Search DGCL Section 220

The Delaware Supreme Court recently provided guidance to corporate litigators regarding the nuances of DGCL Section 220, which most readers recognize as the statute that allows stockholders to demand certain corporate records if the prerequisites in the statute–and those imposed by countless court decisions–have been satisfied. In NVIDIA Corp. v. City of Westmoreland Police and Fire Retirement System, Del. Supr., No. 259, 2021 (July 19, 2022), a divided en banc bench of Delaware’s High Court explained in a 54-page decision why the “credible basis” requirement may be satisfied in some circumstances by “reliable hearsay”.

Regular readers of these pages will be forgiven if their reaction might be: what more can be said about the relatively simple right of stockholders to demand corporate records, in some circumstances, pursuant to DGCL Section 220–that hasn’t already been covered by the hundred or more Section 220 cases highlighted on these pages over the last 17 years, as well as the thousands of court decisions on the topic over the many decades preceding this publication? In short, when the Delaware Supreme Court speaks, those who labor in its vineyard need to listen. And one indication that this topic is not as simple as the statute might suggest, is that those with the final word on Delaware corporate law–the members of the Delaware Supreme Court–were not in complete unanimity in their decision in this case. A concurrence was not in 100% agreement with the majority opinion.

Key Takeaway

Prior to this decision, it was not well-settled whether a stockholder could satisfy the “proper purpose” requirement under DGCL Section 220 with hearsay–instead of live testimony, for example. The Delaware Supreme Court ruled that: “The Court of Chancery did not err in holding that sufficiently reliably hearsay may be used to show proper purpose in a Section 220 litigation, but did err in allowing the stockholders in this case to rely on hearsay evidence because the stockholders’ actions deprived NVIDIA of the opportunity to test the stockholders’ stated purpose.” Slip op. at 4. (emphasis added).

Overview of Background

After finding post-trial both a proper purpose and a credible basis for the requests, the trial court ordered the production of documents to investigate: possible wrongdoing and mismanagement; the ability of the board to consider a pre-suit demand; and to determine if the board members were fit to serve on the board. The trial court rejected the defenses that: the requests were overbroad and not tailored with rifled precision to what is necessary and essential for the stated purpose; no proper purpose was shown; no credible basis was demonstrated to infer wrongdoing; and the stockholder failed to follow the “form and manner” requirements–in part by changing the list of requested documents during the litigation.

Several stockholders consolidated their demands prior to suit, and 530,000 pages were produced prior to the litigation. Suit was filed in February 2020 based in part on public statements made during an earnings call. Prior to trial, the stockholders were less than forthcoming about whether they would call any witnesses, or which witnesses they would call at trial to establish their proper purpose. The Supreme Court held that the lack of pre-trial transparency by the stockholders deprived the company of the option to depose witnesses to explore the proper purpose issue prior to trial.

The Basics

Most readers are familiar with the basic Section 220 requirements, but the Court’s review provides a helpful reminder. Some of the prerequisites include:

  • Stockholders must demonstrate by a preponderance of the evidence a credible basis from which the court may “infer possible mismanagement that would warrant further investigation.” Slip op. at 18
  • The requested documents must be “essential to the accomplishment of the stockholder’s articulated purpose of inspection.” Id.

Key Highlights and Takeaways

  • The Court of Chancery has discretion to trim overly broad requests to craft a production order circumscribed with rifled precision.
  • Although a stockholder may not broaden the scope of their requests throughout the litigation, a Section 220 plaintiff may narrow their requests if they do so in good faith and such narrowing does not prejudice the company.
  • The Court observed that Section 220 cases are “summary proceedings” and such trials do not always include live testimony. Thus, the court reasoned that: “hearsay is admissible in a Section 220 proceeding when the hearsay is sufficiently reliable.” Slip op. at 38.
  • The Court cautioned that Section 220 plaintiffs should not abuse the hearsay exception, and “must be up front about their plans regarding witnesses” in the pre-trial phase of a case. Slip op. at 41. In this case the Court held that the company was deprived of the “ability to test the stockholders’ purpose”, such as through a deposition or otherwise, because the stockholders did not give the company sufficient notice about what they would rely on at trial to establish a proper purpose. Slip op. at 42-43.
  • In dicta, the Court upheld the trial court’s inference made by “connecting the dots” that the credible basis requirement was satisfied based on a combination of: insider stock sales, public statements that may have been false, and concurrent securities litigation supported by ample research. Slip op. at 45.
  • The Court restated the law that the “credible basis threshold may be satisfied by a credible showing, through documents, logic, testimony, or otherwise, that there are legitimate issues of wrongdoing.” Slip op. at 46.

