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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
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One proper purpose for a books and records inspection under Section 220 of the Delaware General Corporation Law is to investigate potential plenary claims. But what happens when the stockholder seeks records under Section 220 after it already initiated its plenary claims on the same subject? Shouldn’t investigations, by their nature, precede a charge? And may Section 220 be used as an end-around discovery rules in the pending plenary action? This decision addresses these issues, discusses the relevant Delaware precedent, and explains that, “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.” Special circumstances may include where the plenary complaint was dismissed without prejudice, with leave to amend. No special circumstances were present in this books and records action, so the Court of Chancery dismissed it.
It is sometimes fair to characterize plaintiff-side representative litigation in the corporate context as lawyer-driven. This decision is notable because it addresses how that dynamic might affect a stockholder’s right to inspect corporate books and records under Section 220 of the Delaware General Corporation Law. The right to access records is not a license to fish. A stockholder can get necessary records, for a proper purpose—one that is in fact the stockholder’s true and primary purpose. That is where a lawyer’s involvement might make a difference. The purposes stated by counsel might not align with the stockholder’s actual motivations. More ›
Delaware Supreme Court Addresses Emails and Jurisdictional Use Conditions in Books and Records Actions
Two prevailing questions for books and records inspections under Section 220 of the Delaware General Corporation Law are what records can I get, and what can I do with them? This decision from the Delaware Supreme Court addresses both issues. More ›
As a general matter, under Section 220 of the DGCL, directors of a Delaware corporation enjoy the right to virtually unfettered access to the corporation’s books and records so they can exercise their fiduciary duties. In this recent post-trial decision, the Court of Chancery addressed a request by Papa John’s founder and longtime spokesperson, John Schnatter, to inspect documents and communications leading up to the formation of a special committee that decided to terminate certain relationships with him following remarks construed as racial in nature. While the parties resolved most of their disputes consensually, the remaining issues turned largely upon the Court’s factual finding that Schnatter sincerely wished to investigate potential mismanagement in connection with the committee’s decision to distance the company from him. Particularly noteworthy, after considering recent precedents in this area, the Court ordered the production of communications relating to this issue that may be found in the other directors’ personal email accounts or on personal devices. Also notable, in light of all the circumstances, the Court declined to find a separate action for breach of fiduciary duty filed by Schnatter in his capacity as a stockholder was a basis for denying inspection in his capacity as a director.
Litigation seeking to inspect a corporation’s records under Section 220 of the DGCL might toll the statute of limitations for certain claims under the right circumstances. There are important limits to this form of tolling. For example, it is not automatic and will only apply to claims that are the subject of the inspection demand. This decision does a good job of explaining these limits and the factors a court will consider in determining whether inspection-based tolling should apply. It otherwise examines and applies the law on the statute of limitations and issues of inquiry notice.
Court of Chancery Outlines Proof Sufficient for Books and Records Inspection and Permits Inspection of Emails
This decision reflects a good example of how summary books and records actions often proceed in the Court of Chancery: the parties typically work to narrow the issues for trial; the defendant often moots less objectionable records requests, many times in the weeks or days leading to trial; and the plaintiff often narrows disputed requests shortly before trial. Here, the parties did all the above. The petitioner thereafter carefully marshaled its evidence and showed why it should be permitted to inspect emails and other materials that are sometimes off limits in books and records actions. As the Court put it regarding email inspection, the petitioner established that “(1) the produced documents do not allow it to adequately address the stated purposes, and (2) the produced documents also suggest that other documents exist, including emails, that address the crux of the stated purposes and are unavailable from another source.”
An investor seeking books and records for the purpose of investigating wrongdoing or mismanagement must establish a “credible basis” from which to infer such conduct may have occurred. This Master in Chancery report well demonstrates how the Court of Chancery analyzes a books and records demand for such a purpose. The decision discusses several important principles. First, the credible basis standard is very low, requiring only some evidence to suggest misconduct. Second, proving a credible basis is not the same thing as proving actual misconduct. Thus, as the other side of that same coin, the Court generally will not consider defenses that go to the merits of whether wrongdoing actually occurred. Third, the Court will analyze the action before it and not necessarily be influenced by a decision in another court regarding similar allegations.
