Stockholder Books and Records Actions: Delaware Supreme Court Levels the Playing Field for Stockholders Seeking to Investigate Malfeasance
December 15, 2020
Types : Alerts
Stockholder books and record inspection rights under 8 Del. C. § 220 is a topic that seldom dazzles the senses and fires the imagination; yet, as business litigators (Delaware business litigators, in particular), we frequently are called upon to assist clients in responding to (or pursuing, as the case may be) records demands. On December 10, 2020, the Delaware Supreme Court issued an en Banc opinion in AmerisourceBergen Corp. v. Lebanon County Employees’ Retirement Fund, deciding a certified interlocutory appeal containing “substantial issues of material importance” relating to Section 220’s “proper purpose” requirement in the context of investigations into corporate wrongdoing. In the realm of shareholder inspection rights, it is worthy of note.
As background for the uninitiated, Section 220 of the Delaware General Corporation Law grants stockholders the right to inspect a corporation’s books and records, provided they establish a “proper purpose” reasonably related to such person’s interest as a stockholder, which for corporate wrongdoing or mismanagement requires the stockholder to establish a “credible basis” for the purported wrongdoing sufficient to warrant further investigation.
For more than twenty-five years, the Delaware courts have urged stockholders suspecting corporate malfeasance to investigate claims on a pre-suit basis through Section 220, and have sought to “maintain a proper balance between the rights of shareholders to obtain information based upon credible allegations of corporation mismanagement and the rights of directors to manage the business of the corporation without undue interference from stockholders.” Viewing such demands as a prelude to war and thus seeking to cabin Section 220 inspection rights as much as possible, corporations frequently assume defensive postures when confronted with records demands.
One defensive approach has been to establish that the “purpose” of a Section 220 demand is limited to bringing the potential claims under investigation, then attack that narrow purpose as not “proper” by lodging merits-based defenses against those potential claims. Over the past decade or so, the Court of Chancery has grappled with how best to referee this strategy within the context of the streamlined proceedings envisioned by Section 220. In AmerisourceBergen, the Delaware Supreme Court has resolved this tension, and in doing so has dealt this particular defense strategy two significant blows.
The respondent corporation in AmerisourceBergen argued that the stockholders’ purpose was limited to bringing derivative litigation because no other objective was explicitly stated in their demand. But the Court rejected the notion that a Section 220 demand related to wrongdoing must explicitly disclose any non-litigation objectives and held that in this case the demand could fairly be characterized as embracing non-litigation objectives from its reference to “other corrective measures,” including demanding that the board take remedial action. The effect of this holding, of course, is to deny corporate respondents the ability in most instances to stave off records demands by challenging the ultimate merits of the potential claims implicated by the malfeasance under investigation.
The Court also addressed (in dicta) a second argument raised by the corporate respondent: that a stockholder who demonstrates a credible basis from which the court can infer wrongdoing must also demonstrate that the wrongdoing is “actionable.” Here, the corporate defendant argued that the stockholders’ stated purpose was not proper because the claim they sought to investigate was fatally barred by a Section 102(b)(7) charter exculpatory provision and by the doctrine of latches.
In rejecting defendant’s second argument, the Court concluded that, “[i]t has become evident that the interjection of merits-based defenses—defenses that turn on the quality of the wrongdoing to be investigated—interferes with” the summary nature of Section 220 proceedings. It held that, generally, the Chancery Court should not consider “defenses that do not directly bear on the stockholder’s inspection rights, but only on the likelihood that the stockholder might prevail in another action.” Only in “the rare case in which the stockholder’s sole reason for investigating mismanagement or wrongdoing is to pursue litigation and a purely procedural obstacle, such as standing or the statute of limitations, stands in the stockholder’s way such that the court can determine, without adjudicating merits-based defenses, that the anticipated litigation will be dead on arrival, the court may be justified in denying inspection.”
In the end, AmerisourceBergen does not entirely preclude corporate respondents from utilizing the litigation-only/merits attack strategy relied on in years past, but it limits its use severely. It does this by clarifying that stockholders invoking Section 220 inspection rights do not bear the initial burdens of (i) explicitly stating their non-litigation purposes and of (ii) demonstrating the actionability of the misconduct under investigation. Rather, corporate respondents now will bear the burden of disproof by demonstrating that the stockholder’s actual purpose is other than its stated purpose.
If you have any questions regarding stockholder books and records inspection rights, please feel free to contact the authors of this article or any member of Montgomery McCracken’s Business Litigation Practice Group.