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Henry v. Phixios Holdings, Inc.

Court of Chancery of Delaware

July 10, 2017

JON HENRY, Plaintiff,
PHIXIOS HOLDINGS, INC., a Delaware corporation, Defendant.

          Submitted: April 10, 2017

          Michael W. McDermott, BERGER HARRIS LLP, Wilmington, Delaware; Attorney for Plaintiff.

          Carl D. Neff and E. Chaney Hall, FOX ROTHSCHILD LLP, Wilmington, Delaware; Attorneys for Defendant.


          MONTGOMERY-REEVES, Vice Chancellor.

         In this action, an alleged stockholder seeks books and records for the purpose of investigating mismanagement of the company, communicating with other stockholders, and valuing his shares. He points to the chief operating officer's own in-court admissions of using corporate funds for personal expenses and the company's precarious financial situation as a credible basis to infer mismanagement sufficient to establish a proper purpose under 8 Del. C. § 220.

         The company has rebuffed all examination efforts because it alleges that the plaintiff is no longer a stockholder. According to the company, its initial three directors adopted bylaws that contain stock transfer restrictions, and all company stock certificates were issued after that time and are subject to those restrictions. Under the restrictions, stock may be revoked by a majority of all voting stockholders if a stockholder is found to be engaging in acts that are damaging to the company. The company admits that the stock transfer restrictions are not noted on the stock certificate. Instead, the company asserts that the stockholder plaintiff knew about these restrictions and consented to be bound before he obtained stock in the company. The chief operating officer (who is partially the subject of the investigation) purportedly explained the restrictions multiple times and provided the bylaws to the stockholder before he accepted stock in the company. Thereafter, she sent the bylaws again, and the stockholder acknowledged receipt. Thus, according to the company, the stockholder was bound by the restrictions. The company contends that after the stock was issued, the stockholder engaged in efforts to compete with the company, and, in response, the company validly rescinded his stock under the bylaws. As such, the company claims he has no right to the documents except to value his shares.

         The plaintiff stockholder responds that he did not have actual knowledge of the stock transfer restrictions before he acquired the stock and never assented to the restrictions after he acquired the stock, which is required under 8 Del. C. § 202. Through this action, the plaintiff stockholder requests that the Court: (1) declare that his stock is not subject to the restrictions and that he is still a stockholder of the company; (2) order the company to grant him access to all documents sought in his demand letter; and (3) award the plaintiff attorneys' fees.

         I hold that under Section 202, in order for a stockholder to be bound by stock transfer restrictions that are not "noted conspicuously on the certificate or certificates representing the security, " he must have actual knowledge of the restrictions before he acquires the stock. If the stockholder does not have actual knowledge of the stock transfer restrictions at the time he acquires the stock, he can become bound by the stock transfer restrictions after the acquisition of the stock only if he affirmatively assents to the restrictions, either by voting to approve the restrictions or by agreeing to the restrictions.

         After a full trial, I find that the plaintiff stockholder did not have actual knowledge of the restrictions prior to acquiring his stock. Although the plaintiff stockholder may have received knowledge after he was granted stock, he did not assent to be bound by the restrictions. Therefore, the company could not rescind his stock under the bylaws, and he remains a stockholder of the company. As a valid stockholder, he is entitled to inspect the books and records of the company for any proper purpose. The stockholder has stated a proper purpose for inspection, and the company has failed to prove any of its defenses. Thus, the company must produce the requested documents as they are necessary to effectuate the stockholder's stated purpose. The plaintiff, however, is not entitled to attorneys' fees.

         I. BACKGROUND

         These are my findings of fact based on the parties' stipulations, documentary evidence, and the testimony of two witnesses during a half-day trial. I accord the evidence the weight and credibility I find it deserves.[1]

         A. Parties and Relevant Non-Parties

         Plaintiff Jon Henry became a stockholder of Phixios Holdings, Inc. in March 2015. Non-party Rhonda S. Henry is Jon Henry's wife. Non-party RSH Business Consulting Services ("RSH") is a consulting company owned by Rhonda.