The concurring opinion of one member of the High Court observed that Section 220 cases often involve the issue of whether the “stated purpose” is the “actual purpose”, which makes the truth of the stockholder’s statements on that point a key issue.  The concurrence also emphasized the importance of the distinction between a proper purpose and the threshold requirement of credible basis–and that a stockholder who is neither an employee nor an officer of a company will rarely have first-had knowledge of wrongdoing, but a typical stockholder “will always have knowledge of her purpose because it is, after all, her purpose.” Slip op. at 54. (emphasis in original).

In Sum

Although this decision may make it easier in some ways for a stockholder to prove its case in a Section 220 lawsuit, companies still have several tools at their disposal to test the basis for a stockholder’s assertion of a proper purpose and other statutory and court-made prerequisites for a Section 220 demand.

Caspian Select Credit Master Fund Ltd. v. Key Plastics Corp., C.A. No. 8624-vcn (Del. Ch. Feb. 24, 2014).

Practical Insights on Decision: This Chancery opinion is one of many examples highlighted on these pages over the last 9 years or so, of the not infrequent inefficiency and unsatisfying nature of an action based on DGCL Section 220 in which a shareholder seeks books and records of a corporation. In this instance, the defendant company made the shareholder incur the substantial time and expense of going to trial based on what I would regard as a tactic by the company to make it as expensive and time-consuming as possible to obtain the books and records sought to value the shares of the company, notwithstanding the truism that valuation has been well-established as a proper purpose for a demand under Section 220.

The company’s defense, that only a lawyer could assert with a straight face, was that the stated proper purpose was merely a pretense for another unstated, improper purpose. It took the considerable expense of discovery and a trial for the court to conclude that the stated purpose of valuation was the “actual, real”, primary purpose, and any secondary purposes would not defeat the Section 220 claim. In an instance of the “pot calling the kettle black”, the defendant claimed, unsuccessfully, that the “real” purpose of the plaintiff was to use litigation as an expensive tactic to force a purchase of the plaintiff’s shares.

Bottom line: After the expense of a trial, even though the plaintiff stockholder won, the plaintiff now has the unfulfilling task (and continuing expense) of haggling with the defendant company about what documents the company claims to have that comply with the court’s ruling to produce the requested books and records.

Concluding Comment: DGCL Section 220 as a basis to demand books and records of a company (despite the apparent simplicity of the statute and the courts’ frequent exhortation to use Section 220 before filing a plenary action), is a tool that is neither suitable for the fainthearted nor for those who lack the financial stamina to deal with recalcitrant companies. Stated another way, unless there is substantial money at stake in terms of the value of one’s shares, if a company is determined to wage a war of financial attrition, Section 220 is not an economically rational option for most non-institutional or non-substantial shareholders to exercise.

Qualcomm was sued recently in the Delaware Court of Chancery based on a request pursuant to DGCL Section 220, seeking corporate records regarding the company’s political contributions. Professor Stephen Bainbridge provides a scholarly analysis with copious citations to case law, suggesting that the prerequisites of Section 220 are not likely to be satisfied in such a claim.

Yours truly was quoted in an article about the suit in the publication called Law360, with a similar prediction.

       

Graulich v. Dell, Inc., 2011 WL 1843813 (Del. Ch. May 16, 2011).

What this case is about:

This Court of Chancery opinion involved a demand by a shareholder for books and records of Dell, Inc. for the ostensible purpose of enabling him to investigate possible mismanagement. Further summary and commentary follows, but first a word from our sponsor.

