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CHC Investments, LLC v. FirstSun Capital Bancorp

Court of Chancery of Delaware

January 24, 2019


          Date Submitted: December 13, 2018

          James D. Taylor, Jr. of SAUL EWING ARNSTEIN & LEHR LLP, Wilmington, Delaware, and OF COUNSEL, Michael C. Manning, Jeffrey J. Goulder, Stefan M. Palys, and Christy M. Milliken of STINSON LEONARD STREET LLP, Phoenix, Arizona, Attorneys for Plaintiff CHC Investments, LLC

          Jon E. Abramczyk, William M. Lafferty, and Sabrina M. Hendershot of MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware, and OF COUNSEL, Lawrence Portnoy and Julia Kiechel of DAVIS POLK & WARDWELL LLP, New York, New York, Attorneys for Defendant FirstSun Capital Bancorp


          McCORMICK, V.C.

          Plaintiff, CHC Investments, LLC ("CHC"), filed this action pursuant to Section 220 of the Delaware General Corporation Law to inspect the books and records of FirstSun Capital Bancorp ("FirstSun"). Before demanding inspection, CHC filed plenary claims in this Court against FirstSun (the "Plenary Action"). CHC's sole basis for demanding inspection is to investigate the claims asserted in the Plenary Action. Consistent with this Court's holdings in King v. Verifone, [1]Central Laborers Pension Fund v. News Corporation, [2] and Amalgamated Bank v. NetApp, Inc., [3] this decision finds that CHC's pending Plenary Action renders CHC's purpose for inspecting records improper, and therefore grants FirstSun's Motion to Dismiss.

         I. BACKGROUND

         The facts are drawn from CHC's complaint and the documents it incorporates by reference, including the complaint filed in the Plenary Action.

         CHC has held shares in Strategic Growth Bancorp, Inc. ("SG Bancorp"), which merged into FirstSun in 2017, since at least April 5, 2013.[4] In March 2014, CHC purchased approximately $25 million in additional SG Bancorp securities through a private placement (the "Private Placement").[5] SG Bancorp solicited this investment to fund the build-out of SG Bancorp's national mortgage platform and real estate investment trust operations.[6] At the time of the Private Placement, two high-ranking SG Bancorp employees were defending two securities fraud class actions and a lawsuit by the Federal Housing Finance Agency.[7] These lawsuits concerned the offer and sale of residential mortgage backed securities and resulted in "nine- and ten-figure settlements."[8] CHC alleges that it first learned of the lawsuits in December 2014.[9]

         Although the stated purpose of the Private Placement was to grow the SG Bancorp mortgage unit, [10] within months of the Private Placement, SG Bancorp announced its intention to spin off that unit.[11] To consummate the spin-off, SG Bancorp launched an exchange offer (the "Exchange Offer").[12] Through the Exchange Offer, SG Bancorp common stockholders were offered up to 85% of the nonvoting preferred stock and 35% of the common stock of a new holding company.[13] Management retained the remaining 65% of the common stock.[14] CHC declined to participate in the Exchange Offer.[15]

         On May 18, 2015, SG Bancorp released financial statements.[16] CHC alleges that those statements revealed for "the first time"[17] information that was concealed from CHC and SG Bancorp's stockholders.[18] Around June 2017, SG Bancorp and its affiliate, Strategic Growth Bank Incorporated, merged with FirstSun.[19]

         On May 17, 2018, CHC commenced the Plenary Action in this Court against FirstSun and certain former directors, officers, and stockholders of SG Bancorp.[20]CHC alleges that SG Bancorp's disclosures regarding the Private Placement and Exchange Offer contained material misrepresentations or omissions about SG Bancorp's mortgage business.[21] In the Plenary Action, CHC asserts claims of breach of fiduciary duty, fraud, inadequate disclosure, and related causes of action, and seeks damages, rescission, and costs and attorneys' fees.[22] CHC asserts these claims directly and not in a representative capacity. CHC's Section 220 Complaint expressly incorporates the complaint files in its Plenary Action.[23]

         After commencing the Plenary Action, CHC served FirstSun with a demand pursuant to 8 Del. C. § 220 to inspect books and records of FirstSun, SG Bancorp, and Strategic Growth Bank Incorporated (the "Demand").[24]

         The Demand's stated purpose for inspection is to "investigate the facts behind . . . [SG Bancorp's] incomplete disclosures, corporate mismanagement in association with the split-off of its operation into [a] separate Delaware limited liability company . . ., and improprieties underlying the terms of the . . . Exchange Offer . . . ."[25] The Demand seeks twenty-one categories of documents.[26]

         FirstSun responded to the Demand on July 13, 2018 denying inspection in light of the pending Plenary Action.[27] CHC commenced this action on August 17, 2018.[28] FirstSun moved to dismiss the Section 220 Complaint on September 12, 2018.[29] The parties completed briefing on FirstSun's motion to dismiss on November 16, 2018, [30] and the Court heard oral argument on December 13, 2018.[31]

         II. ANALYSIS

         To determine whether the Section 220 Complaint states a claim, the Court must "accept all well-pleaded allegations as true and draw all reasonable inferences in the plaintiff's favor."[32] The Court will grant a motion to dismiss under Court of Chancery Rule 12(b)(6) only if the "plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of proof."[33]

         To be entitled to inspect books and records under Section 220, a stockholder must state a proper purpose for inspection.[34] FirstSun contends as its primary argument in support of dismissal that CHC fails to state a proper purpose. CHC admits that the categories of documents it seeks are "all designed to give Plaintiff the information necessary to investigate the claims" asserted in the Plenary Action.[35] FirstSun argues, as a matter of law, that investigating claims asserted in a pending plenary action is not a proper purpose under Section 220.