         Defendant Phixios Holdings, Inc. ("Phixios" or the "Company") is a Delaware corporation formed in July 2013 as a holding company to build product lines, make them successful, and sell them. Non-parties James Walker ("Walker"), Delbert Walker, and Michael Jacobson were the initial directors of Phixios. Walker is the Chief Executive Officer of Phixios. Non-party Jacobson was the Chief Information Officer during all relevant times. Non-party Penni Blake is the Chief Operating Officer of Phixios. Non-party Condor Monitoring, Inc. ("Condor") is a subsidiary of Phixios.

         B. Facts

         1. The directors adopt bylaws that contain stock transfer restrictions

         On July 18, 2013, the board of directors of Phixios, Walker, Delbert, and Jacobson, approved and executed the Phixios Holdings, Inc. Stockholder Agreement (the "Stockholder Agreement").[2] The purpose of the Stockholder Agreement was to "protect the company and everybody in it from somebody who would potentially do something that could be harmful" to the Company.[3] The Stockholder Agreement provides, in relevant part:

Stock maybe [sic] surrendered only by the registered owner except in the following circumstances:
• A stockholder is found to be engaging in acts, or has previously engaged in acts, that are damaging to Phixios. Examples include but are not limited to:
o Working for a competitor.
o Willfully disclosing proprietary information.
o Other willful acts that are harmful to Phixios as determined by a majority vote of the board of directors and all voting stockholders.
In these circumstances, by a majority vote of all voting stockholders, the ownership of the stock will be revoked and returned to Phixios Treasury and may be redistributed. . . . Phixios will pay par value of the stock at the time of revocation to the registered stock holder.[4]

         The Company did not retain legal counsel but rather Googled how to draft a stockholder agreement.[5] Blake was advised by a "" lawyer "that the majority of the directors had to sign it and that this would be what every shareholder was bound by" so long as Phixios explained the agreement to each potential stockholder before stock in the Company was issued to that stockholder.[6] Blake testified that Phixios had corporate controls in place to ensure every stockholder received an explanation. The Company would e-mail the agreement to every potential stockholder, and Blake would explain each provision to each potential stockholder prior to the issuance of any stock certificate.[7] The Company, however, did not require any written evidence of the potential stockholder's knowledge of or assent to the Stockholder Agreement because the Company "operated on trust."[8]

         2. The Company hires Henry and issues stock to him

         In February 2015, Jacobson contacted Henry to see if he would consider becoming involved with Phixios.[9] On February 27, 2015, Blake e-mailed Henry an employment offer.[10] The offer stated, in relevant part:

. . . understanding our limited funds right now, I'd like to propose the following:
1) We will give you 50, 000 shares of Phixios Holdings, Inc. stock immediately.
2) Salary of $130, 000 per year beginning day you start.
3) 30% yearly bonus (based on personal performance, company performance, and customer sat)
4) We can only pay you $1, 000 per month right now until revenue is high enough to cover your full salary.
5) 100% of back pay will be paid as soon as we get to the revenue point to pay your full salary.
We understand we are asking for a fulltime commitment with a deferred salary. Hence, the 50, 000 shares of stock.[11]

         Henry accepted the offer and was "officially on board" as of March 5, 2015.[12]

         On March 25, 2015, Walker signed and issued Henry's stock certificate for 50, 000 shares of Phixios.[13] The certificate does not contain or note any stock transfer restriction, and there is nothing in writing to show the restrictions were provided to Henry by March 25th. In a March 25, 2015 e-mail exchange titled "Stock Certificates, " Blake provided Henry with a tracking number, and Henry responded, ". . . thanks for the discussion today, it made me feel much more comfortable with everything."[14] That e-mail does not attach or reference the Stockholder Agreement. In an affidavit submitted on September 6, 2016 in support of Phixios's opposition to Henry's motion for summary judgment, Blake stated that the "discussion" referenced in Henry's e-mail was a telephone conversation in which she explained "each and every section of the Stockholder Agreement to Henry."[15] Blake testified at trial that she e-mailed Henry the Stockholder Agreement on the same day she sent the stock certificate.[16] Blake did not provide any credible explanation for why one e-mail exchange from March 25, 2015 could be produced but another exchange from the same day that purportedly attached the Stockholder Agreement could not be produced. She merely stated that the "e-mail has gone missing, " presumably because she "switched computers."[17] No explanation was provided as to why "switch[ing] computers" would affect the availability of certain e-mails and not others.