[Editor’s note: Regular readers are undoubtedly aware that in addition to the recently installed new graphics that gave this homepage its first facelift in the six years of its existence, the last few weeks may have witnessed the fewest number of case summaries in the six-plus years of this blog’s existence. The diminution in output is due to my concurrent affiliation with a new firm and the concomitant extra time devoted to that exercise in addition to the demands of paying clients. I plan to catch up imminently and I am grateful for the patience of my many (free) subscribers. Civil and constructive comments on the new graphics are welcomed.]

The Corporate Statute that this Chancery Opinion is Based on:

Section 220 of the Delaware General Corporation Law (DGCL) allows a stockholder to demand certain books and records under circumscribed circumstances if various prerequisites are satisfied. For example, in order to prevail on a Section 220 demand, a stockholder must demonstrate: (i) that she is actually a stockholder of the corporation during the relevant periods involved; (ii) certain format and content requirements of the demand have been met; and (iii) the stockholder has a “proper purpose” reasonably related to her interest as a stockholder. Moreover, the courts have superimposed the requirement of a “credible basis” for alleged wrongdoing onto DGCL Section 220 in order for one to support the stated purpose of investigating even potential wrongdoing.

Factual Background of Decision

The stockholder in this case sought books and records in order to allow him investigate possible mismanagement and thereafter to pursue derivative claims based on Dell’s sale of OptiPlex computer systems sold from 2003 to 2005. The allegation was that certain parts related to those systems required Dell to incur costs for replacement and servicing, and that the problems had a negative impact on its brand name. In addition, the allegation was that the board of Dell failed to monitor or otherwise address the situation appropriately.

Highlights of Court’s Decision

The Court rejected the demand for books and records in a thoroughly reasoned opinion that was based on three fundamental points:

(i) The claims were barred by a settlement agreement and release in a prior class action styled as In Re Dell, Inc., Derivative Litigation,

(ii) The applicable statute of limitations on any such claim (that could be brought in a later derivative action) had already run.

(iii) The stockholder did not satisfy the “proper purpose” requirement of Section 220 because the only purpose stated was to pursue a derivative suit with the data requested, and the stockholder would not be able to bring a derivative suit because he was not a stockholder during the time period in which the matters complained of were alleged to have taken place. Plus, even if that hurdle were to have been overcome, the Court cast doubt on the ability to satisfy the substantive challenge of prevailing on a Caremark claim based on the facts presented.

Short Commentary

We have written frequently on these pages about Section 220 decisions and their nuances.  See, e.g., compilation of Section 220 cases and commentary highlighted on this blog here. This most recent Chancery decision is another example of how difficult Section 220 demands for books and records can be. (Although this case may not be the best example because it seems to have been based on a comparatively weak Section 220 argument.) Many decisions from Delaware’s Supreme Court and Court of Chancery exhort practitioners to use what the courts refer to as the “tools at hand” (i.e., Section 220), to obtain detailed information from a company before filing a derivative action. However, this case demonstrates that not all efforts to obtain books and records pursuant to Section 220 prevail–despite the apparent simple provisions of the statute. And there are ample examples of a stockholder pursuing his case all the way to the Delaware Supreme Court only to be told by the court after the time and expense of that appeal, that the stockholder is not entitled to books and records based on the particular facts presented.

One “take-away” message based on the decisions summarized on this blog over the past six years, is that it is not cheap, simple or fast to pursue a Section 220 demand, especially if a company is committed to making the shareholder spend as much time and money as possible, and if the company intends to make it as difficult as possible for the stockholder to obtain any data. Admittedly, the stockholder in this case had at least 3 strikes against him before those considerations came into play.

But even in those cases where a stockholder prevails in his Section 220 demand after trial, the company may further frustrate the intent of Section 220 by playing a game of “hide the ball” and the stockholder can spend substantial money and time trying to force the company to produce all the data to which the stockholder is entitled –even after a ruling in favor of the stockholder.

Still more time and money needs to be spent if the stockholder seeks electronic data. The statistics in the business world today indicate that most data produced today is produced electronically–but  is never printed in hard paper format.

