Article Law360

Del. Courts Continue Limiting Books And Records Demands

Section 220 of Title 8 of the Delaware Code allows a corporation’s stockholders to make a written demand to inspect the corporation’s “books and records.” While initially conceived as an expansion of the common law right of stockholders to monitor the performance of their agents in corporate affairs,[1] Section 220 has evolved into a tool that stockholders (and their lawyers) use to obtain discovery to pursue litigation against a corporation’s directors and officers. To make a Section 220 demand, a stockholder must, among other things, identify a proper purpose for the demand and the requested books and records must be “necessary” for that purpose.

Although books and records demands have been available for decades, there has been a recent upswing in their use as stockholders (including activist stockholders) have discovered the usefulness of Section 220 in obtaining materials for future litigation and campaigns. However, as Section 220 demands and disputes have increased, courts have imposed additional boundaries on their use. In particular, in recent years, courts have held that stockholders must demonstrate that they are not investigating conduct that has been statutorily exculpated and that they have good reason to request the production of emails.

Rising Use of 220 Demands to Prepare for Litigation

Stockholders are increasingly relying upon 220 demands in connection with mergers and acquisitions to gather information to potentially pursue damages claims after the closing of the transaction.[2] For reference, we will call stockholders who serve these kinds of demands, “potential M&A plaintiffs.” These post-closing damages claims often come in the form of breach of fiduciary duty claims against the corporation’s board of directors. Potential M&A plaintiffs usually seek materials relating to the M&A sale process and aim to use that information to criticize the process.

Potential M&A plaintiffs are pursuing books and records demands in court and, in some cases, through to trial. In the past year alone, they have obtained books and records in three Section 220 trials following an M&A transaction.[3] For example, in Inter-Local Pension Fund Graphic Communications Conference of the International Brotherhood of Teamsters v. Calgon Carbon Corp., stockholder Inter-Local Pension Fund GCC/IBT issued a demand to inspect defendant Calgon Carbon Corp.’s books and records under Section 220.[4]

Calgon had executed a merger agreement with a Japanese company named Kuraray Co. Ltd. for $1.1 billion. The fund’s stated purpose for its 220 demand was to “investigate the events leading to the [a]cquisition in order to determine whether it is appropriate to pursue litigation ... and [to investigate] the independence and disinterestedness of the directors generally with respect to the [a]cquisition.” Calgon rejected the demand and the fund sued in Delaware Chancery Court. After a trial, Vice Chancellor Morgan Zurn held that the fund’s purposes were proper under Section 220 and that the fund was entitled to books and records necessary to allow it to investigate potential corporate wrongdoing.

In Morrison v. Berry,[5] The Fresh Market Inc. filed a series of public disclosures in connection with its proposed transaction with Apollo Global Management LLC. The public disclosures included information about rollovers for The Fresh Market’s founder, Ray Berry, and his son, Brett Berry. A stockholder plaintiff then brought a Section 220 demand to investigate whether the company’s directors had breached their fiduciary duties during the sale process. The plaintiff eventually obtained what the Delaware Supreme Court described as “several key documents ... and a crucial e-mail from [a director’s] counsel to the company’s lawyers.”

This “crucial” email (the “Nov. 28 email”) was sent prior to the beginning of the sales process from Ray Berry’s counsel to Fresh Market’s board and allegedly suggested that Ray Berry had already agreed to roll over his shares if Apollo was the winning bidder. After obtaining these documents through her Section 220 demand, the plaintiff in Morrison brought a breach of fiduciary duty claim against Fresh Market’s board of directors, claiming that, because the board did not publicly disclose this key information about Ray Berry’s relationship with Apollo, the stockholders were misled. The trial court dismissed the plaintiff’s breach of fiduciary duty claims and found that the merger was approved by a fully informed majority of stockholders.

The Delaware Supreme Court reversed. It analyzed the differences between the statements in the Nov. 28 email and the company’s public disclosures and found that the email suggested additional facts that the company did not disclose. Given this, the claims were allowed to proceed to discovery.