         Additionally, Blake's testimony regarding when and how many conversations occurred regarding the Stockholder Agreement changed throughout trial. Initially, there were two conversations between Blake and Henry before February 27, 2015.[18]One conversation was at a "high-level, " and the other went through "every single paragraph."[19] Blake testified that she specifically discussed the terms of the Stockholder Agreement, including the stock transfer restrictions, and that Henry said "he was fine, he was happy" and that "it sound[ed] good. He understood."[20] Then Blake testified that there was a conversation on February 27, 2015 and another on March 25, 2015.[21] Later Blake said she had at least three phone calls with Henry.[22]Finally, Blake explained that she didn't "have the dates right in [her] mind, " but there were "a bunch" of telephone conversations.[23]

         Henry testified that he and Blake did not discuss the Stockholder Agreement before his employment offer.[24] The purpose of their conversation was to address Henry's concern that Phixios had delayed the issuance of shares.

         On August 10, 2015, Blake sent an e-mail titled "Stockholder Agreement" to multiple Phixios stockholders attaching the Stockholder Agreement.[25] Blake wrote, "I think everyone already has this, but just sending again as I'm trying to get everything in order with documentation and such to get ready for growth."[26] Henry responded, "Thank you for getting a copy out for my records" and forwarded the e- mail to his wife, Rhonda.[27] Henry testified at trial that he did not look at the Stockholder Agreement when he received it but rather sent it to his wife to print a copy and put it with their "important paperwork."[28] He thought this document was a "set of instructions" that would tell him what day Phixios stockholders had the ability to tender their stock if they wanted to and how to go about tendering if the occasion ever came up.[29]

         3. Business begins to suffer and the Company explores further opportunities

         By the end of 2015, things at the Company were "slowing down significantly, " and there "weren't nearly as many prospects."[30] To deal with these concerns, Walker and Jacobson discussed alternatives to increase the business's lagging revenue.[31] Henry testified that Walker asked Jacobson to explore the Federal Business Opportunities ("FBO") process and to use Henry's services for the "documentation of those processes."[32] That testimony is corroborated by a January 2016 e-mail exchange between Henry, Jacobson, and Walker, in which Henry stated to Jacobson: "Based upon the brief text message you sent me last weekend you've asked me to look into and define to [sic] new processes that would allow us to take advantage of Contract Proposals (RFP's) issued by the Federal Government."[33] The e-mail further stated: "After some research and direct communications, I've put together a process."[34] Jacobson responded by stating, in part:

Jon & James
FBO website needs to be utilized until I can figure when/if paying for the actual gov contract web site is a more viable option. Concur?
That said why is [sic] Phixios representatives unable to login to FBO and is this going to be rectified?[35]

         On March 10, 2016, Rhonda registered an account for RSH with the FBO Vendor System, and Henry e-mailed Jacobson the information.[36] Henry testified that this registration was necessary in order to obtain an FBO access ID.[37] Henry never attempted to register Phixios through the FBO, and to his knowledge, neither did Jacobson.[38]

         After completing the FBO registration process, throughout March and April, RSH began to receive numerous requests for proposals and requests for quotations for various contracts.[39] Henry and Jacobson communicated through their Phixios e-mail accounts, considered many of these solicitations, and worked to document the processes that would be required to pursue these opportunities.[40] Phixios points to several exchanges in particular that it believes evidence RSH's, and thus Henry's, competition with the Company. For example, on March 31, 2016, Jacobson e-mailed Henry about a potential FBO opportunity and told Henry: "So I figure it is something you should check out or we should look into together . . . You know turn the other check[.] [sic]"[41] Additionally, in response to a discussion regarding a government on-boarding call, Henry told Jacobson:

We need to keep in mind that the business is registered as a Sole Proprietorship owned by a women, [sic] If you and I attempt to make the call without my wife being on the line, it could quickly go against us. We might need to do the on boarding call with her present in the event they expect to speak to the owner?[42]