So, if a company only produces hard copies of the data requested, and refuses to produce electronic data, the stockholder is faced with spending more money to fight that issue because I am here to tell all readers that, (as hard as it may be to believe), there is no authoritative Delaware court opinion that squarely addresses the issue of whether electronic data must be produced under Section 220–even when a court has ruled that a stockholder is entitled to “books and records” under Section 220. I am co-authoring an article on that very issue that we hope to publish in the near future.

The following article appeared in the current issue of the recently debuted publication called the Delaware Business Court Insider.

Courts Clarifying Shareholders’ Rights to Information
Kevin. F. Brady and Francis G.X. Pileggi
Special to the Delaware Business Court Insider | April 13, 2011

Two recent decisions help clarify the type of information a shareholder may obtain from a corporation under Section 220 of the Delaware General Corporation Law (DGCL), and the timing of when a Section 220 suit may be brought.

In Louisiana Municipal Police Employees Retirement System v. Morgan Stanley & Co., the Court of Chancery on March 4 allowed a shareholder, Louisiana Municipal Police Employees Retirement System (Lampers), to obtain information regarding the investigation by a board committee and the report of its counsel. This follows the recent decision of King v. VeriFone by the Supreme Court, which refused to dismiss a Section 220 suit simply because it was filed after a derivative suit for which the shareholder was seeking additional details to amend the derivative complaint.

The Lampers Case

In Lampers, the plaintiff sought information to “investigate whether the board of directors of Morgan Stanley & Co. wrongfully refused an earlier demand by the shareholder that Morgan Stanley must initiate litigation against certain officers and directors for alleged wrongs arising out of the involvement by the company with auction rate securities.”

The court granted the motion to dismiss to the extent that some information was not reasonably required to investigate whether the litigation demand was wrongfully refused, but denied the motion to dismiss to the extent that the request lacked a “proper purpose.”

Notably, Lampers had previously filed a stockholder derivative action against Morgan Stanley without first using Section 220 to obtain books and records, but nonetheless asserted in the derivative action that presuit demand was futile.

Lampers had originally filed a separate derivative action in federal court in New York but that complaint was provisionally dismissed for failure to comply with Rule 23.1. The federal court, however, retained jurisdiction and set a schedule to allow for: (i) the plaintiff[s] to make a demand on the board; (ii) the board to respond; and (iii) the plaintiffs to seek any further relief necessitated by the board’s response. The federal court thereafter stayed the derivative case pending a decision by the Delaware Court of Chancery in the Section 220 proceeding.

Eight months after the litigation demand, the board hired the law firm of Simpson Thacher & Bartlett to investigate the litigation demand and eight months later the board received a report. Based upon that report, the board refused to take any action. In addition, in its reply to Lampers’ litigation demand, the board merely described the process followed by Simpson Thacher in rendering a report and recommendation. However, the board’s explanatory letter did not provide any “substantive insight” into the reasoning behind the decision to refuse to take action in response to the demand. Thereafter, Lampers submitted a demand seeking certain books and records pursuant to Section 220.

In addition to information relating to the investigation and report by Simpson Thacher, Lampers also sought a report prepared by Skadden Arps Slate Meagher & Flom in connection with the separate investigation it did in 2007 and 2008 into Morgan Stanley’s involvement with auction rate securities.

The court recited the well-established truism that “books and records actions” pursuant to Section 220 are summary proceedings that “are to be promptly tried.” The court in this instance entertained the motion to dismiss because it appeared that the underlying facts were largely undisputed, although dispositive motion practice may otherwise be inefficient in a summary proceeding, which often can be tried within approximately two months of filing.

Proper Purpose

The court observed that under Section 220(b), a shareholder must have a “proper purpose” for requesting the information the shareholder is seeking and that has has been defined as “a purpose reasonably related to such person’s interest as a stockholder.” Referring to prior decisions of both the Delaware Supreme Court and the Delaware Court of Chancery, the court explained that the stockholder plaintiff did not, by making a pre-suit demand, waive the right to claim that demand has been wrongfully refused. In that explanation, the court cited the 1996 Delaware Supreme Court decision in Grimes v. Donald (Grimes I). In addition, in its 1998 decision Grimes v. DSC Communicatons Corp. (Grimes II), the Court of Chancery decided that a request for books and records to determine whether a special committee complied with Delaware law in their analysis and rejection of a pre-suit demand — was a proper purpose,

The court also relied on Delaware Supreme Court precedent — Grimes I — for the position that a pre-suit demand does not concede the independence or the disinterestedness of the board for purposes of demand refusal analysis (as opposed to demand futility).