220 Demands and Activist Stockholders

Activist stockholders are also increasingly using books and records demands to gather information about corporations.[6] They have done so to mixed success. In Highland Select Equity Fund LP v. Motient Corp.,[7] an activist’s 220 demand was rejected because its purported purpose “verge[d] on being a ruse.” The activist had intended to file a proxy contest and had sufficient information to do so prior to issuing its demand. “Highland thus appear[ed] to have maintained its books and records demand in large part because it ... derived utility from the demand itself as a rhetorical platform.” Subsequent activist stockholders have had to demonstrate that they have a proper purpose and are not bringing their demand to harass or embarrass the corporation.[8]

Limitations on 220 Demands

Exculpated Conduct

The Delaware Supreme Court has recently made clear that the ability to obtain these documents for use in potential litigation is not unfettered. Alleged corporate wrongdoing by directors can be exculpated under Section 102(b)(7) of the Delaware General Corporation Law.[9] This statute allows stockholders to adopt a provision protecting their directors from monetary liability for violations of the duty of care.[10] The Delaware Supreme Court held in Southeastern Pennsylvania Transportation Authority v. Abbvie Inc. that, in light of this statute, investigating wrongdoing is only a proper purpose for obtaining books and records under Section 220 “insofar as the investigation targets nonexculpated corporate wrongdoing.”[11] This is because the potential wrongdoing must be actionable.

The Supreme Court’s Abbvie holding has been extended to the Section 141(e) context. Section 141(e) is a Delaware statute that states, in part, that a board member is “fully protected” in relying in good faith on the opinions of subject matter experts who have been selected with reasonable care by the corporation.[12] In Beatrice Corwin Living Irrevocable Trust v. Pfizer Inc.,[13] Judge Abigail LeGrow, sitting as a vice chancellor by designation, denied plaintiffs’ Section 220 demand based on the Supreme Court’s reasoning in Abbvie.

The plaintiffs’ stated purpose for their books and records demand was to investigate possible mismanagement and evaluate potential litigation against the board. However, the only mismanagement or wrongdoing by the board that the plaintiffs raised was supposedly “failing to assure compliance with applicable accounting rules.” The court in Beatrice Corwin denied plaintiffs’ 220 demand because the board of directors relied upon KPMG in that regard, finding that “[t]he board’s reliance on KPMG’s opinion that Pfizer’s financial statements were prepared in accordance with GAAP protects the board from the claims the plaintiffs seek to investigate through the [d]emand.”

Because plaintiffs did not provide evidence that: (1) The board did not rely on KPMG; (2) The board did not believe the opinion to be within KPMG’s field of expertise; or (3) KPMG was not selected with reasonable care, the plaintiffs had not “overcome the presumptions of [Section 141(e)]” and the court could not infer nonexculpated breaches of fiduciary duty.

Email Production

Stockholders pursuing books and records under Section 220 with increasing frequency demand emails and other communications between officers and directors of the corporation as indicia of potential wrongdoing.[14] The Delaware Supreme Court in KT4 Partners LLC v. Palantir Technologies Inc. provided clarity on this issue:

Ultimately, if a company observes traditional formalities, such as documenting its actions through board minutes, resolutions and official letters, it will likely be able to satisfy a [Section] 220 petitioner’s needs solely by producing those books and records. But if a company instead decides to conduct formal corporate business largely through informal electronic communications, it cannot use its own choice of medium to keep shareholders in the dark about the substantive information to which [Section] 220 entitles them.[15]

A company can therefore avoid producing emails if it can show that the relevant information is reflected in its formal records.

While the above focuses on books and records demands under Delaware law, other states permit books and records demands to varying degrees. For example, in California, a shareholder can inspect “accounting books and records and minutes of proceedings of the shareholders and the board and committees of the board ... at any reasonable time during usual business hours, for a purpose reasonably related to such holder’s interests as a shareholder.”[16]

In New York, “shareholders have both statutory and common-law rights to inspect a corporation’s books and records so long as the shareholders seek the inspection in good faith and for a valid purpose ... the common-law right of inspection is broader than the statutory right.”[17] Because of this difference, while stockholders still rely on both the statute and common law in their books and records petitions, their reliance on the permissive common law is more likely to be successful.[18]

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Melzer v. CNET Networks, Inc., 934 A.2d 912, 917 (Del. Ch. 2007).

[2] See, e.g., In re Pilgrim’s Pride Corp. Derivative Litig., No. CV 2018-0058-JTL, 2019 WL 1224556 (Del. Ch. Mar. 15, 2019); In re Tangoe, Inc. Stockholders Litig., No. CV 2017-0650-JRS, 2018 WL 6074435 (Del. Ch. Nov. 20, 2018); Busch on Behalf of Richardson Elecs., Ltd. v. Richardson, No. CV 2017-0868-AGB, 2018 WL 5970776 (Del. Ch. Nov. 14, 2018); Tilden v. Cunningham, No. CV 2017-0837-JRS, 2018 WL 5307706 (Del. Ch. Oct. 26, 2018); In re Tesla Motors, Inc. Stockholder Litig., No. CV 12711-VCS, 2018 WL 1560293 (Del. Ch. Mar. 28, 2018), appeal refused sub nom. Musk v. Arkansas Teacher Ret. Sys., 184 A.3d 1292 (Del. 2018).

