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Mehta v. Kaazing Corp.

Court of Chancery of Delaware

September 29, 2017

Kaazing Corporation

          Date Submitted: August 2, 2017

          Sidney S. Liebesman, Esquire Montgomery McCracken Walker & Rhoads, LLP.

          Gerald J. Hager, Esquire Margolis Edelstein.

         Dear Counsel:

         To follow is the Court's post-trial decision in this matter. As you know, the Plaintiff, Vikram Mehta, seeks to inspect certain books and records of Defendant, Kaazing Corporation. For the reasons that follow, I have determined that Mehta is entitled to inspect some, but not all, of the books and records he seeks.


         The following facts reflect my factual findings based on a preponderance of the evidence as presented in the parties' pre-trial stipulation and order, the thirty- four (34) joint documentary exhibits introduced at trial on August 2, 2017, and the parties' pre-trial briefing and post-trial status update.[1]

         Kaazing Corporation ("Kaazing" or the "Company") is a Delaware corporation with its principal place of business in San Jose, California.[2] It "offers products that enable mobile users, applications, marketplaces and machines to connect and communicate in real-time."[3]

         Mehta is a stockholder of Kaazing. He was Kaazing's Chief Executive Officer ("CEO") from October 2013 to April 2015, when he was terminated from that position by the Kaazing Board of Directors (the "Board").[4]

         In early 2013, prior to Mehta's employment with the Company, the Company raised $15 million in a Series B financing round led by Columbus Nova Technology Partners ("CNTP") and New Enterprises Associates ("NEA"). Following their investments, both NEA and CNTP were represented on the Company's Board.[5] Soon after the Series B financing closed, Mehta led an additional capital raise of $6.9 million through a Series C financing round, and then arranged for a $3 million working capital line of credit with Comerica Bank.[6]

         At the time of Mehta's termination, a term sheet for a $1.5 million extension to the Comerica Bank line of credit had been executed and Mehta was finalizing discussions with Intel Capital as well as a syndicate of individual investors to invest in the Series C financing round.[7] These investments were calculated to provide an additional $7 million investment into the Series C financing round.[8] On April 17, 2015, when Mehta was informed of his termination, he was under the impression that the Comerica Bank line of credit extension had been secured, that the documents necessary to finalize the Intel Capital investment were being prepared by attorneys and that around $1.25 million of the syndicate investor commitment had already been wired to a Company escrow account.[9] Despite Mehta's efforts, the Company ultimately failed to close on Intel Capital's $4 million Series C financing and did not receive the extension on the Comerica Bank line of credit.[10]

After Plaintiff's termination, Mohsen Moazami, CNTP's Managing Director, became Executive Chairman of the Board. At that time, Kaazing also named Robert Miller ("Miller") as interim CEO and, in September 2015, appointed Miller as permanent CEO.[11] Miller, in turn, hired Michael Floyd ("Floyd"), whom he knew from a prior business association, as Kaazing's Chief Operating Officer in August 2015.[12] According to Mehta, both Miller and Floyd were able to obtain unusually generous compensation packages, further harming the already financially strained Company.[13]

         Mehta also asserts that, in the summer of 2015, the Company inexplicably terminated the employment of a number of Kaazing engineers who had been tasked during Mehta's time as CEO with developing an end-to-end messaging system that would have greatly advanced the Company's offerings.[14] These employees were subsequently hired by TIBCO to the further detriment of the Company.[15]

         Despite the failure to close on the investments Mehta had, in his eyes, secured prior to his termination, Miller contacted shareholders on February 28, 2016, to apprise them that the Company "ended 2015 with a very strong Q4."[16] In this communication, he further informed the shareholders of Kaazing's plans to extend its Series C financing round to raise an additional $15 million and noted that the opportunity to invest would be open to "all existing investors" with "CNTP leading the round."[17] Mehta did not receive this communication when it was first mailed.[18] After Mehta made several inquiries to the Company, Miller forwarded the communication to Mehta via email on March 29, 2016, well after others had already invested.[19]

         On March 25, 2016, Kaazing delivered a vastly different message to its stockholders when it informed them of the need to engage in a $1 million bridge financing (the "2016 bridge financing") so that the Company could continue to operate.[20] This 2016 bridge financing was again led by CNTP which had already committed to contribute up to $500, 000 through a promissory note (the "CNTP note") with the remainder of the financing opportunity to be open to other shareholders.[21] According to Mehta, the CNTP note contained terms favorable to CNTP to the detriment of the Company and its shareholders.[22] Without prior notice to shareholders, the Company's 2016 bridge financing note was thereafter amended twice to allow for investments of up to $2 million. Here again, the Company permitted CNTP to participate in the financing round prior to extending the opportunity to other shareholders.[23] In the midst of scrambling to secure bridge financing, at some point in mid-2016, Kaazing acquired Montage Studio, a software company, and thereafter employed a number of former Montage Studio employees. Stockholders were not advised of the acquisition until after the deal was signed.[24]