The court also provided a long list of exemplary “proper purposes” under Section 220 (quoting from a leading treatise on Delaware corporate law), which included:

(1) Seeking to investigate allegedly improper transactions or mismanagement.

(2) To clarify an unexplained discrepancy in the corporation’s financial statements.

(3) To investigate the possibility of an improper transfer of assets out of the corporation.

(4) To ascertain the value of stocks.

(5) To aid litigation and to contact other stockholders regarding litigation and to invite their association with the case.

(6) To inform fellow shareholders of one’s view concerning the wisdom or fairness, from the point of view of the shareholders, or a proposed recapitalization and to encourage shareholders to seek appraisal.

(7) To discuss corporate finances and inadequacies of management, and then depending on the response, to determine stockholder sentiment for either a change in management or a sale.

(8) To inquire into the independence, good faith and due care of a special committee formed to consider a demand to institute derivative litigation.

(9) To communicate with other stockholders regarding a tender offer.

(10) To communicate with other stockholders in order to effectuate changes in management policies.

(11) To investigate stockholders’ possible entitlement to oversubscription privileges.

(12) To determine an individual’s suitability to serve as a director.

(13) To obtain names and addressed of stockholders for contemplated proxy solicitation.

(14) To obtain particularized facts needed to adequately allege demand futility after the corporation has admitted engaging in backdating stock options.

The court also referred to the 2010 Delaware Supreme Court decision in City of Westland Police and Fire Retirement Systems v. Axcelis Tech Inc. for the position of Delaware law that books and records may be demanded under Section 220 for the purpose of “evaluating the suitability of directors to serve.” It was further explained that whether or not the board acted wrongfully in denying and refusing to pursue the claim was not currently at issue. Rather the issue was whether Lampers’ purpose for inspection was proper and the court found that it was. This may be compared with the March 25 Chancery Court transcript ruling in Espinoza v. Hewlett-Packard Co., which denied a Section 220 request for a report from counsel of board committee, based on attorney-client privilege and the attorney work product doctrine.

Scope of Inspection

While the language of Section 220 refers to “books and records” as the scope of inspection is limited to information that is “necessary to accomplish the stated purpose.”

In this case, the court concluded that Lampers stated a proper purpose and was entitled to obtain the information it requested, including:

(1) The minutes of any meeting of the board or the Audit Committee where the litigation demand was discussed or evaluated.

(2) Simpson Thacher’s written report and presentation to the Audit Committee in connection with the firm’s recommendation to refuse the litigation demand.

(3) The Audit Committee’s report and presentation to the board.

(4) Any documents and other records upon which the board relied.

Moreover, the court found that Lampers stated a proper purpose to obtain the engagement letter of Simpson Thacher in order to evaluate the scope of the firm’s engagement and its economic incentives. In addition, the court concluded that Lampers had a right to obtain the report prepared by Skadden Arps and those parts of the investigation by Skadden Arps that were considered by Simpson Thacher.

Lastly, the court granted leave for Lampers to pursue a future Section 220 demand in which it would be permitted to make arguments based on the materials it obtained.

A Prelude to Lampers

In a prelude of sorts to the Chancery decision in the Lampers case, the Supreme Court in King v.VeriFone Holdings Inc., a Jan. 28 opinion, also provided added clarity to practitioners regarding the “proper purpose” and related prerequisites that a shareholder must satisfy in order to successfully seek books and records under DGCL Section 220. This ruling reversed a Court of Chancery decision that found a lack of proper purpose in part because the Section 220 action was filed after a derivative suit was filed. Delaware’s high court explained that it remains preferable to file Section 220 suits to obtain books and records prior to filing a derivative suit, but following that chronology is not, per se, a fatal flaw in a Section 220 action.