         Seeking inspection under Section 220 to investigate pending claims-the "sue first, ask questions later"[36] approach-is problematic for a number of reasons. First, the plenary and Section 220 complaints are inherently contradictory.[37] On the one hand, by commencing plenary litigation a plaintiff represents that it has sufficient information to support its allegations.[38] On the other hand, to inspect books and records under Section 220 to support its plenary claims, a stockholder must represent that the information is necessary to its plenary claims.[39] Second, once a stockholder commences plenary litigation, discovery rules dictate what information relevant to its claims the stockholder may receive and when the stockholder may receive that information. Using Section 220 inspections to investigate pending plenary claims undermines well-established discovery law.[40]

         Despite problems inherent in the "sue first, ask questions later" sequence, in "special circumstances," Delaware courts have enforced a stockholder's Section 220 rights notwithstanding the stockholder's pending plenary complaint.[41] In opposition to FirstSun's dismissal argument, CHC relies on two cases framing special circumstances in which Delaware courts will permit this approach: Khanna v. Covad Communications Group, Inc.[42] and King v. VeriFone.[43]

         In Khanna, a stockholder plaintiff filed substantive derivative claims while his Section 220 action was pending out of a concern that his substantive claims would become time barred.[44] The defendant argued that by commencing the derivative litigation, the plaintiff waived his right to pursue the Section 220 claims.[45]This Court rejected the defendant's argument, which "overlook[ed] the simple reality that the overlap of the Section 220 action and the Derivative Action is attributable to [the defendant's] failure to comply with its obligations under Section 220 . . . ."[46]

         CHC interprets Khanna broadly to mean that when a stockholder faces statute of limitations or laches pressures, regardless of the cause of those pressures, the stockholder may pursue its plenary claims while seeking to investigate those claims under Section 220. As described above, the ruling of Khanna is not so broad. Rather, Khanna is limited to circumstances in which timing pressures are caused by the defendant, or, at least, not caused by the plaintiff.

         The circumstances at issue in Khanna are not present here. CHC alleges no facts suggesting that FirstSun is at fault for the timing of this action.[47]

         King is likewise inapposite. In King, the Delaware Supreme Court enforced a stockholder's inspection demand to investigate prior-filed plenary claims where a California federal court dismissed the plenary claims with leave to re-plead.[48] In dismissing the claims, the California court expressly encouraged the plaintiff to demand inspection in order to meet the onerous pleading requirements applicable to derivative claims.[49]

         CHC interprets King broadly to permit a plaintiff that has filed a plenary action to pursue a Section 220 inspection where the plaintiff has the opportunity to amend the plenary complaint.[50] By contrast, FirstSun interprets King to prevent a plaintiff that has filed a plenary action from pursuing a Section 220 inspection unless the plenary complaint has been dismissed without prejudice and with leave to amend.[51] CHC's interpretation focuses on the opportunity to amend. FirstSun's interpretation focuses on prior judicial action.[52]

         FirstSun's interpretation finds support in two decisions of this Court directly addressing the issue. In News Corp. I, this Court dismissed a Section 220 claim for lack of a proper purpose in light of a prior-filed plenary action.[53] The Court observed that "no judicial action ha[d] occurred that would suggest a need or reason for further pleadings or efforts to gather important facts to support a cognizable purpose for an inspection . . . ."[54] Similarly, in NetApp, this Court held that a "right to seek to amend" standing alone, does not create a proper purpose for inspection.[55] Rather, this Court emphasized that to have a proper purpose for Section 220 inspection, the court considering the plenary claims must have taken action-i.e., "granted leave to amend."[56]

         FirstSun's interpretation of King mitigates the two problems that otherwise arise when Section 220 actions proceed while plenary claims are pending. After a court has deemed the plenary complaint insufficient and permitted a stockholder to re-plead or amend, the stockholder is not taking the inherently inconsistent positions of standing by its pleadings while simultaneously averring a need for information to support those pleadings. After a court has deemed the plenary complaint insufficient and permitted a stockholder to re-plead or amend, the stockholder is not impermissibly evading well-established discovery rules by seeking inspection.[57]

         Consistent with News Corp. I and NetApp, I construe King narrowly and find that its exception does not apply unless a court has deemed the plenary complaint insufficient and permitted a stockholder to re-plead or amend. At this stage, no judicial action has occurred in the Plenary Action. The exception of King, therefore, does not apply.

         Further, Khanna and King are distinguishable because both involved derivative claims that import policy considerations not implicated by CHC's plenary claims. Delaware policy encourages stockholders in the derivative and representative context to use the "'tools at hand' (e.g., Section 220) to gather information before filing complaints that will be subject to heightened pleading standards."[58] Also, because meritorious derivative and representative claims "further[] the interest of all stockholders and . . . increase [the] stockholder return, "[59]there are greater incentives to seek to preserve such claims. In evaluating the conduct of plaintiffs seeking to use the "tools at hand" to pursue derivative and representative claims, King reflects the Delaware Supreme Court's view that these policies favor some measure of leniency in certain circumstances.[60] No such policy warrants a lenient approach to CHC's Section 220 action.

         In sum, although there is no bright-line rule prohibiting stockholders from using Section 220 to investigate pending plenary claims, Delaware courts have enforced those inspection demands in special circumstances only. None of those circumstances are present here.

         Because CHC alleges no special circumstances, the problems inherent in parallel plenary and Section 220 actions defeat CHC's purpose for inspection. By commencing the Plenary Action, CHC represented that it had all facts necessary to support the plenary claims, and thus CHC lacks a proper purpose to inspect FirstSun's books and records.[61] CHC's purpose is also improper because, having asserted the Plenary Action, CHC's corresponding information rights are governed by a ...

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