Agreement and to furnish default provisions when the members' agreement is silent.").
Defs.' Post-Trial Br. at 16.
This construction, while reasonable, fails to give meaning to all of the terms of Section 9.2. The first sentence indicates that the LLCs will keep "books of account." The remaining sentences discuss the "books and records" of the LLCs. If the contract were referring only to the "books of account" in the subsequent sentences, it would suffice to say "books, " or even "these books, " rather than "all books and records of the Company." It is difficult to infer an implicit limitation on the availability of corporate documents in the face of this broad language. The LLC Agreements provide members with the right to inspect and copy "records, " which under ordinary principles of contract interpretation must have independent meaning. This is particularly so when the phrase used, "books and records, " has a common and well-understood definition. The list of "records" found in the LLC Act contains much more than just books of account; it also includes, among many other things, federal tax returns. Because the LLC Agreements provide Arbor with a contractual right to inspect and copy the LLCs' federal tax returns, I need not reach any issues raised in connection with § 18-305.
The meaning of the ten "books and records" can readily be understood through § 18-305 of the LLC Act and through its corporate law and limited partnership law counterparts, 8 Del. C. § 220 and 6 Del. C. § 17-305, respectively. Moreover, nothing in the LLC Agreements suggests an intention to define books and records in a more restrictive maimer than those tens are commonly understood to mean.
See 6 Del. C. § 18-305 (a)(2) (listing "a copy of the limited liability company's federal, state and local income tax returns for each year" as one of the records of an LLC).
II. THE MEMBER LIST
Arbor has requested a list of the names and addresses of the other members of the LLCs in order to "contact the other members and discuss with them the business and affairs" of the LLCs. The defendants argue that Arbor's request does not fall within Section 9.2 of the LLC Agreements, that Section 13.1 of the LLC Agreements prohibits disclosure of the member lists, that the circumstances of the investment support a presumption of confidentiality, and that providing the member lists to Arbor may be in violation of federal securities law.
Pl.'s Post-Trial Br. at 11.
I note initially that the defendants' argument with regard to Section 9.2 must fail because, as with the LLCs' tax returns, the LLCs' member lists fall within the broad language of Section 9.2 as they are clearly understood to be "records" of the company.
For example, one item on the list of records in § 18-305 is "[a] current list of the name and last known business, residence or mailing address of each member and manager." 6 Del. C. § 18-305 (a)(3).
The defendants' second argument is that Section 13.1 of the LLC Agreements requires that the member lists be kept confidential. Section 13.1 provides:
Unless approved by the Managing Member in advance, this Agreement, the transactions contemplated hereby and all other matters related to the Company and/or the Fund and their respective operations shall be held confidential... and shall not be disclosed, either orally or in writing, by any Member (or any Affiliate of a Member) to any other person except in accordance with the provisions of this Section 13.1.
The defendants argue that the identity of the members is a matter "related to the Company" and as such must be kept confidential. The existence of Section 13.1, they contend, supports "a principle of confidentiality" that would preclude Arbor from inspecting the member lists. One contractual provision cannot be read to vitiate another, however, and Arbor correctly points out that reading Section 13.1 to prohibit disclosure of the books and records of the LLCs would render Section 9.2 meaningless. I find that nothing in the LLC Agreements says that Encore will not reveal members' identities.
Defs.' Post-Trial Br. at 17.
The defendants next argue that the circumstances of the investment support a presumption of confidentiality. The documents relied on in support of this presumption are "Confidential Subscriber Questionnaires" (the "Questionnaires") given to all potential investors before they invest in the LLCs. The Questionnaires provide that all information collected "WILL BE KEPT STRICTLY CONFIDENTIAL." The confidentiality provision in the application form was designed to protect the identity of potential investors. The Questionnaires obligated Encore not to reveal the identity of people who were being screened to determine whether they qualified to become investors in the LLCs. Once the investors qualified and elected to invest in the LLCs, however, they were governed by the LLC Agreements, which expressly grant members access to books and records (which under § 18-305(a)(3) includes membership lists). As sophisticated parties, they knew (or should have known) when they invested that there was a right of access that they enjoyed, along with every other member, to the books and records of the LLCs. Any presumption of confidentiality created by the Questionnaires during the application process is defeated by the express language of the separate and distinct LLC Agreements entered into after an applicant was determined to be a "sophisticated investor."
