The Rise of Books and Records Demands Under Section 220 of the DGCL

Roger A. Cooper is partner and Vanessa C. Richardson, and Kimberly Black are associates at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary Gottlieb memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

In recent years, in part in response to decisions like Corwin that have raised the pleading standard for stockholder plaintiffs, the Delaware courts have encouraged stockholders to seek books and records under Section 220 of the Delaware General Corporation Law (DGCL) before filing stockholder derivative or post-merger damages suits, and—in response—each year more stockholders have done so. As a result of this trend, we have already seen several important decisions addressing books and records demands in 2019. These decisions have (i) clarified the types of documents that may be obtained, including (in some limited circumstances) personal emails or text messages; (ii) explained when a stockholder’s demand will be denied as impermissibly lawyer-driven (and when it will not be); and (iii) described the threshold showing of suspected wrongdoing that stockholders must make. As the plaintiffs’ bar makes more use of Section 220, these are important issues for boards of directors to consider.

In Limited (And Unusual) Circumstances, Emails And Text Messages May Be Available Under Section 220

In a dispute between Palantir and one of its stockholders, KT4 Partners, regarding a proposed amendment of an investors’ rights agreement, the Delaware Supreme Court recently clarified when emails may be available as part of a books and records demand. [1] The Court of Chancery had denied KT4’s request to inspect emails relating to Palantir’s conduct in amending the investors’ rights agreement. On appeal, KT4 argued that the emails were necessary to its investigative purpose and that Palantir’s formal board-level materials were not sufficient because there was evidence that Palantir “does much of its business informally.” Indeed, Palantir conceded at oral argument that “there are no board-level documents,” but “there may very well be emails.”

In analyzing whether emails should be produced in connection with the books and records demand, the Delaware Supreme Court, in an opinion by Chief Justice Strine, explained that “if a company . . . decides to conduct formal corporate business largely through informal electronic communications [rather than through formal minutes and resolutions], it cannot use its own choice of medium to keep shareholders in the dark about the substantive information to which Section 220 entitles them.” Chief Justice Strine emphasized that Section 220 “must be interpreted in light of companies’ actual and evolving record-keeping and communication practices.” But he added that the decision “does not leave a respondent corporation like Palantir defenseless and presumptively required to produce emails and other electronic communications. If a corporation has traditional, non-electronic documents sufficient to satisfy the petitioner’s needs, the corporation should not have to produce electronic documents.”

Another important decision on the scope of Section 220 arose out of litigation brought by the founder of the Papa John’s pizza chain, John Schnatter against the Papa John’s board. [2] Schnatter, who was ousted as CEO and board chairman following his controversial comments about the NFL player protests during the national anthem, sought various documents relating to his termination, including a request to obtain certain emails and text messages from directors’ personal accounts and devices. [3]

The company resisted the demand as too personal and too broad, arguing that “Schnatter is just curious about what his fellow fiduciaries were saying about him.” However, Chancellor Bouchard noted that the production was limited to communications reflecting any consideration by the board of changing Schnatter’s relationship with the company, including assessments of Schnatter’s behavior or performance in his various roles at the company, during the specified time period. The Court found that to be sufficiently precise for the purposes of Section 220.

The Court went on to say that “[a]lthough some methods of communication (e.g., text messages) present greater challenges for collection and review than others, and thus may impose more expense on the company to produce, the utility of Section 220 as a means of investigating mismanagement would be undermined if the court categorically were to rule out the need to produce communications in these formats.” Noting that the Court of Chancery has both granted and denied access to personal email accounts and devices in Section 220 actions, [4] the Court found that if the directors used personal accounts and devices to communicate about changing the company’s relationships with Schnatter, then they should expect to have to provide that information pursuant to Section 220. The Court explained that this was not a bright line rule, but that a court “should apply its discretion on a case-by-case basis to balance the need for the information sought against the burdens of production and the availability of the information from other sources.”

Stockholder’s Proper Purpose Must Align With Counsel’s Purpose

After Calgon Carbon Corporation merged with Kurarary Company, Ltd., an investment fund and former Calgon stockholder sent a books and records demand requesting information about the retention of Calgon’s chairman and CEO, bonuses for certain board members, and equity awards to directors and officers. [5] The fund sought to investigate whether these incentives were the true motivation for the merger. Calgon declined to produce any books and records, and the fund sued.