         In July 2016, Kaazing executed a term sheet with CNTP for a Series 1 financing round (the "Series 1 Financing"). [25] The Series 1 Financing was presented to shareholders in correspondence from the Company dated August 5, 2016. At the same time, shareholders were invited to participate in additional 2016 bridge financing. This communication also apprised shareholders that the Series 1 Financing would lead to a reverse stock split and recapitalization of all shares of preferred stock into common stock.[26] Given the significant impact of the Series 1 Financing on existing shareholders, the shareholders were advised that, prior to acceptance of the CNTP term sheet, Kaazing's Board had formed a "disinterested" sub-committee which reviewed the proposed transaction and had unanimously approved the CNTP proposed term sheet.[27] Mehta asserts that, consistent with other financing rounds, the Series 1 Financing term sheet was favorable to CNTP while requiring other shareholders to waive certain shareholder rights before they could participate, effectively excluding him and similarly-situated shareholders from the opportunity.[28]

         After certain shareholders (including Mehta) expressed concern regarding the impact of the Series 1 Financing on their investment, Kaazing held a shareholder meeting on September 22, 2016, to provide information concerning the Series 1 Financing.[29] During this meeting, Mehta and other similarly-situated shareholders again received an invitation to participate in the Series 1 Financing on the condition that they sign certain documents that Mehta believed might result in the relinquishment of shareholder rights under Kaazing's Investors' Rights Agreement.[30] For that reason, he declined to participate. The Series 1 Financing led to a dilutive conversion of Mehta's 506, 124 shares of Series B-1 preferred stock to 10, 616 shares of common stock.[31]

         On January 10, 2017, Mehta sent a demand to Kaazing pursuant to 8 Del. C. § 220 (the "Demand") in which he sought inspection of certain books and records to "(i) ascertain the value of his stock; (ii) ascertain whether there has been mismanagement, waste, or wrongdoing by the Company's agents and representatives; (iii) determine what impact if any this mismanagement, waste, or wrongdoing, has had, or might have, on the value of Plaintiff's shares of the Company; and (iv) communicate with other shareholders of the Company concerning the above."[32] Kaazing responded by noting that the Demand did not comply with Section 220 in that it lacked the required oath, was overbroad and failed to state a proper purpose.[33] Nevertheless, Kaazing offered to make certain documents available to Mehta (and other shareholders) if they signed an appropriate confidentiality agreement. It also offered to meet and confer with his counsel to ascertain whether additional documents might be made available for inspection.[34] Mehta rejected the offer and, soon after, filed this Section 220 action on February 6, 2017.[35]

         II. ANALYSIS

         Under Section 220, a shareholder seeking to inspect books and records has the burden of proving (1) that he is in fact a stockholder of the defendant company, (2) that he has complied with the Section 220 requirements concerning form, manner and making of the demand and (3) that the inspection is sought for a proper purpose. Kaazing no longer disputes the form and manner of Mehta's Demand.[36]Instead, its defense focuses on whether Mehta has stated a proper purpose for inspection and whether he has properly limited the scope of the documents he seeks.

         A proper purpose under Section 220 is "a purpose reasonably related to such person's interest as a stockholder."[37] The stockholder has the burden of proving the proper purpose by a preponderance of the evidence, and such proper purpose must be proven for every item sought.[38] When a plaintiff seeking inspection demonstrates a proper primary purpose, the fact that a secondary purpose may also prompt the demand for inspection is irrelevant.[39]

         Kaazing maintains that Mehta's true purpose in demanding inspection is to gather documents not accessible to him through discovery in employment litigation he has initiated against the Company and, more generally, to pursue a personal vendetta he has against the Company. [40] For his part, Mehta alleges in his Complaint that his purposes for seeking inspection are to:

(i) value his membership interest; (ii) ascertain whether there has been mismanagement, waste, or wrongdoing by the Company's agents and representatives pertaining to the 2016 Bridge Financing Transactions and Bridge-Financing linked Series 1 Financing Transactions; (iii) determine what impact any mismanagement, waste, or wrongdoing has had or might have, on the value of Mr. Mehta's shareholding of the company; (iv) communicate with other shareholders of the Company concerning the above; and (v) consider possible breaches of fiduciary duties by managers and directors of the Company.[41]

         Of these, at trial Mehta continued to advance as his proper purposes the valuation of his membership interest in Kaazing and the investigation of mismanagement, waste or wrongdoing.[42]

         It is settled in Delaware law that the valuation of one's stock can be a proper purpose for the inspection of books and records if there is a particular need or reason for the valuation.[43] In this case, however, Mehta has not demonstrated that valuing his membership interests justifies inspection since he has failed to identify any reason why he needs to value his membership interests at this time.[44]