         In an e-mail chain titled "NASA Mentor Protege Program, " Jacobson tells Henry to call him about this NASA opportunity. An attachment highlights the requirement that a protege "must meet one of the eligibility requirements, " and the attachment highlights the "Woman-Owned Small Businesses (WOSBs)" category.[43] Henry testified that Phixios did not qualify as a woman-owned small business or any of the additional categories mentioned in the attachment. This meant Phixios would not have been able to receive "preferential points to awardment of a contract potentially."[44] Henry testified at trial that he was using RSH to explore potential revenue sources and opportunities for Phixios and reporting his findings back to Jacobson. Ultimately, because the Company was so overwhelmed in other areas, Phixios did not pursue any of these potential contracts.

         4. Conflicts with Blake surface

         On January 28, 2016, Walker sent an e-mail to Jacobson attaching 60 days of Wells Fargo Bank statements stating, "As you can see I need to have a talk with Penni."[45] The attached statements included various seemingly personal purchases, such as iTunes and Target transactions. Blake reviewed these communications at trial and confirmed that they related to her. She testified at trial that she was "a signer on the account, " and she "got to decide how money was spent and when it was spent."[46] She explained that because finances were tight, she did not take her full salary and used the debit card when she "had to buy something or pay something "[47] She paid herself "$6, 000 less that year" and "1099'd" herself for everything she spent.[48] She testified that during a discussion about this behavior Walker said, "Your heart was in the right place, but that was really dumb, so don't do it again."[49] Walker also told her that if she did it again, he would have to fire her.[50] Blake further testified that Walker made her "do a full accounting of all the money that was spent against all the bank accounts and show him" in the March-April 2016 timeframe.[51]

         5. Henry is fired and the litigation begins

         On May 6, 2016, Walker sent Henry an e-mail stating, in part:

Jon, I tried to reach you this morning to discuss a layoff. Effective immediately. As a company we can no longer financially support outside contractors. If the company sells or starts making money you will receive what is owed to you.[52]

         Henry replied that he had "stopped billing [Phixios] as of April 1 st since things had slowed down due to the cut backs in available revenue. This blocked our ability to purchase any parts needed to test, build or deliver anything to sales or the customer base."[53] He also stated that he understood the situation and thanked Walker for the opportunity to work with him for the past year.[54] Henry testified that he went back to being retired after he left Phixios.[55] On October 14, 2016, Blake submitted an affidavit in support of Phixios's opposition to Henry's motion to quash and stated her understanding that "Henry, through RSH, is continuing to compete with Phixios now."[56] At trial, she admitted that her belief was based solely on a conversation with Chuck Nash, a person with whom Phixios suspected Henry and Jacobson were continuing to do business.[57] Blake has no first-hand basis for believing that Henry continues to compete with the Company and no proof to support the statement in her affidavit.[58]

         In June 2016, Henry, Rhonda, and Jacobson received a cease-and-desist letter from counsel representing Phixios.[59] The letter addressed to Henry alleged that he was "conspiring with Mr. Jacobson to defraud the Company and misappropriate Company assets for [his] own personal gain."[60] On June 8, 2016, Jacobson delivered a Section 220(d) demand to the Company requesting inspection of certain books and records.[61] On June 19, 2016, the Company sent notice to stockholders of a special meeting to be held June 30, 2016.[62] On June 21, 2016, Henry sent a request under Section 219 to examine the list of the Company's stockholders entitled to vote at the special meeting.[63]

         On June 23, 2016, Henry and Jacobson delivered a written demand (the "Demand Letter") to the Company requesting that the Company allow Jacobson and Henry "to examine a list of the Company stockholders in connection with a special meeting the [C]ompany has purportedly noticed to take place on June 30, 2016" pursuant to Section 219.[64] The Demand Letter also seeks the inspection of books and records "(i) to communicate with other stockholders concerning the June 30 special meeting; (ii) to value their stock; and (iii) to investigate mismanagement and wrongdoing" pursuant to Section 220(b).[65] The Demand Letter asks for the following specific documents:

