This Delaware Court of Chancery opinion is notable for denying, after trial, a demand for books and records of a publicly held company for purposes of valuation and to seek documents under Section 220 to investigate alleged mismanagement based on Caremark claims.  Beatrice Corwin Living Irrevocable Trust v. Pfizer, Inc., C.A. No. 10425-JL (Del. Ch. Sept. 1, 2016). This opinion provides an excellent explanation and example of a successful defense to a demand by a stockholder for corporate records.

This is the second Section 220 opinion within the span of a few days by former Master in Chancery LeGrow, who is now a Delaware Superior Court Judge, but was appointed to decide these cases as a Vice Chancellor-by-Designation under Del. Const. art. IV § 13(2). The prior case was also highlighted on these pages.

Background:

The stockholder seeking books and records under Section 220 in this matter is a trust. The two stated purposes for the demand were both proper purposes but they still did not satisfy the nuanced requirements established by case law which must be satisfied in order for the proper purpose requirement to be met. The purposes for demanding books and records in this case were to investigate mismanagement of alleged Caremark claims for failure to disclose the amount of tax liability for the billions of dollars in revenue that was “located” outside the United States–if the funds were repatriated into the U.S. But the company had no plans to repatriate those funds in the United States, at which time they would be subject to taxation. The company maintained that it had no foreseeable plans to repatriate the funds and therefore there was no need to determine the tax liability. Moreover, they were not required to do so under the applicable accounting standards based in part on their position that to do so was not practicable.

The plaintiff maintained that nonetheless it was a violation of the board’s fiduciary duty of oversight not to determine the amount of potential tax if the funds were repatriated, and they claimed that would have an impact on the valuation. The Court disagreed based on a careful and thoughtful analysis.

Analysis:

The court provided the public policy reasons why it must balance the interests of a stockholder in obtaining books and records with the duties of the board of directors to manage the affairs of the corporation under DGCL § 141. This opinion provides excellent recitations of important principles of corporate litigation and corporate governance involved in Section 220 demands. The many nuances of this common claim as established by case law over the years are explained in lucid fashion.

The sole issue in this case was whether the plaintiff satisfied the prerequisites for establishing a proper purpose for the inspection. The court found that the trust failed to satisfy the necessary elements of a proper purpose which in this case meant that the plaintiffs neither: (i) established that they have a credible basis to investigate mismanagement or wrongdoing based on their Caremark allegations, (ii) nor have they shown that the tax issues for which they sought information would have any material impact on the valuation of the company.

Importantly, the court explained that in order to satisfy a proper purpose for investigation of mismanagement, “mere suspicion” or “subjective belief of wrongdoing, without more, is not sufficient to stay a proper purpose.”

The court provides a very useful explanation of the details that would satisfy the credible basis standard when a Section 220 demand alleges the failure of the board to fulfill its duties under Caremark.

Compare the case cited at footnote 39 in which a successful 220 case based on a Caremark claim was recognized by the Court of Chancery. See Oklahoma Firefighters Pension and Retirement System v. Citi Group, Inc., 2015 WL 1884453, at *5-6 (Del. Ch. Apr. 24, 2015).

This opinion is also helpful to explain those situations in which a publicly held company can successfully defend against a demand for books and records when the purpose stated is valuation and there has not been a satisfactory justification for explaining why the documents requested are necessary for purposes of valuation – – or not otherwise publicly available.

Commentary:

This opinion should be read together with the opinion by Vice Chancellor-by-Designation LeGrow which was published within a few days of this decision in the matter of Bizzari v. Suburban Waste, highlighted on these pages here, in which the demand for corporate records by a director was denied based on somewhat unusual facts involved in that case.

Both of these cases involve post-trial denials of Section 220 demands. Readers of these pages over the years will be forgiven for perceiving a constant refrain in the commentary on many of the Section 220 cases highlighted on these pages in which one might detect a theme that Section 220 cases can be quite expensive and time-consuming and, after trial, do not always result in any substantial document production for the plaintiff.

Why this Case is Noteworthy: The Court of Chancery’s opinion in Laborers’ District Council Construction Industry Pension Fund v. Bensoussan, C.A. No. 1123-CB (Del. Ch. June 14, 2016), is the second decision from the Court of Chancery in two months that provides a reasonable basis for skepticism about whether, as a practical matter, plaintiffs’ attorneys should wait for the results of a Section 220 action before filing a plenary derivative suit. This case involves the popular Lululemon brand of athletic apparel, and allegations of insider trading at the company.

Overview: This opinion needs to be viewed in the context of a Chancery opinion issued last month styled In Re Wal-Mart Stores, Inc. Delaware Derivative Litigation, in which the court found that Delaware derivative litigation was barred due to a prior dismissal in another state of a derivative suit that was filed involving similar claims. The plaintiffs in that related litigation in another state, that was dismissed with prejudice, did not use Section 220. In the Wal-Mart case, as in the instant case, the Delaware plaintiffs waited until their Section 220 claims were litigated before filing their plenary action. By that time however, the litigation that was filed earlier in another jurisdiction, and which was not delayed by Section 220 demands, was dismissed. The Court of Chancery in this case found that the additional information that was obtained through the Section 220 action was not a sufficient reason to avoid the principles of issue preclusion, and claim preclusion, that prohibited the Delaware case from proceeding.

Readers should closely review the 40-page decision, but among several highlights include the following:

Procedural Background:

This litigation was preceded by two separate Section 220 actions. In one of those actions, after trial, the court largely rejected the request for books and records under Section 220. In the other Section 220 action that preceded this litigation, the court ordered the production of some documents but still a motion to compel was required because of a dispute about attorney/client privilege. That dispute resulted in a written opinion that was highlighted on these pages here. See In Re Lululemon Athletica Inc. 220 Litigation, Cons. C.A. No. 9039-VCP (Del. Ch. Apr. 30, 2015).

