Navigating Section 220 Demand for Corporate Books and Records
POMERANTZ MONITOR | JULY AUGUST 2023
Section 220 of the Delaware General Corporation Law (“Section 220”) grants shareholders the right to access corporate books and records, provided they fulfil the necessary “form and manner” requirements specified in the statute, and provided the demand is in furtherance of a “proper purpose.” Per Section 220, a proper purpose is one that is “reasonably related” to the shareholder’s interest as a shareholder. Most commonly, shareholders use Section 220 to investigate potential corporate misconduct, such as breaches of fiduciary duty by directors or officers, cases of mismanagement, corporate waste, or other wrongdoing, all of which have been recognized as “proper purposes” by Delaware courts.
To proceed, a stockholder must demonstrate a “credible basis” for suspecting wrongdoing or mismanagement, which is the “lowest possible” burden of proof under Delaware law. While mere speculation, curiosity, and suspicions do not satisfy it, the threshold is satisfied through documents, logic, testimony, or otherwise demonstrating that there may be legitimate issues of wrongdoing or mismanagement. Further, the Delaware Supreme Court has affirmed that “where a stockholder meets this low burden of proof … [the] stockholder’s purpose will be deemed proper under Delaware Law” and that the stockholder “is not required to specify the ends to which it might use the books and records.” Thus, a stockholder is not required to demonstrate that the suspected wrongdoing it seeks to investigate is “actionable” under Delaware law. Once a stockholder establishes proper purpose and credible basis, they are entitled to access the relevant corporate books and records that are considered “necessary” to investigate the specific wrongdoing that the stockholder has identified in their Section 220 Request.
The Delaware Court of Chancery has encouraged stockholders to avail themselves of the ‘tools at hand’ and request company books and records before filing derivative complaints and has admonished plaintiffs when they have not attempted to gather reasonable information to substantiate their allegations before filing a derivative complaint. Section 220 has thus become a popular and widely used tool for stockholders seeking to investigate corporate wrongdoing and mismanagement. This wide usage of Section 220 has led to an evolution of Delaware’s jurisprudence reflecting judicial efforts to maintain a balance between the rights of stockholders to obtain information based on credible allegations of corporate wrongdoing and the rights of corporations to manage their business without undue interference from stockholders. The “credible basis” standard forms part of judicial efforts to maintain this balance. Courts have thus ruled against plaintiffs where investigations are deemed to be “indiscriminate fishing expeditions," and thus adverse to the interests of the corporation.
In “The Paradox of Delaware’s ‘Tools at Hand’ Doctrine: An Empirical Investigation,” published by Duke University School of Law in 2019, James D. Cox, Kenneth J. Martin, and Randall S. Thomas state that the results of their study “support[s] the positive social benefits of Delaware’s innovative tools at hand doctrine.” In recent years, they found, a trend emerged with defendants increasingly treating Section 220 actions as a “surrogate proceeding to litigate the possible merits of the suit” and to “place obstacles in the plaintiffs’ way to obstruct them from employing it as a quick and easy pre-filing discovery tool.” Courts have reprimanded corporations that use such “overly aggressive” litigation tactics while responding to Section 220 demands. Pomerantz has successfully litigated against such defense campaigns by different corporations. In a case filed against Biogen where plaintiff sought to investigate potential corporate wrongdoing and mismanagement arising from a federal investigation and a former employee’s allegations in a wrongful termination suit, the Delaware Court of Chancery noted that Biogen followed “the recent trend in adopting what has been referred to as an “overly aggressive defense strategy” in opposing inspection and granted plaintiffs access to board-level materials.
In another instance, Pomerantz, along with two other firms, filed a complaint against Gilead, when Gilead employed similarly aggressive strategies against plalintiffs’ Section 220 demands. The purpose of these demands was to investigate possible wrongdoings concerning the production, marketing and sales of Gilead’s HIV drugs. In her decision, Chancellor McCormick (Vice Chancellor at the time) noted that “Gilead exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights.” Chancellor McCormick also found that Gilead’s approach called for fee-shifting since Gilead had engaged in bad faith conduct. Ultimately, defendants were sanctioned and ordered to pay Pomerantz and other plaintiffs’ counsel $1.76 million in attorney’s fees.
Another emerging trend is that stockholders are using Section 220 demands to investigate a company’s commitments to diversity and other ESG concerns. In Asbestos Workers Phila. Welfare & Pension Fund v. Scharf, No. 3:23-cv-1168 (N.D. Cal. Mar. 15, 2023), shareholders relied on information and documents received pursuant to a Section 220 demand to allege that the Wells Fargo Board disregarded “pervasive issues of discrimination” and further alleged that the bank conducted fake interviews with minority candidates. Similarly, a Tesla stockholder relied on Section 220 documents to allege that the Tesla Board fostered a company culture of tolerating sexual harassment and racial discrimination.
In a recent case on this issue, Simeone v. The Walt Disney Company (Del. Ch. June 27, 2023), the Delaware Court of Chancery rejected an action filed by a Walt Disney stockholder seeking to compel inspection of books and records relating to the company’s opposition to Florida’s “don’t say gay” law – in a stance that allegedly caused Florida’s Governor and state legislature to retaliate against the company by stripping it of special state-granted tax treatment and other benefits. In ruling against the stockholder, the Court held that he had not established a proper purpose for his Section 220 demand because the stated purpose belonged to the stockholder’s counsel, rather than to the stockholder himself. The stockholder testified that he had been solicited to make the Section 220 demand and had been put in touch with the Thomas More Society, a “public interest law firm championing Life, Family, and Freedom.” He also testified that his only purpose in requesting inspection was to “know the person or persons who were responsible for making th[e] political decision at Disney to publicly oppose” the law. The Court also held that “[t]he plaintiff is not describing potential wrongdoing. He is critiquing a business decision. A stockholder cannot obtain books and records simply because the stockholder disagrees with a board decision, even if the decision turned out poorly in hindsight.” The Court further explained that a corporation’s “choosing to speak (or not speak) on public policy issues is an ordinary business decision,” even if the topic is a “divisive” one, and even if it is “external to [the company’s] business.” The Court concluded that “At bottom, the plaintiff disagrees with Disney’s opposition to [the Florida law]. He has every right to do so. But disagreement with [a] business judgment is not evidence of wrongdoing warranting a Section 220 inspection.”
The Walt Disney case differs from the other decisions and is interesting for several reasons, one being that it focuses on the stockholder’s – not their lawyers’ – purpose, and emphasizes that even if an alleged bad corporate decision has been made, it does not necessarily mean that a wrongdoing at the level of a breach of fiduciary duty occurred. Delaware Courts have consistently emphasized that “bad” or “misguided” business decisions that do not involve legal violations typically do not qualify as breaches of fiduciary duty. Furthermore, there have been discussions among courts and experts questioning whether such decisions can be considered breaches of fiduciary duty if they are not connected to any legal violations. In any event, these spates of decisions highlight the growing trend of ESG-related litigation, which continues to be bolstered by Section 220 requests.
Given the popularity of Section 220 requests and their usefulness in investigation of corporate wrongdoings, it will be interesting to see how these trends develop and evolve.