• All executed stockholder agreements, any amendments thereto, and any current capitalization table, and the stockholder list described above;
• Annual, quarterly and monthly financial statements, including both audited and internally-prepared income statements, balance sheets, cash flows and stockholders' equity statements, from the Company's 2013 inception through the present;
• Federal, state and local income tax returns and reports together with supporting documentation;
• General ledger, check registry and related journal entries for the years 2013 to the present;
• Schedule of current Company debt;
• Schedule of compensation paid to the officers, managers and board of directors;
• Payroll records from July 2013 to present;
• Bank statements from July 2013 through the present for all Company bank accounts;
• Documents constituting budgets, projections, or business plans; and
• Documents relating to any actual, potential or contemplated transaction resulting in a merger or other business combination, or the sale of the Company's assets.[66]

         On June 30, 2016, the Company held a special meeting of the stockholders and voted to remove Jacobson as a director.[67] On July 12, 2016, the Company held another special meeting of the stockholders and purported to revoke all of the common stock held by Henry and Jacobson under Section 11 of the Stockholder Agreement.[68] Henry testified that he never received notice of the July 12, 2016 meeting.[69] In a letter dated July 19, 2016, Phixios notified Henry and Jacobson that their common stock had been revoked on July 12, 2016.[70] On July 22, 2016, Henry was added as a plaintiff to this action.[71]


         In this case, the Company alleges that the Stockholder Agreement was adopted as part of the bylaws of the Company long before Henry was issued stock in the Company. The Company further maintains that although the restrictions were not noted conspicuously on the stock certificate representing Henry's stock, Henry had actual knowledge both before and after the shares were issued, either of which is adequate under 8 Del. C. § 202(a). Henry concedes that the Stockholder Agreement was in place before Henry's stock was issued. But he contends that the provisions contained in the Stockholder Agreement are not bylaws of the Company. Even accepting as true that the provisions in the Stockholder Agreement are bylaws, Henry argues that he is not bound under Section 202 because he did not have actual knowledge of the restrictions before the stock was issued, and he did not consent to be bound after the stock was issued.

         I need not decide whether the provisions in the Stockholder Agreement constituted bylaws because whether the restrictions were adopted through bylaws, through an agreement, or otherwise does not change the analysis. Instead, I must determine whether Henry had actual knowledge by the time the stock was issued. If the answer is no, I must also determine whether under Section 202 Henry may be bound by restrictions that were in place before the securities were issued to him if he gained actual knowledge of the restrictions after the securities were issued to him. If the answer to that question is no, I must determine whether Henry otherwise consented to be bound by a subsequent agreement or vote in favor of the restrictions.

         In order to obtain a declaratory judgment, the plaintiff bears the burden of proving each element of his claim by a preponderance of the evidence.[72] "Proof by a preponderance of the evidence means proof that something is more likely than not. It means that certain evidence, when compared to the evidence opposed to it, has the more convincing force and makes you believe that something is more likely true than not."[73]

         A. Principles of Statutory Interpretation

         Under Delaware law, "a statute or an ordinance is to be interpreted according to its plain and ordinary meaning."[74] "Where a statute contains unambiguous language that clearly reflects the intent of the legislature, then the language of the statute controls."[75] Delaware courts "construe statutes 'to give a sensible and practical meaning to a statute as a whole in order that it may be applied in future cases without difficulty.'"[76] The courts also "read each relevant section of the statute in light of all the others to produce a harmonious whole."[77] "Words in a statute should not be construed as surplusage if there is a reasonable construction which will give them meaning, and the courts must ascribe a purpose to the use of statutory language, if reasonably possible."[78]

         B. Knowledge and Consent Requirements Under Section 202

         Section 202(a) of the Delaware General Corporation Law provides:

A written restriction or restrictions on the transfer or registration of transfer of a security of a corporation ... if permitted by this section and noted conspicuously on the certificate or certificates representing the security or securities so restricted . . . may be enforced against the holder of the restricted security or securities or any successor or transferee of the holder. Unless noted conspicuously on the certificate or certificates representing the security or securities so restricted ... a restriction, even though permitted by this section, is ineffective except against a person with actual knowledge of the restriction.[79]

         Thus, a written restriction on the transfer of a security may be enforceable against a particular stockholder if: (1) it is noted conspicuously on the certificate representing the security in the case of certificated shares; or (2) the person ...

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