That decision on Section 220 issues was rendered approximately two years after the first Section 220 litigation was filed in Delaware as a prelude to the instant decision in the plenary case. My comments at the above link regarding the Section 220 opinion, and the shortcomings of Section 220 in general, apply here as well.

Key Takeaway:

The court found that simply because the plaintiffs and their counsel in the New York litigation did not first file a 220 action, or wait for a 220 action to conclude, that fact alone did not, ipso facto, make the plaintiffs in that derivative case inadequate representatives for that litigation. See page 32 and footnote 69 – 70 and accompanying text. See also footnote 75 referring to the Delaware Supreme Court opinion in Pyott, highlighted on these pages, which held that not using Section 220 prior to a derivative action does not create an irrebuttable presumption of inadequacy of representation.

As Frank Reynolds of Thomson Reuters reports, the long-running effort of a stockholder to obtain additional documents from Wal-Mart in a Section 220 proceeding appears to have reached a conclusion, though it may still be the subject of second appeal. Frank Reynolds reports that the Court of Chancery ruled from the bench on May 7 that Wal-Mart should not be held in contempt and the plaintiff was not correct in asserting that Wal-Mart failed to comply with the Supreme Court opinion.

Prior posts on these pages have highlighted the Delaware Supreme Court decision ordering Wal-Mart to produce certain documents in response to a Section 220 demand, with exceptions applicable to the attorney-client privilege. Subsequently, the stockholder argued in the Court of Chancery that Wal-Mart did not comply with the ruling of the Supreme Court to the extent that the retailer did not produce all the documents that ruling required.

Delaware decisions have often instructed lawyers to use DGCL Section 220 as one of the “tools at hand” to acquire details and data about potential claims before filing a plenary lawsuit. The saga of the Wal-Mart proceedings involving Section 220, and other cases noted on these pages over the last ten years, support the observation that Section 220 can be a blunt instrument, more akin to a sledgehammer than a scalpel, and utilization of the instrument is often expensive and time-consuming as well as unsatisfying.

Oklahoma Firefighters’ Pension & Retirement System v. Citigroup, Inc., C.A. No. 9587-ML (VCN) (Del. Ch. Apr. 24, 2015).

This Delaware Court of Chancery opinion allowed an inspection of books and records pursuant to DGCL Section 220 in order to investigate mismanagement and possible breaches of fiduciary duty by the directors and officers of Citigroup in connection with allegations of fraud by its Mexican subsidiary.  The plaintiff also sought to investigate, in contemplation of derivative litigation, the disinterest of the board to determine whether pre-suit demand would be excused.  It is not surprising that such a demand would be granted in light of the many exhortations by the Delaware courts that Section 220 should be used prior to filing a plenary complaint asserting Caremark claims.

More noteworthy is a practical commentary on procedural points.  The initial demand pursuant to DGCL Section 220 was made on March 17, 2014.  A trial on the paper record was held in June 2014 before a Master in Chancery.  Exceptions to the prompt decision of the Master were submitted by Citigroup after which the parties briefed those exceptions and the Master promptly issued a Final Report and recommendation.  In October 2014, Citigroup filed its Notice of Exception to the Master’s Final Report.  The final arguments were submitted to the Court of Chancery in December and this decision followed.

The point is, that it took more than a year, through no fault of the court, to reach a final decision — and after all that effort, including the work of no less than seven attorneys (listed on the first page of the opinion) from three offices of an AmLaw 100 Law Firm opposing the demand, the winning plaintiff now enjoys the prize of having the right to receive documents that it hopes will support a claim in a plenary lawsuit.  So much for a statute that appears on its face to be simple to use and which provides for summary proceedings. The many cases highlighted on these pages on this topic suggest that Section 220 litigation is not always simple corporate litigation.

Fuchs Family Trust v. Parker Drilling Company, C.A. No. 9986-VCN (Del. Ch. March 4, 2015). This opinion of the Delaware Court of Chancery analyzes a stockholder demand pursuant to DGCL Section 220 seeking information concerning violations by the company of the Foreign Corrupt Practices Act (the “FCPA”).  The court rejected the stockholder request for documents in this post-trial opinion based on a paper record, which would reveal identities of those who allegedly violated the FCPA.

After explaining the nuances and prerequisites of a stockholder demand under Section 220, the court explained in a 20 page opinion with 57 footnotes why the stockholder was not entitled to any documents.  This is a highlight of the basis for the court’s decision.  The court explained that:

Even if a plaintiff demonstrates a proper purpose [under DGCL § 220], that plaintiff is not entitled to inspect all the documents that he or she believes are relevant or even likely to lead to information relevant to that purpose.  The scope of inspection . . . is limited to those documents that are necessary, essential and sufficient to the stockholder’s purpose.  A requesting stockholder bears the burden of proving that the books and records sought are essential to accomplish its purpose.  (footnotes omitted.)

The court held that the stockholder did not satisfy the foregoing prerequisite because it already had sufficient information to make a demand on the board to take further action against wrongdoers even if it did not know the identity of the wrongdoers.

This case is another example of how expensive and lacking in simplicity Section 220 cases can be.  In my view, unless a stockholder has a substantial amount of  money at stake, and is willing to spend a considerable amount of time and money to obtain those documents, Section 220 is not a cost effective way to obtain records from a company – – especially if that company is determined to make it as difficult and as expensive as possible for a stockholder to exercise her rights under Section 220.