Recent Trends in Books and Records Demands

Section 220 of the Delaware General Corporation Law has been called an important tool to gather information from a company and a key weapon in a plaintiffs lawyer’s toolkit. The statute provides that a stockholder is entitled to inspect a corporation’s “books and records” for a “proper purpose,” and is typically used as a means to gather discovery in order to file a derivative lawsuit. A proper purpose is “a purpose reasonably related to such person’s interest as a stockholder.” The investigation of alleged corporate misconduct, so long as the stockholder provides credible evidence from which a court could infer actionable wrongdoing, may be a “proper purpose” for demanding books and records pursuant to Section 220. But that leaves the question of what level of alleged wrongdoing is sufficient to allow a stockholder access to a company’s nonpublic information. Can any implausible, trivial or pretextual assertion of “wrongdoing” be used to justify a court-sanctioned fishing expedition? More and more often, courts are saying “no.” Courts are also empowering corporations to place reasonable conditions on the production of any documents in response to Section 220 demands. This article briefly discusses recent opinions addressing these topics.

Standing: Stockholder at the Time Complaint is Filed

Before considering whether a stockholder’s purpose for making a demand is proper, a court must first determine whether the stockholder has standing to compel the production of a corporation’s books and records.[1] In a February 2017 decision, Weingarten v. Monster Worldwide, the Delaware Chancery Court grappled with an issue of first impression: whether “a former stockholder squeezed out in a merger thereafter lacks standing” to bring an action pursuant to Section 220. The court held that stockholders must own stock as of the date of filing an action to demand books and records: “The language of Section 220(c) is plain and unambiguous. By requiring that a plaintiff under Section 220, to seek relief from this Court, demonstrate ... that it ‘is’ — present tense — a stockholder, the legislature has made clear that only those who are stockholders at the time of filing have standing to invoke this Court’s assistance under Section 220.”[2] Therefore, when a stockholder loses his status as a stockholder due to a merger or otherwise, the stockholder will no longer have standing to file a complaint to pursue books and records under Section 220.

Proper Purpose: Alleged Corporate Wrongdoing

In another recent decision, the Delaware Supreme Court held that seeking books and records to determine whether to pursue a derivative action for breaches of directors’ duty of care was not a “proper purpose” where the corporation had an exculpation clause that exempted directors from liability for such conduct.[3] In that case, AbbVie, the corporation in question, had an exculpation clause, as permitted under Delaware law, that exempted its directors from liability for duty-of-care violations. As a result, the court held that investigating directors for potential breaches of the duty of care was not a “proper purpose” because the directors could not be liable for any such breaches. In other words, even if the books and records supported a claim of breach of fiduciary duty, no claim could be pursued for such alleged wrongdoing.

The court held that, to have stated a “proper purpose,” the stockholder needed to provide credible evidence to suggest a nonexculpated breach of fiduciary duty, e.g., a breach of the duty of loyalty. Of course, a nonexculpated breach-of-loyalty claim against a director, commonly referred to as a “Caremark claim,” is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment”[4] and a high hurdle to overcome. And in AbbVie, the stockholder failed in showing a credible basis for the court to infer that a nonexculpated breach of fiduciary duty occurred.

Proper Purpose: Lawyer-Driven Exercise

In a case decided in November 2017, Wilkinson v. A. Schulman, the Delaware Chancery Court denied a stockholder access to books and records on grounds that it was not really the stockholder who wanted the records.[5]  Rather, an enterprising plaintiffs lawyer had drafted and been pursuing the 220 demand. The court held that to be proper, the purpose of a 220 demand must belong to the stockholder, and not his or her counsel. “A stockholder obviously can use counsel to seek books and records …. [However,] having an entrepreneurial law firm initiate the process, [and] draft a demand to investigate different issues than what motivated the stockholder”[6] will not be sufficient for a shareholder to gain access to a corporation’s books and records.

Conditions to Production: Exclusive Venue Provision and Incorporation By Reference

Even when a stockholder’s purpose is proper, Delaware courts have repeatedly held that reasonable conditions may be placed on the production of books and records, pursuant to 8 Del. C. §220, to “protect the legitimate interests of Delaware Corporations.”[7]  “In restricting a stockholder's ability to use corporate books and records in certain ways, Delaware case law has consistently reflected the underlying principle that the stockholder’s inspection right is a qualified one.”[8] Under these cases, corporations producing documents under the statute are entitled to require that those documents are used in an agreed venue and in an appropriate context.