In VeriFone, a shareholder filed a derivative complaint in California based on VeriFone’s restatement of financial statements. Notably, however, VeriFone provided most of the requested “categories of documents” that were sought before suit except one: “The Audit Committee Report with the results of an internal investigation regarding the issues surrounding the restatement of VeriFone’s financial statements.” The purpose of this demand, which was pursuant to the specific direction of the federal court in which the derivative suit was pending, was to use information gathered through the DGCL § 220 suit to amend the complaint, in order to assist King in pleading demand futility in the California suit.

The Supreme Court’s Analysis

Delaware’s high court recognized “investigation of corporate mismanagement” as a “proper purpose” for seeking books and records pursuant to DGCL § 220. Other cases were cited for the Delaware court’s frequent exhortations to practitioners to use DGCL § 220 to obtain detailed information prior to a plenary lawsuit, in order to obtain the detailed facts needed to successfully plead “demand futility” for purposes of satisfying Court of Chancery Rule 23.1 in derivative suits.

Delaware’s high court recognized that it may be ill-advised to file a § 220 suit after a derivative case is filed, but the court explained that such a sequence “has not heretofore been regarded as fatal.”

Three Delaware decisions were discussed at length to support the court’s reasoning that: “both this court and the Court of Chancery [have] permitted stockholder-plaintiffs to utilize the Section 220 inspection process to gather new information and replead their derivative complaints.” Two other Delaware cases that reached a different result were distinguished.

The court emphasized that it was reaffirming “long-standing Delaware precedent” recognizing that a proper purpose under Section 220 includes seeking books and records to aid in pleading demand futility in a “to-be-amended” complaint in an existing plenary derivative action.

Moreover, while rejecting the Court of Chancery’s holding that a prerequisite of a § 220 action is to file a § 220 suit prior to a derivative suit; the Delaware Supreme Court did not endorse that particular sequence as a best practice in connection with filing a § 220 suit. Although the court was sensitive to the policy issues involved with its rejection of a bright-line test for the timing of a § 220 suit, it explained that the Delaware General Assembly would need to amend the statute to impose a sequential prerequisite, and it would not be appropriate for the judiciary to do so.

Contentious, Complex and Costly

The Lampers and the VeriFone decisions highlight how Section 220 actions can be contentious, complex and costly. The tortuous procedural background particularly in VeriFone, indicates that so-called summary proceedings can be hard fought and often are. While it is rare for the members of the Delaware Supreme Court and Court of Chancery to disagree on the interpretation of basic provisions of the DGCL as in the VeriFone case, there are many decisions denying Section 220 requests. Also, these matters can be costly because as the VeriFone case illustrates, these cases are frequently appealed to the Delaware Supreme Court. And it is important to remember that after all that effort, if the plaintiffs “wins” they merely get information.

In sum, these two cases taken together clarify for practitioners that seeking data about a board committee’s investigation of alleged wrongdoing by a company’s officers and directors, as well as the report of the committee’s counsel, may be a proper purpose for a Section 220 action, and that a Section 220 case may not be dismissed for the sole reason that it was filed after a derivative case by the same plaintiff. We will have to wait and see if the Delaware General Assembly responds to the Supreme Court’s comment in VeriFone that in order for a sequential prerequisite to be part of Section 220 (e.g., requiring that it be filed prior to a derivative action), the statute must be amended to expressly provide as much.

Kevin F. Brady is a partner with Connolly Bove Lodge & Hutz in Wilmington. He is the chair of the firm’s business law group as well as chair of the information security, electronic discovery and records management group.

Francis G.X. Pileggi is the founding partner of Fox Rothschild’s Wilmington office. He practices primarily corporate and commercial litigation, with an emphasis on representing public and privately held corporations, directors, stockholders and members or managers of limited liability companies and other alternative entities.

 

 

Bosse v. WorldWebDex Corp., Del. Ch., No. 4443-CC (July 30, 2009), read letter decision here.

