Delaware Supreme Court Grants Investor Request To Inspect Electronic Corporate Record
ATTORNEY: SAMUEL ADAMS
POMERANTZ MONITOR SEPTEMBER/OCTOBER 2019
A recent decision by the Delaware Supreme Court clarified that shareholders are potentially entitled to receive emails, text messages, and other electronic records in connection with well-founded books and records requests under certain circumstances. Previously there had been some doubt that produceable “books and records” included those stored in electronic form, with courts often limiting production to hard copy documents actually reviewed by the board. In most cases, traditional, non-electronic documents will likely be sufficient to satisfy a plaintiff’s proper purpose in a books and records action.
By way of background, many states, including Delaware, allow shareholders to request access to review corporate books and records provided, in general, that the shareholder can articulate a “proper purpose” and that the documents sought are narrowly-tailored and reasonably related to the shareholder’s proper purpose. A shareholder may inspect a corporation’s books and records for any proper purpose rationally related to the stockholder’s “interest as a stockholder.” Commonly accepted proper purposes include valuing a shareholder’s interest in a company and investigating wrongdoing, mismanagement or corporate waste. Shareholders also commonly request books and records in anticipation of serving a litigation demand on a public company.
A books and records request can be a vital tool for shareholders weighing whether to file a potential shareholder lawsuit. Documents produced in response to a books and records demand can be instrumental in providing additional evidence that allows a plaintiff to prevail on a motion to dismiss, by presenting detailed and specific information detailing the alleged wrongdoing and demonstrating that the directors participated in or known about the wrong-doing or otherwise have a conflict of interest. In recent years shareholder plaintiffs have increasingly made use of books and records demands prior to commencing litigation. In particular, the Delaware courts have admonished shareholders to use the “tools at hand” and request access to critical books and records prior to commencing certain types of shareholder lawsuits, including share-holder derivative actions and lawsuits challenging mergers and acquisitions.
In KT4 Partners LLC v. Palantir Techs., Inc., the Delaware Supreme Court reversed a lower court’s decision denying a request for access to certain electronic books and records. The plaintiff’s books and records demand sought to “investigate fraud, mismanagement, abuse, and breach of fiduciary duty” by officers and directors of Palantir. Although the trial court found that the plaintiff had shown a proper purpose, it nonetheless denied the plaintiff’s requests for the production of emails and other electronic documents related to that proper purpose.
On appeal, the Delaware Supreme Court determined that the Court of Chancery had abused its discretion by “denying wholesale [plaintiff’s] request to inspect emails” related to its proper purpose. In this instance, the plaintiff was able to identify documents that it needed and provided a basis for the court to infer that those documents likely existed in electronic form. The Delaware Supreme Court concluded that Palantir “did not honor traditional corporate formalities … and had acted through email in connection with the same alleged wrongdoing that [plaintiff] was seeking to investigate.” Making matters worse, Palantir, faced with plaintiff’s allegations, failed to present any evidence of its own that more traditional materials, such as board resolutions or minutes, even existed, much less would satisfy plaintiff’s need to investigate its proper purpose. Thus, the court took the unusual step of ordering the production of emails in addition to more traditional corporate books and records.
A clear takeaway from the court’s decision is that, if a company elects to conduct business through electronic communications, it assumes the risk that these electronic communications may be the subject of a books and records demand. To this end, the court noted that a company “cannot use its own choice of medium to keep stock-holders in the dark about the substantive information to which [the Delaware books and records statute] entitles them.” Conversely, where a company is careful to conduct all of its official business through more traditional channels, a plaintiff will likely have more difficulty demonstrating its need to access electronic communications and electronic documents in a books and records action.
Following the reasoning of the KT4 decision, the Delaware Chancery Court recently ordered the production of electronic communication in a books and records action against Facebook involving data privacy breaches. Among other categories of documents, the plaintiffs in that action sought “electronic communications, if coming from, directed to or copied to a member of the Board,” regarding the alleged misconduct. There, the court found that “[p]laintiffs have presented evidence that [Facebook] Board members were not saving their [hardcopy] communications regarding data privacy issues for the boardroom.” Limiting its production to hard copy documents, Facebook produced only a compilation of highly redacted Board minutes that contain “essentially no information regarding the relevant subject.” Accordingly, the court in that instance granted in part plaintiffs’ request to produce electronic communications, even though Facebook ad-hered to many “traditional corporate formalities” which Palantir did not.
Read together, KT4 and Facebook indicate that Delaware courts are beginning to take a more contemporary, real world approach in considering whether the production of electronic communications are necessary to satisfy a plaintiff’s proper purpose in a books and records actions. Where plaintiffs are able to present evidence that a company utilizes electronic communications in conducting official business, they will be able to present stronger arguments in favor of the production of electronic communications in books and records actions and, in the process, potentially secure the production of evidence which may, in turn, be critical in building a case at the early stages of litigation. Given the crucial role played by electronic communications in most business transactions, it is likely that production of such documents will be far more commonplace in future books and records cases.