Delaware Business Litigation Report

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

Authored by Albert H. Manwaring, IV
This article was originally published in the Delaware Business Court Insider | January 15, 2014

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.

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