 In this short letter opinion, the court addressed a demand for books and records under DGCL Section 220. The court granted, sua sponte, judgment on the pleadings to a pro se plaintiff, in part due to the long history of the defendant’s failure to produce documents despite a clear right of the shareholder to those documents from the company (who was represented by counsel).

The issue presented in this short 2-page letter decision was whether “a proper purpose" was established in connection with the Section 220 demand.

The court recognized well established precedent for the position that a valuation of an interest in a privately-held company is a proper purpose under Section 220. Thus, the court required that the stockholder be given the right to inspect “such documents, board minutes and financial reports as are necessary and essential to the stated purpose of valuing his stock and determining his ownership interest in the company.”

The court ordered that the company, within ten days from the date of the letter decision, identify “specifically the records, books, reports and minutes that the company will make available for inspection and copying, at [the stockholder’s] expense, in order to facilitate its proper purpose."

I have summarized many cases on this blog regarding Section 220 of the Delaware General Corporation Law (DGCL) which provides the right of a shareholder to demand books and records if the prerequisites in the statute are satisfied. (e.g., just type 220 in the search box in the right margin.) The current issue of the Delaware Law Review  just arrived in the mail and the lead article provides an analysis of recent 220 cases. See  S. Mark Hurd and Lisa Whittaker, Books and Records Demands and Litigation: Recent Trends and Their Implications for Corporate Governance,  9 Del. Law Rev. 1(2006) (published by the Delaware State Bar Association, www.dsba.org.)

In Polygon Global Opportunities Master Fund v. West Corp., 2006  WL 2947486 (Del. Ch., October 12, 2006), read opinion here, the Delaware Chancery Court addressed another request for books and records under DGCL Section 220 by a hedge fund and found it wanting, as explained in this thoroughly reasoned opinion. For another recent Chancery decision, Highland Select, denying a Section 220 request by an equity fund, due at least in part to the request being overly burdensome in scope, see the summary on this blog here.  In that  Highland case,  trial was held about 6 weeks after the complaint was filed.

 I have summarized about 30  Delaware decisions on DGCL Section 220 demands  on this blog over the last 18 months or so (which can be searched by inserting "220" in the search box at the right margin of this blog). One theme that I see is that an enormous amount of time and money can be spent in an effort to obtain books and records under DGCL Section 220 without success. To look at the statute one might think it is a rather pedestrian procedure to follow in order for a shareholder to obtain books and records of the corporation in which she owns shares, but the cases suggest that it requires careful observance of the statutory requirements, which do not all lend themselves to mathematical precision.

This case involved a trial that took place about 2 months after the complaint was filed. To state the obvious, the limited scope of the trial was for the purpose of determining entitlement to the documents sought–something  that in the ordinary case one would obtain in routine discovery.

The court noted that the plaintiff hedge fund often invested in arbitrage situations and in this case heavily invested in the defendant corporation following the announcement of a going private transaction. The stated purpose of the demand under 220 was to: (i) value their stock; (ii) determine whether to seek appraisal; (iii) investigate breaches of duty; and (iv) communicate with other stockholders.

 The court found no entitlement in this case under Section 220 because the plaintiff: (i) had already obtained "all necessary, essential and sufficient" data to determine whether to seek appraisal; (ii) did not have a proper purpose to investigate wrongdoing; and (iii) did not seek a stockholder list for a proper purpose.

 Notably, after suit was filed, the court asked the plaintiff to "prepare a chart" linking :(i) the documents sought with (ii) the proper purpose for each document sought, as asserted in the demand for records (resulting in a pared-down list prior to trial).

 The court made clear that valuation of shares is a proper purpose for a Section 220 demand, especially in the context of determining whether to pursue an appraisal–but if the data is already available in the public domain (e.g., in an SEC filing) the Section 220 claim may be obviated. It was also made clear that SEC Rule 13e-3 requires, as here, more data about valuation in a going private transaction than would otherwise be available. This highlights the different lens through which a demand involving a public company  will be viewed as opposed to a closely-held one. Although there is no per se rule that a Section 220 claim for valuation purposes may be mooted in a squeeze-out merger subject to disclosures under SEC Rule 13e-3, in this case that was the result.