To facilitate the proper exercise of one’s fiduciary duties, the right of directors to inspect a corporation’s books and records is broad, often referred to as unfettered. The right of managers to inspect an LLC’s books and records generally is equivalent, subject to modification in the LLC agreement. A significant showing is required to avoid a fiduciary’s inspection on the basis that is not for a proper purpose, i.e., any purpose reasonably related to the inspector’s fiduciary status. The company must put forward concrete evidence that the fiduciary will violate duties and use the information to harm it. Without such a showing, the Court generally does not assume the role of questioning the fiduciary’s business judgment about the records he needs to do his job. This decision is an example of the LLC failing to prove the manager lacked a proper purpose for his inspection, with the backdrop of much friction and other litigation among the LLC’s several managers.
To obtain inspection rights from a Delaware corporation to investigate alleged wrongdoing, the petitioner needs some evidence to support his suspicions. As this decision explains, the filing of a suit by someone else is not enough. However, when that other complaint has detailed facts to support it or documents attached that show wrongdoing, that will suffice. This is also a good decision on the scope of inspection rights.
When a demand to inspect corporate records states a purpose other than to value the corporation’s stock, it is often difficult to determine if the basis for the demand is properly supported by the facts in the petition. The petition must state a credible basis to investigate any alleged wrongdoing. This decision is an excellent summary of what facts are sufficient to support such a demand and the analysis the Court will use to decide that issue.
This books and records decision addresses inspection rights granted under an LLC agreement. It also is useful as a reminder that a mere decline in an entity’s performance is not a sufficient proper purpose supporting inspection. While the “credible basis” standard for suspecting mismanagement is low, it is not that low.
While the standard to win the right to inspect corporate records to investigate alleged wrongdoing is a lenient one, it is still not enough to just allege something was done improperly. As this decision shows, you still need to prove some factual basis for the inspection. Just showing the contract with an insider was amended does not get you the right to inspect.
This decision has potential far-reaching consequences for shareholder-plaintiff litigation. As is well known, some entrepreneurial plaintiff-side corporate law firms advertise that they are “investigating” matters following a corporation’s report of some misfortune. That is done to attract a stockholder as a potential client. They then use that client’s status as a stockholder of the corporation to bring suit or, often, to demand an inspection under Section 220 of the DGCL of the books and records they need to support a well-pled complaint. This decision holds that when the demand is really generated by the law firm, and not the client, inspection will be denied for failure of an actual “proper purpose.” The case turned on its facts showing that the client had no real interest in what the law firm wanted to investigate. While some will argue that problem may be cured by a better “informed” client, that perhaps is too cynical. We shall see if this decision makes it harder for such plaintiff-side firms to bring such cases in the future.
A stockholder may inspect a corporation’s records for any recognized proper purpose, including investigating alleged mismanagement. If that stockholder later files a complaint based on the records produced, must the stockholder agree that any reviewing court may consider all those records in ruling on a motion to dismiss rather than being limited to the complaint’s allegations? Under this decision, and a similar decision in the Yahoo! litigation, yes, potentially. While this decision notes that such a condition is within the Court’s discretion, the language of the opinion suggests that condition will be granted as a matter of course.
Court Of Chancery Protects Privilege In Books and Records Action And Addresses Corwin’s Effect On Mismanagement Investigation Claims
This is an important decision for its analyses implicating the Garner and Corwin rules. The Garner rule is that, under certain narrow circumstances where the plaintiff establishes good cause, the attorney-client privilege will be unavailable to corporate fiduciaries who are defending against claims brought by the stockholders who are the object of their fiduciary duties. Here, the Court of Chancery declined to invoke the Garner rule and protected the attorney-client privilege in a books and records case where the same stockholders were already pursuing derivative litigation against the company on the same subject as the records demand but could not gain access under Garner in that earlier litigation. More ›