The Questionnaires were given to all potential investors in the LLCs as part of an application process to make sure that only "accredited investors" (i.e., investors who meet certain experience, sophistication and net worth requirements under federal law) were allowed to become members of the LLCs.
Finally, in connection with Arbor's statutory claim, the defendants argued that they believed, in good faith, that disclosure would harm the LLCs because it would contravene the privacy notices distributed by the LLCs as required by federal law. Regulation S-P was adopted by the Securities and Exchange Commission to implement privacy provisions contained in the Gramm-Leach-Bliley Act of 1999. That regulation prohibits disclosure of confidential customer information unless customers first receive an initial privacy notice explaining what nonpublic personal information will be disclosed, to whom, and under what circumstances, and then are given the chance to opt out of that disclosure. While this is true as a general proposition, it does not preclude disclosure in this case because of the exception found in 17 C.F.R. § 248.15(a)(7)(i). That subsection provides that the otherwise-applicable requirements of notice and the right to opt out do not apply when nonpublic personal information is disclosed "[t]o comply with federal, State, or local laws, rules and other applicable legal requirements." Disclosure of nonpublic personal information in this case — specifically of a list of names and addresses — would fall within 17 C.F.R. § 248.1 5(a)(7)(i) because it would be required under state law and other applicable legal requirements. The defendants' argument based on federal law thus fails as well. I note as a final matter, however, that Arbor's use and disclosure of the member lists is limited by 17 C.F.R. § 248.11 (a).
Although the statute provides for a good faith defense to a statutory claim for production of books and records, see 6 Del. C. § 18-305(c), this does not appear to be the proper standard to apply in response to a contractual claim to inspect books and records. In a case interpreting 6 Del. C. § 17-305, the limited partnership analog to § 18-305, this Court has held that a partnership agreement can create a contractual inspection right that is "in addition to and separate from" the statutory inspection right. Bond Purchase, L.L.C. v. Patriot Tax Credit Properties, L.P., 746 A.2d 842, 853 (Del.Ch. 1999). This contractual right may be broader or narrower than the statutory right by its own tens, and under the "implied proper purpose" defense, production can only be denied if it "would in fact be adverse" to the entity. Id. at 853, 859. Reliance on a limited partnership case is appropriate because Delaware's LLC Act was "modeled on the popular Delaware LP Act. In fact, its architecture and much of its wording is almost identical to that of the Delaware LP Act." Elf Atochem N. Am., Inc. v. Jaffari, 727 A.2d 286, 290 (Del. 1999) (footnotes omitted). In any case, regardless of the proper standard, it is important to consider whether ordering production of the member lists would be ordering the LLCs to violate federal law.
This act, also known as the Financial Services Modernization Act, is codified at 15 U.S.C. § 6801 et seq.
This basic requirement is contained in 17 C.F.R. § 248.10. The general scheme created by Regulation S-P is as follows: A "consumer," as defined by 17 C.F.R. § 248.3(g)(1), is "an individual who obtains or has obtained a financial product or service from [a financial institution] that is to be used primarily for personal, family, or household purposes, or that individual's legal representative." An initial privacy notice, required by 17 C.F.R. § 248.4, must be sent to any consumer before nonpublic personal information of that consumer is disclosed to any unaffiliated third party. This mandatory notice must indicate what nonpublic personal information is collected, what information is disclosed, and what affiliates or non affiliated third parties will receive the infonation, among other things. 17 C.F.R. § 248.6 (a). Each consumer must then be given the right to opt out of that disclosure. 17 C.F.R. § 248.7 (a). These requirements are all subject to exceptions, as discussed below.
Technically, the exceptions found in 17 C.F.R. § 248.14 and 248.15 exempt institutions from §§ 248.4(a)(2), 248.7, and 248.10. Practically, the effect of this is to allow disclosure of nonpublic personal information subject only to the requirements for delivery of annual privacy notices and, if necessary, revised privacy notices. 17 C.F.R. § 248.6 248.8. If the exceptions are complied with, these notices need not be delivered before information is disclosed.
