A recent post-trial decision from the Delaware Court of Chancery denied a claim for corporate books and records based on DGCL § 220 after finding that there was no credible basis for wrongdoing to support the stated investigative purpose for the demand. Hoeller v. Tempur Sealy International, Inc., C.A. No. 2018-0336-JRS (Del. Ch. Feb. 12, 2019). Section 220 cases are among the most common forms of Delaware corporate litigation. (In terms of the number of recent Delaware cases highlighted on this blog, it might only be outnumbered by forum selection clause cases.)
About 100 or more Delaware court decisions on Section 220 have been highlighted on these pages over the last 14 years. Regular readers will recall many commentaries about Section 220 that include this lawyer’s respectful skepticism, or lack of enthusiasm, for Section 220 as a tool to obtain information as part of one’s preparation for a plenary complaint. To the extent that Section 220 is a tool, the decision highlighted in this post supports the view that in some cases Section 220 may be more akin to a sledgehammer than a scalpel, to the extent that Section 220 can often be expensive and time consuming and unsatisfying as a means of obtaining information from a corporation by a stockholder.
For busy readers, the most noteworthy aspects of this 39-page decision can be explained through the use of bullet points to highlight the court’s comprehensive and well-reasoned review of the facts and law involved in an unsuccessful Section 220 claim.
This case involved a demand for corporate books and records in connection with the termination of a long-term corporate customer relationship which accounted for over 20% of the sales of the defendant company. This important relationship was the subject of alleged misrepresentations that were allegedly more optimistic about the future of the relationship than was warranted. Although some documents were produced in response to a pre-suit Section 220 demand, the complaint in this case was filed when additional documents demanded were not provided.
Although internal Chancery guidelines suggest a trial within about 90 days of a complaint, the trial in this case was held within a still comparatively prompt 6-months after the complaint was filed, in November 2018. This February 2019 post-trial decision provides for a relatively quick determination, however unsatisfying to the plaintiff, although prior Section 220 cases highlighted on these pages indicate that when Section 220 cases are appealed, and in some cases remanded, litigation involving Section 220 conceivably could last for several years.
Some of the key legal principles that can be found in this post-trial opinion include the following well-known prerequisites for a Section 220 claim, and important nuances of those requirements, many of which are not expressly stated in the statute:
- The prerequisite of a “proper purpose” for inspection is defined as one that is reasonably related to the interest to the plaintiff as a stockholder.
- Although the desire to investigate mismanagement or wrongdoing is a recognized proper purpose, a stockholder must prove by a preponderance of the evidence that it has presented a “credible basis” from which the court can infer that the alleged wrongdoing occurred. Credible basis requires merely “some evidence” of wrongdoing–and not that wrongdoing actually occurred.
- A stockholder must also state the reasons why he seeks to inspect books and records. That is, what the plaintiff will do with the information or the goal of the investigation. The court applies this requirement to avoid fishing expeditions. In the absence of evidence of a fiduciary duty breach, where a decision falls within the business judgment rule’s protection, the proper purpose requirement fails as there is no claim for a stockholder to pursue in that situation. (Also, for example, though valuation is a well-established Section 220 proper purpose, some cases have required an explanation about the reason a valuation is sought.)
- Where the purpose of a stockholder is based on the possible breach of the duty of oversight, such as in a Caremark claim, a stockholder must provide “some evidence” from which the court may infer that the board “utterly failed to implement a recording system or ignored red flags.” Moreover, in that context, there must be evidence of non-exculpated corporate wrongdoing in order to survive a defense (in the event that a corporation has a Section 102(b)(7) provision).
- In this case, there was an allegation that there were misrepresentations about the future of important customer relationships, but the court found that there was insufficient evidence to satisfy the “credible basis” requirement.
- In addition, the court referred to prior cases in which the plaintiff could not explain the basis for the wrongdoing that was being investigated or the need for the documents that were requested. In those prior cases, the court found that it was the attorneys who were the driving force behind the litigation and not the plaintiff that was requesting the documents. Although the court suspected that to be applicable in this matter, the court did not deny the claim on that basis, but rather reasoned that: “the plaintiff has failed to proffer even a scintilla of evidence to support a credible basis that a claim may exist” under Caremark.
- The court also reasoned that the fact that active negotiations failed to lead to a deal with a key customer does not support a Caremark claim, especially based on evidence that the board was apprised of, and at times involved in, the negotiations.
- An important aspect of the court’s decision is the following rationale: “Disagreement with a business decision, in the absence of evidence from which the court may infer a possible breach of fiduciary duty, does not create a credible basis from which the court can infer mismanagement.” See Slip op. 26-27, n. 90.