[3] See, e.g., Inter-Local Pension Fund GCC/IBT v. Calgon Carbon Corp., No. CV 2017-0910-MTZ, 2019 WL 479082 (Del. Ch. Jan. 25, 2019); Mudrick Capital Mgmt., L.P. v. Globalstar, Inc., No. CV 2018-0351-TMR, 2018 WL 3625680 (Del. Ch. July 30, 2018); In re UnitedHealth Grp., Inc. Section 220 Litig., No. CV 2017-0681-TMR, 2018 WL 1110849 (Del. Ch. Feb. 28, 2018), aff’d sub nom. UnitedHealth Grp. Inc. v. Amalgamated Bank as Tr. for Longview Largecap 500 Index Fund, 196 A.3d 885 (Del. 2018).

[4] See Inter-Local Pension Fund GCC/IBT, 2019 WL 479082, at *1.

[5] Morrison v. Berry, 191 A.3d 268 (Del. 2018), as revised (July 27, 2018).

[6] See, e.g., Disney v. Walt Disney Co., 857 A.2d 444 (Del. Ch. 2004) (noting that activist shareholder obtained documents through a Section 220 demand but denying shareholder the ability to publicly disseminate the information as part of its campaign); Mudrick Capital Mgmt., L.P., 2018 WL 3625680 (holding that activist shareholder was entitled to emails and special committee materials).

[7] Highland Select Equity Fund LP v. Motient Corp., 906 A.2d 156 (Del. Ch. 2006).

[8] See Mudrick Capital Mgmt., L.P., 2018 WL 3625680; Caspian Select Credit Master Fund Ltd. v. Key Plastics Corp., No. CIV.A. 8625-VCN, 2014 WL 686308, at *1 (Del. Ch. Feb. 24, 2014) (finding that activist shareholder had a proper purpose and distinguishing Highland).

[9] “A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit.” Del. Code Ann. tit. 8, § 102(b)(7) (West).

[10] The statute does not allow exculpation for breaches of duty of loyalty or acts or omissions done in bad faith. See Del. Code Ann. tit. 8, § 102(b)(7) (West).

[11] Southeastern Pennsylvania Transportation Auth. v. Abbvie Inc., No. CV 10374-VCG, 2015 WL 1753033, at *13 (Del. Ch. Apr. 15, 2015), judgment entered sub nom. Se. Pennsylvania Transp Auth. v. Abbvie, Inc. (Del. Ch. 2015), and judgment entered sub nom. Rizzolo v. Abbvie Inc. (Del. Ch. 2015), and aff’d, 132 A.3d 1 (Del. 2016).

[12] “(e) A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.” Del. Code Ann. tit. 8, § 141 (West).

[13] Beatrice Corwin Living Irrevocable Trust v. Pfizer Inc., 2016 WL 4548101 (Del. Ch. Aug. 31, 2016).

[14] See, e.g., In re UnitedHealth Grp., Inc. Section 220 Litig., 2018 WL 1110849 (holding that plaintiffs were entitled to books and records but not email communications); Mudrick Capital Mgmt., L.P., 2018 WL 3625680, at *9 (holding that plaintiff was entitled to emails and other communications because the produced documents were inadequate and suggested that emails were necessary).

[15] No. 281, 2018, 2019 WL 347934, at *2 (Del. Jan. 29, 2019) (reversing the Chancery Court’s denial of emails because it was shown that formal books and records did not exist on the issue).

[16] See Innes v. Diablo Controls, Inc., 248 Cal. App. 4th 139, 142, 203 Cal. Rptr. 3d 375, 376 (2016); see also Cal. Corp. Code § 1601 (West).

[17] Ret. Plan for Gen. Employees of City of N. Miami Beach v. McGraw-Hill Companies, Inc., 120 A.D.3d 1052, 1055, 992 N.Y.S.2d 220, 223 (1st Dep’t 2014); see also N.Y. Bus. Corp. Law § 624 (McKinney).

[18] See, e.g., Pokoik v. 575 Realties, Inc., 143 A.D.3d 487, 488, 38 N.Y.S.3d 553, 555 (N.Y. App. Div. 2016) (reversing trial court and granting stockholders’ petition to obtain books and records of both the corporation and its wholly owned subsidiary under the common law).