The defendants also argue that the privacy notices distributed by the LLCs do not contemplate disclosure to any non affiliated third parties. This is untrue, however. The privacy policies of Encore Opportunity and Encore Strategic, joint exhibits T and U, respectively, each state that "[w]e do not disclose any information about you or about former investors to anyone except as permitted by law." 17 C.F.R. § 248.6 (b) provides that disclosure to third parties under § 248.15 (among other things) need not be listed in the privacy notices other than by stating that disclosures will be made "as permitted by law." Moreover, Appendix A to Part 248, which provides sample clauses for use in privacy statements, indicates that the clause "[w]e do not disclose any nonpublic personal information about our customers or former customers to anyone, except as permitted by law" may be used "if you do not disclose nonpublic personal information to any party, other than as permitted by the exceptions in §§ 248.14 and 248.15."
Those limits pertain to the redisclosure and reuse of information received under an exception in §§ 248.14 or 248.15.
III. THE FUNDS' PORTFOLIO AND RECORDS
In addition to its requests for tax records and membership lists of the LLCs, Arbor requested books and records of the LLCs showing how the LLCs arrived at the monthly asset values reported to Arbor and the other LLC members. Additional requests were made by Arbor to inspect certain books and records of the Funds showing how the underlying investments were valued and for a list of the specific investments in the Funds' portfolios. I will first address the records of the Funds, including the portfolio list, and then address any relevant records of the LLCs, under the provisions of the LLC Agreements. Next, I will address Arbor's asserted statutory right to the Funds' record.A. The LLC Agreements
The LLC Agreements permit the inspection of the books and records of the LLCs. Arbor is now seeking the books and records of the Funds. This clearly falls outside the provisions of the LLC Agreements, which allow inspection of "all books and records of the Company." Arbor has no contractual right to inspect the records of the Funds. The request to inspect all records relating to the underlying investments by the Funds therefore cannot be granted under the language of the LLC Agreements.
Certain records pertaining to the Funds, however, may become records of the LLCs and accordingly fall within Section 9.2. This category includes, for example and without limitation, periodic financial reports (audited or otherwise) and other records that would be used to produce monthly reports to members of the LLCs. Any such documents are records of the LLCs and must be made available for inspection. Unfortunately for Arbor, the record in this case indicates that those documents may not exist. Monthly net asset value reports for Arbor and the other members of the LLCs are generated by Olympia Capital (Cayman), Limited ("Olympia"), the administrator of the Funds. Olympia, an independent company, provides many services for the Funds and the LLCs, including generating monthly reports and maintaining the books and records of both the Funds and the LLCs. It appears from the record that intermediate reports from the Funds to the LLCs may never have been made.
See Carapico v. Philadelphia Stock Exchange, Inc., Del. Ch., C.A. No. 16764, mem. op. at 11, Lamb, V.C. (Sept. 27, 2000) (explicitly refusing to pierce the corporate veil and limiting an order under § 220 of the DGCL to books and records of a parent company but allowing inspection, in accordance with that order, of financial information about subsidiary companies in the possession of the parent company).
B. Section 18-305 of the LLC Act
I must now consider whether Arbor has a statutory fight to inspect the records of the Funds. To establish a right to inspect records under § 18-305 of the LLC Act, a plaintiff must demonstrate a proper purpose for the inspection. The defendant then has the opportunity to establish a good faith belief that disclosure of the desired information would not be in the best interest of the entity or some other good faith defense to the production of the requested records.
The defendants in this case contend that Arbor has no statutory right to inspect the records of the Funds because Arbor is not a shareholder of either of the Funds. They contend further, assuming Arbor has a statutory right of inspection in the first place, that Arbor has not asserted a proper purpose for such an inspection and that, in any case, they have met their burden of establishing a good faith defense to the production of those records.
I agree with the defendants that Arbor has no statutory right to inspect the books and records of the Funds because they are separate companies from the LLCs. The separate existence and rights of discrete entities is well established in Delaware law and the Court is reluctant to ignore such separate existence even in the case of a wholly-owned subsidiary. The books and records of the Funds are not the books and records of the LLCs. The simple fact that the LLCs might possess, or could provide, certain useful information does not make that information available to Arbor under § 18-305.
Indeed, in this case § 18-305, which applies to Delaware LLCs, has no applicability whatsoever to the Funds, which are Cayman Islands corporations.