 It was also made clear (as stated in many cases) that a Section 220 case is not a substitute for normal discovery in a regular lawsuit, nor will it be allowed as a substitute for discovery in a subsequent  appraisal action. The  scope of documents available in regular discovery under Rule 34 is much different than the scope of documents available under Section 220 (citations omitted).

Referring to DGCL Section 327 and related cases, the court emphasized the important public policy against "the evil of purchasing stock in order to attack a transaction which occurred prior to the purchase of the stock" (citations omitted)(i.e., purchasing a basis for litigation). Due to the claim here that the investigation into wrongdoing related to an event prior to the purchase of stock, the court observed that the plaintiff did not have standing for a derivative claim; nor did it have standing to make allegations based on entire fairness.

 Regarding its alleged interest in communication with other stockholders, though the burden is on the corporation in this type of request to establish an improper purpose for the request of a stockholder list, and is rarely denied, here the reason for the request was based on the 2 prior reasons which were rejected by the court. (e.g., the list was not requested for a proxy solicitation but merely to "share" what it got from the Section 220 case and to inquire about  anyone else who might be seeking appraisals.) In sum, on this point, the court said that simply because a stockholder may communicate with other stockholders based on Federal Securities Laws, that fact in and of itself does not support a proper purpose under Section 220.

 Though it might be tempting to do so, I don’t think this case can be read as imposing a higher hurdle for hedge funds making a Section 220 demand. Rather, the relevant background of the stockholder, to the extent it provides insight into the stockholder’s intent in buying the stock, and its "end-game", will be  part of the court’s analysis of whether the requirement of a "proper purpose" has been satisfied.

If this blog format lent itself to footnotes, I would add one in closing here, but instead I will mention this aside as a final sentence. As a human interest anecdote, few people have the pleasure of seeing in a court’s opinion in a case that one has argued, that the court has cited to an article or a treatise that one has written in the same case (especially when that same lawyer prevailed). So it is in this case that my friend Michael Pittenger was on the winning side, and the court in its opinion cited to a leading treatise that Mike co-authored, titled: Donald Wolfe and Michael Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery (2006). It must make victory even sweeter. Congratulations, Mike.

In  Kaufman v. CA, Inc., read decision here, the Chancery Court denied a Motion to Compel in a proceeding for books and records under DGCL Section 220.  The company provided considerable documentation but the stockholder thought she was entitled to additional documents.  The court disagreed.

 The court denied the request for more records and determined that the stockholder:

 “failed to sufficiently articulate why the additional documents are either necessary or essential to her concededly proper purpose and thus failed to meet the standard under 8 Del. C. Section 220. "

 In a previous opinion, the Chancery Court denied a Motion to Stay the Section 220 case in favor of the investigation being conducted by the company’s Special Litigation Committee.  See Kaufman v. Computer Associates International, Inc., 2005 WL 3470589 (Del. Ch., Dec. 13, 2005). [Note: CA, Inc. was formerly known as Computer Associates.]  After that 2005 decision, CA agreed to produce the requested documents, subject to any applicable privileges.  The plaintiff in this case filed a Motion to Compel after that production, believing that she was entitled to certain documents that were not produced.

 The court noted the somewhat unique procedural posture of the motion, styled as one to compel, in a Section 220 case in which the defendant has conceded the propriety of the Section 220 demand and has already furnished substantial documentation.  Thus, the motion required the court to consider issues that usually arise in the course of a substantive Section 220 trial.  The court summarized the limited nature of  a proceeding to consider a demand for books and records to which one is entitled, if the prerequisites of Section 220 have been satisfied.  That is, “when a books and records action is brought with the goal of evaluating a possible derivative suit, the books and records that satisfy the [220] action are those that are required to prepare a well pleaded complaint.  Of course, this means that Section 220 is not meant as a replacement for discovery under [Rule] 34.”  (emphasis mine.)

 In denying the request for additional documents, the court observed:  “that a document would be potentially discoverable under Rule 34 does not make it necessary and essential under Section 220” (emphasis mine.) This is another example, among others summarized on this blog, that a Section 220 case is not always a simple matter.