In defense, Calgon argued that the fund did not have a proper purpose under the statute, and the Section 220 demand was an impermissibly lawyer-driven effort. [6] In particular, Calgon noted that the fund had portfolio monitoring agreements with its counsel at Robbins Geller—the law firm who drafted and sent the books and records demand—to monitor its investments, identify potential mismanagement or wrongdoing, and pursue appropriate legal action. Based on testimony at trial, the Court of Chancery held as a factual matter that the fund’s purpose was not different from that of counsel, and thus permitted a limited inspection to go forward. But the case is a helpful reminder that books and records actions may be dismissed if discovery shows that there are differences between the stockholder’s and its counsel’s purposes in bringing such actions.

Vice Chancellor Zurn also determined that, given the nature of the information sought, the fund was unlikely to uncover any meaningful answers in the more traditional, formal books and records, such as minutes or letters between the companies. Thus, the Court found that the production of emails by the company was necessary and essential to the fund’s proper purpose. This included the personal emails of management, but only to the limited extent that they were not duplicative of emails from company emails and devices.

Requirement To Set Forth A Credible Basis To Suspect Wrongdoing Is Not A “Speed Bump”

When Tempur Sealy’s contract with one of its largest customers, Mattress Firm, terminated unexpectedly and breach of contract litigation ensued, stockholder David Hoeller sought books and records in order to investigate mismanagement and potential breaches of fiduciary duty. [7] At trial, Hoeller’s attorney argued that large customers don’t just leave “at the drop of a hat” and added that “Something is off. And under Delaware law, that’s enough to get books and records.”

Vice Chancellor Slights disagreed, finding that Hoeller had not set forth a credible basis to suspect wrongdoing. He described the mismanagement theory as “in essence, a ‘where there’s smoke there’s fire’ syllogism.” He concluded that “[i]f that were enough to trigger inspection rights under Section 220, the printers and copiers of Delaware corporations would be humming day and night to satisfy the curiosities of stockholders who wondered why their fiduciaries had failed to ‘close the deal,’ or negotiate a ‘better deal.’”

Vice Chancellor Slights noted that “this Court does not hesitate to enforce inspection rights when the stockholder meets that burden and demonstrates that he has satisfied the statutory form and manner requirements.” But he emphasized that “the court cannot view the stockholder’s burden as a mere speed bump.” Thus, he concluded that “in the absence of evidence of a fiduciary duty breach, the investigation of a decision that falls squarely within the business judgment rule cannot be a proper purpose as it provides no claim against corporate fiduciaries for the stockholder to pursue.”

* * *

These decisions show that, at the same time that the Delaware courts are raising the pleading bar for many kinds of stockholder lawsuits, they are increasingly willing to permit stockholders to gain access to board documents, including emails (even, in some cases, personal emails and text messages) where there are gaps in the board’s minutes and other formal materials, although such stockholders must continue to make a threshold showing that they have a proper purpose and legitimate need before the court will order such records turned over. Boards should therefore be aware that their emails and/or text messages may be subject to stockholder inspection rights, and should take steps to ensure their minutes and other means of formal recordkeeping are robust enough to ward off any future argument that such records are incomplete, thus requiring the production of emails and/or text messages.

Endnotes

1KT4 Partners LLC v. Palantir Techs. Inc., No. 281, 2018, 2019 WL 347934 (Del. Jan. 29, 2019).(go back)

2Schnatter v. Papa John’s Int’l, Inc., C.A. No. 2018-0542-AGB, 2019 WL 194634 (Del. Ch. Jan. 15, 2019).(go back)

3Stockholders have also begun to seek books and records relating to board investigation and response to sexual misconduct allegations. See, e.g., Morrell v. Alphabet Inc., C.A. No. 2019-0081-KSJM (Del. Ch. 2019).(go back)

4The court cited Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 792-93 (Del. Ch. 2016) (granting access to CEO’s personal email account) and In re Lululemon Athletica Inc. 220 Litigation, 2015 WL 1957196, at *6-7 (Del. Ch. Apr. 30, 2015) (denying access to directors’ personal email accounts).(go back)

5Inter-Local Pension Fund GCC/IBT v. Calgon Carbon Corp., C.A. No. 2017-0910-MTZ, 2019 WL 479082 (Del. Ch. Jan. 25, 2019).(go back)

6Calgon cited Wilkinson v. A. Schulman, Inc., 2017 WL 5289553 (Del. Ch. Nov. 13, 2017), where the Court of Chancery declined to order a production of books and records under Section 220 because “an entrepreneurial law firm initiate[d] the process, draft[ed] a demand to investigate different issues than what motivated the stockholder to respond to the law firm’s solicitation, and then pursue[d] the inspection and litigate[d] with only minor and non-substantive involvement from the ostensible stockholder principal.”(go back)

7Hoeller v. Tempur Sealy Int’l, Inc., C.A. No. 2018-0336-JRS, 2019 WL 551318 (Del. Ch. Feb. 12, 2019).(go back)

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