Pileggi Analyzes Chancery Decision on Books and Records and Companies Formed to do Business in Asia

Francis Pileggi has a very detailed analysis of the Delaware Court of Chancery's recent verdict in In Re China Agritech, Inc. Shareholder Derivative Litigation, C.A. No. 7163-VCL (Del. Ch.), which is worth reading in its entirety.

There is a lot going on in this decision, which revolves around demand futility in the context of a books and records demand under Section 220 of the Delaware General Corporation Law. But the case is particularly noteworthy because it involves Delaware business entities formed to do business in Asia.  As Pileggi notes: 

This is important for several reasons.  As the recent decisions in Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS (Del. Ch., Feb. 6, 2013) highlighted HERE, and Rich v. Chong, C. A. No. 7616-VCG  (Del. Ch., April 25, 2013) highlighted HERE, board oversight issues have become a significant problem.  In addition, there are problems associated with entity formation and independent directors.  Vice Chancellor Laster noted with disfavor at the outset of this opinion that China Agritech, Inc. (“China Agritech” or the “Company”) “accessed the domestic securities markets in February 2005 through a reverse merger with an inactive corporation that had retained its NASDAQ listing.”  The Court noted:
[U]sing a defunct Delaware corporation that happens to retain a public listing to evade the regulatory regime established by the federal securities laws is contrary to Delaware public policy . . . Delaware has no interest in facilitating reverse mergers with defunct but still publicly registered shell corporations as a means to circumvent the regulatory protections provided by the federal securities laws.
With respect to the issue of Chinese companies and independent directors, problems arise when family members assume roles in the corporation that require independence.  As the Court noted in this case, a director lacks independence when she is unable to base her decision on the corporate merits of the issue before the board and close family relationships, like the parent-child relationship, create a reasonable doubt as to the independence of a director.