The cases in which an inspection of the books and records of a nominally separate corporate entity has been allowed all involved facts which at least suggested the absence, in reality, of separate entities. Arbor points to Salovaara v. SSP, Inc., where this Court stated that "a stockholder with the right to inspect books of the parent may access the subsidiary's books if the parent controls or possesses them." As this Court later observed in Saito v. McKesson HBOC, Inc., however, "the nature of the relationship among the parties [in Salovaara] was such that a finding that the subsidiaries were "alter egos' or instrumentalities of the parent was justified." Indeed, as noted in Salovaara, "this Court has consistently held that a stockholder generally has no right to inspect the books and records of a subsidiary corporation where the stockholder merely owns shares of the parent corporation." Arbor has not shown (or even seriously attempted to show) that the corporate veil of the Funds should be pierced in this case. The record indicates that there is a legitimate business purpose for the separate existence of the Funds, that each of the Funds has a separate and functioning board of directors that is not controlled by the LLCs, and that each of the Funds has a significant shareholder other than the LLCs.
Del. Ch., C.A. No. 18903, ltr. op. at 8, Chandler, C. (Jan. 10, 2001).
Del. Ch., C.A. No. 18553, mem. op. at 15 n. 21, Chandler, C. (July 10, 2001).
Salovaara, ltr. op. at 7.
Arbor also attempts to rely on Dobler v. Montgomery Cellular Holding Co., Inc. to support its claim. In Dobler, this Court allowed the plaintiffs to obtain, under § 220 of the Delaware General Corporation Law, all relevant records relating directly to the company in which they were shareholders even if those documents were in the possession and control of a different company in the chain of corporate ownership. Dobler involved a chain of corporations under common control. Robert Price was the controlling shareholder and sole director of each of the corporations. The Court was concerned that the defendant corporation may not actually have documents which it "could, in the normal course of business, be expected to possess... because of the consolidated reporting or record keeping framework implemented by Price." In order to ensure that the plaintiffs' inspection right would not be "defeated simply by having another entity hold the records relating to MCHC which MCHC ordinarily would have, " the Court ordered production of any documents held by other corporations that would have been subject to inspection if they were in possession of the defendant corporation. In other words, the Court ordered the production of documents held by other entities to the extent that Price had ignored the separate existence of the various corporations. The premise underlying the relief granted in Dobler was that the plaintiffs were entitled to the documents at issue in their capacity as shareholders of MCHC. That premise is not applicable in this case, since Arbor has not established a right, directly or derivatively, to any records of the Funds.
Del. Ch., C.A. Nos. 18105, 18499, mem. op., Noble, V.C. (Oct. 19, 2001).
Id., mem. op. at 27. Vice Chancellor Noble stated that the plaintiffs should have access to documents "which MCHC could, in the normal course of business, be expected to possess but, because of the consolidated reporting or record keeping framework implemented by [the controlling shareholder], MCHC does not have, " because "the corporate structure cannot be employed to shield from inspection those documents, assuming that they exist, to which Plaintiffs are entitled." Id. at 26, 27.
Id. at 2 ("[U]nder MCHC's ownership structure, the majority shareholder of MCHC is Palmer Wireless, which is a wholly-owned subsidiary of PrCW, which, in turn, is the wholly-owned subsidiary of the ultimate parent company, Price Communications Corporation. MCHC is the sole shareholder of Montgomery Cellular Telephone Co., Inc., which is the sole shareholder of Price Communications Wireless, IV, the current licensee of the cellular system.").
Id. at 27 (noting that "all of the other Price corporations have only one director [Richard Price] who is the same director").
Id. at 26.
Id.
Because the defendants' first argument is successful, I need not reach the arguments about Arbor's proper purpose and the defendants' good faith defense to production.
IV. CONCLUSION
For the foregoing reasons, Arbor's request to inspect the books and records of the Funds is denied. Arbor's request to inspect the LLCs' tax returns, member lists, and other records pertaining to the monthly valuation of the Funds, if any such records exist, is granted.
IT IS SO ORDERED.
Appendix A to 17 C.F.R. § 248. Disclosure of information under one of the regulatory exceptions is thus contemplated by the privacy notices sent by the LLCs.