         The investigation of mismanagement, waste and wrongdoing is also a proper purpose for inspection.[45] In order to inspect books and records for these purposes, Plaintiff must present "some evidence" that provides a "credible basis" from which the court can infer possible mismanagement.[46] This threshold requirement "sets the lowest possible burden of proof, " and may be met "by a credible showing, through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing."[47]

         With Plaintiff's low burden of proof in mind, I am satisfied that he has adequately demonstrated a credible basis to suspect wrongdoing that justifies further investigation into mismanagement. Mehta's evidence of possible wrongdoing points to Kaazing's stable financial status immediately prior to his termination and the Company's rather sudden need for bridge financing after his termination, as well as the Board's apparently contradictory statements in early 2016 regarding the Company's financial success in 2015.[48] He suggests that mismanagement took place in the form of preferential treatment of certain investors, particularly CNTP, whom he claims had control over the Board.[49]Specifically, Mehta points to the fact that he and other stockholders were boxed out of opportunities to participate in financing rounds while other shareholders were accommodated.[50]

         In addition to his theory that the Board improperly gave preferential treatment to certain shareholders to the detriment of others (including himself), Mehta suggests that mismanagement or waste took place in connection with the employment agreements extended to Miller and Floyd. To support these claims, Mehta presented evidence that Miller and Floyd enjoyed a close professional relationship at Cloak Labs, [51] and that Miller alone set Floyd's compensation.[52]Additionally, Mehta testified that Kaazing's Director of Finance expressed her view that the compensation was substantial (around $50, 000 per month).[53] While this evidence by no means proves wrongdoing, the applicable standard requires Plaintiff to present only some evidence that supports a credible basis for the Court to infer the possibility of wrongdoing such that further investigation is justified. Plaintiff has crossed this low threshold here.

         Having determined that Mehta has demonstrated proper purposes, I turn next to the scope of documents Mehta may inspect in pursuit of these purposes. Once a plaintiff has established a proper purpose, Delaware law provides that he is only entitled to those documents that "address the crux of the shareholder's purpose" and that are unavailable from another source, making the records necessary and essential.[54] Thus, "inspection should stop at the quantum of information that the court deems sufficient to accomplish the plaintiff's stated purpose."[55] "[I]f the stockholder already has sufficient information from other sources or as a result of other books and records requests, then the inspection can be curtailed because the additional documents are not essential."[56]

         Mehta originally sought 26 categories of documents.[57] Since the filing of the Complaint, Kaazing has produced or agreed to produce several documents within these categories, including documents placed in a data room for shareholders to review in connection with the Series 1 Financing opportunity. These documents include the following: "409A Valuation Report - Kaazing 9/30/15, Cash Flow Q316-Q317, Unaudited Balance Sheets Q116-Q216, Unaudited Statement of Cash Flows Q116-Q216, Unaudited Statement of Operations Q116-Q216, Pro Forma Cap Table, [and the] Video tape of September 22, 2016 stockholders meeting."[58]

         In addition to the data room documents, the Company has agreed to produce: communications with shareholders regarding the bridge financing and the Series 1 Financing; shareholder registers and cap tables sufficient to show shareholdings before and after the bridge financings and Series 1 Financing; Board and Board committee and subcommittee meeting materials/presentations and minutes from April 2015 through December 31, 2016; closing documents for B-1, C-1, Series 1 Financing and 2016 bridge financing (including preferred warrant agreements with SQN Capital and a subordination agreement with Comerica that were part of the bridge financing); cap tables from April 17, 2015, February 28, 2016; Miller and Floyd employment agreements and consulting agreements, including documents describing applicable management incentive plans; unaudited quarterly and annual financial statements (balance sheets, income statements, statements of cash flows) for 2014, 2015 and 2016; 409A valuations for 2015 after Series C was completed; closing documents for the Montage Studio acquisition, including any agreements with Montage investors, founders or employees; and the presentation provided by Miller regarding Cloak Labs.[59]

         Upon the Court's request, the parties submitted a letter following closing arguments in which they listed the outstanding document categories that remain in dispute. There are now six disputed categories:

1. The General Ledger of Kaazing Corporation ("Kaazing" or the "Company") for April 2015 through December 2016.
2. Documents evidencing discussions Kaazing's Board and management had with COTA capital, Intel, SQN Capital, NEC, NEA, CNTP, members of the Mehta investment syndicate and any other investor that Kaazing contacted after it sent out the February 28, 2016 communication to shareholders regarding resurrection of the Series C equity financing round.
3. Final, signed minutes of all Board and sub-committee meetings including all materials presented at such meetings between April 1, 2015 and January 2017. If no other presentations exist and/or no other materials were handed out at meetings other than any materials already produced, a written representation that no other materials exist . . . .
4. Any Documents in addition to materials presented at Board or subcommittee meetings that were reviewed by the Company's Board of Directors and any subcommittee thereof regarding the 2016 Bridge Financing and Bridge-Financing linked Series 1 Financing and all email ...

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