For example, the Delaware Supreme Court has held that when a corporation produces books and records, it can condition the production on the stockholder’s agreement to file any subsequent lawsuit that uses those books and records in an exclusive venue, e.g., commence his or her derivative proceeding only in Delaware courts.[9]

In 2017, the Delaware Chancery Court held that documents produced to a stockholder may also be conditioned on the stockholder agreeing that all of the documents that are produced be incorporated by reference into any future derivative complaint (the “incorporation condition”).[10] The court held that the incorporation condition will “ensure that [a] plaintiff cannot seize on a document, take it out of context, and insist on an unreasonable inference that the court could not draw if it considered related documents.”[11] The incorporation condition “protects the legitimate interests of both [the defendant] and the judiciary by ensuring that any complaint that [the plaintiff] files will not be based on cherry-picked documents.”[12]

Also last year, the Chancery Court again granted a defendant’s request for an incorporation condition to allow the defendant “to rely on all documents produced in this action to support any hypothetical motion to dismiss an anticipated derivative complaint.”[13] The court, discussing the efficacy of an incorporation requirement, noted that the incorporation condition “provides a remedy for the unreasonable anti-contextual use of a limited subset of the documents produced, in support of a complaint untenable when examined under the full universe of documents obtained.”[14]

***

While stockholders of Delaware corporations have the right, under certain circumstances, to inspect nonpublic corporate records, that right is not endless or unbounded. As discussed, courts are trending toward restricting what constitutes a proper purpose. Even when there is a proper purpose, to protect the legitimate interests of corporations, courts are allowing various restrictions and conditions on the production of these documents. Accordingly, before responding to a books and records request, companies should consider the latest guidance from the courts in Delaware to determine the appropriate course for responding.

Matthew Solum is a senior litigation partner of Kirkland & Ellis LLP in New York. His practice focuses on high stakes disputes, including M&A, securities and complex commercial litigation.

Vera Esses is a litigation associate in Kirkland’s New York office.

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] 8 Del. C. § 220(c); see also Weingarten v. Monster Worldwide Inc., No. CV 12931-VCG, 2017 WL 752179, at *3 (Del. Ch. Feb. 27, 2017).

[2] Id. at *5.

[3] Se. Pennsylvania Transportation Auth. v. AbbVie Inc., No. CV 10374-VCG, 2015 WL 1753033, at *1 (Del. Ch. Apr. 15, 2015), judgment entered sub nom. Se. Pennsylvania Transp Auth. v. AbbVie Inc. (Del. Ch. Apr. 22, 2015), and judgment entered sub nom. Rizzolo v. AbbVie Inc. (Del. Ch. Apr. 23, 2015), and aff'd, 132 A.3d 1 (Del. 2016).

[4] In re Caremark, 698 A.2d 959, 967 (Del. Ch. 1996).

[5] Wilkinson v. A. Schulman Inc., No. CV 2017-0138-VCL, 2017 WL 5289553, at *3-*4 (Del. Ch. Nov. 13, 2017).

[6] Id. at *3.

[7] United Techs. Corp. v. Treppel, 109 A.3d 553, 558-59 (Del. 2014) (citing Disney v. Walt Disney Co., No. CIV.A. 234-N, 2005 WL 1538336, at *1 (Del. Ch. June 20, 2005) (quoting Stroud v. Grace, 606 A.2d 75, 89 (Del. 1992)); see also CM & M Grp. Inc. v. Carroll, 453 A.2d 788, 793 (Del. 1982) (“Counterposed to the duty to protect the rights of the stockholder, the Court has the duty to safeguard the rights and legitimate interests of the corporation.”); In re Petition of B & F Towing & Salvage Co., 551 A.2d 45, 51 n. 7 (Del. 1988); Henshaw v. American Cement Corp., 252 A.2d 125, 130 (Del. Ch. 1969)).

[8] Id. (internal citations omitted) (emphasis added).

[9] Id. at 554; see also 8 Del. C. § 220(c) (“The Court may, in its discretion, prescribe any limitations or conditions with reference to the inspection, or award such other or further relief as the Court may deem just and proper.”) (emphasis added).

[10] Elow v. Express Scripts Holding Co., No. CV 12721-VCMR, 2017 WL 2352151, at *8 (Del. Ch. May 31, 2017), judgment entered sub nom. Elow v. Exp. Scripts Holding Co. (Del. Ch. June 15, 2017), and judgment entered sub nom. Khandhar v. Exp. Scripts Holding Co. (Del. Ch. June 15, 2017).

[11] Id. at *9 (internal citations omitted).

[12] Id. at *8.

[13] City of Cambridge Ret. Sys. v. Universal Health Servs. Inc., No. CV 2017-0322-SG, 2017 WL 4548460, at *1 (Del. Ch. Oct. 12, 2017).

[14] Id. at *3.

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