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Section 220 Complaint Dismissed Pursuant to Rule 12(b)(6)

January 15, 2014
Albert H. Manwaring, IV
Delaware Business Court Insider

Section 220 of the Delaware General Corporation Law permits a stockholder to  inspect the books and records of a corporation, provided that the demand for  inspection meets certain form and manner requirements, and the inspection is  sought for a proper purpose—one reasonably related to the interests of  stockholders. The Delaware Supreme Court and the Court of Chancery have firmly  established that investigation of corporate mismanagement or wrongdoing is a  proper purpose under Section 220. To state a proper purpose to investigate  mismanagement or wrongdoing of a corporation, a stockholder must, however,  allege a "credible basis" to infer possible mismanagement or wrongdoing. The  "credible basis" standard has been described as having the "lowest possible  burden of proof under Delaware law." Before filing a derivative action, the  Supreme Court and the Court of Chancery have encouraged stockholders to use the  tools at hand by first seeking inspection of a corporation's books and records  in order to successfully plead derivative claims under Court of Chancery Rule  23.1. Further, a Section 220 action for books and records is a summary  proceeding, for which the Court of Chancery counsels against moving to dismiss  based on its expedited nature and the attendant limited time to adjudicate a  dispositive motion before trial.

In a recent decision, Master in Chancery Abigail LeGrow concluded, however,  that despite the recommendations of the Delaware courts to seek a corporation's  books and records before filing derivative claims, and the lowest legal standard  under Delaware law to obtain the right to inspect such records, a stockholder  must nevertheless still satisfy the requirement to allege a "credible basis" for  corporate mismanagement, or the Court of Chancery will entertain dismissal of  even a summary proceeding for books and records at the pleadings stage under  Court of Chancery Rule 12(b)(6). In Louisiana Municipal Police Employees'  Retirement System v. Hershey, C.A. No. 7996-ML (Del. Ch. November 8, 2013),  LeGrow recommended dismissal of a stockholder's complaint in a books-and-records  action under Rule 12(b)(6). LeGrow held that the plaintiff stockholder failed to  sustain its minimal burden of alleging a credible basis to infer mismanagement  or wrongdoing of the defendant, The Hershey Co., as opposed to Hershey's supply  chain for cocoa, to support a proper purpose to inspect Hershey's books and  records under Section 220 of the DGCL.

The plaintiff stockholder brought an action to obtain books and records from  Hershey in connection with its alleged mismanagement and wrongdoing in  purchasing cocoa from farms in West Africa, which utilize child labor, to make  Hershey's iconic chocolate candy. The plaintiff alleged statistics that  approximately 70 percent of the world's supply of cocoa, and the largest  percentage of Hershey's supply of cocoa, comes from West African nations,  including Ghana and the Ivory Coast. The plaintiff then relied upon a number of  recent news reports that child labor on cocoa farms continues to be a problem in  West Africa, with children being forced to work in labor camps under horrific  conditions.

Issues of human trafficking, child labor and abuse in the West African cocoa  industry are pervasive, well known internationally and undeniable. Hershey is a  signatory to a protocol that sought industrywide standards of public  certification by 2005 that cocoa beans and derivative products, such as  chocolate, have been grown or made without the worst forms of child labor.  Hershey failed to meet the goal of the protocol to verify by 2005 that its  supply chain of cocoa was not relying on child labor.

To support its claim of mismanagement or wrongdoing, the plaintiff alleged  that Hershey's purchase of cocoa from suppliers linked to West Africa violated  Ghana, Ivory Coast and federal law. The plaintiff asserted that Hershey violated  laws of Ghana and the Ivory Coast that prohibit employing children below a  certain age, Ghana's Human Trafficking Act and the United States' Trafficking  Victims Protection Reauthorization Act of 2008.

Hershey moved to dismiss the plaintiff stockholder's complaint based on the  plaintiff's failure to state a proper purpose for the inspection of Hershey's  books and records. In her decision, LeGrow first set forth the legal test to  state a proper purpose to investigate mismanagement or wrongdoing of a  corporation under Section 220 of the DGCL. LeGrow ruled that a stockholder must  allege "some evidence" showing a "credible basis" to infer possible  mismanagement or wrongdoing. While noting that the credible-basis standard is  the "lowest possible burden of proof under Delaware law," she explained that the  standard is "not insubstantial," and designed to strike a balance between  granting stockholders access to a corporation's records and protecting them from  wasteful fishing expeditions based on the mere suspicion or curiosity of a  stockholder.

LeGrow found that the plaintiff failed to meet the credible-basis standard.  Turning first to the news articles, upon which the plaintiff relied, she  explained that news articles alone, even when those articles indicate that the  corporation is under investigation for legal violations, are insufficient to  satisfy the credible-basis standard. Moreover, none of the articles implicated  Hershey in the wrongdoing. Second, while pointing out that "statistical  correlation, if adequately supported by a sound, logical methodology and  competent expert testimony" may satisfy the credible basis standard, LeGrow  explained that merely concluding that because Hershey purchased a large amount  of cocoa from West Africa, where cocoa is often produced using child labor,  there is a high probability that Hershey purchased some cocoa that was made  using child labor is insufficient to satisfy the credible-basis standard.

In sum, LeGrow ruled that at most, the plaintiff had demonstrated that  Hershey purchased cocoa from suppliers, which, in turn, purchased cocoa from  West African farms that may utilize child labor. But to find a credible basis to  infer wrongdoing, she reasoned that the plaintiff was required to show that this  conduct or other conduct of Hershey violated the law. LeGrow found that  Hershey's purchase of cocoa from suppliers linked to West Africa did not violate  Ghana, Ivory Coast or federal law. The plaintiff had not alleged that Hershey  was operating a farm or business in Ghana or the Ivory Coast, or that it  employed any children or any person in those countries. The plaintiff had also  not alleged any basis to infer that Hershey had knowledge of any person who was  engaged in human trafficking. Lastly, LeGrow found that merely purchasing cocoa  though a buy-sell supply chain did not constitute "participation in a venture"  that has obtained labor by force, threat or intimidation under the Trafficking  Victims Protection Reauthorization Act.

Accordingly, she held that the plaintiff failed to set forth any evidence to  demonstrate a credible basis to infer that Hershey violated any law. Therefore,  the plaintiff failed to state a proper purpose to investigate mismanagement or  wrongdoing in connection with Hershey's alleged purchase of cocoa from West  Africa.

Lesson Learned

The decision demonstrates that the Delaware courts' recommendation to use  the tools at hand before instituting derivative litigation does not alter the  proper-purpose requirement that a stockholder must present some evidence of  mismanagement or wrongdoing to have the right to inspect a corporation's books  and records under Section 220. The decision confirms that when a plaintiff  stockholder fails to meet its minimal burden to allege a credible basis for  corporate mismanagement, the Court of Chancery will entertain dismissal of even  a summary proceeding for books and records at the pleadings stage under Rule  12(b)(6). The decision also provides helpful guidance on whether statistical  evidence and news reports satisfy the credible-basis standard to investigate  mismanagement in an action to inspect books and records under Section 220.