Realigning Stockholder Inspection Rights

Access to corporate information plays a pivotal role in stockholder litigation. One key to that access is stockholders’ statutory right to inspect a corporation’s books and records prior to filing litigation, enshrined in the Delaware General Corporation Law’s Section 220. In the context of derivative actions – i.e., actions brought by a stockholder on behalf of a company – Section 220 takes on an even greater importance. In order to maintain standing to pursue those claims, the stockholder plaintiff either must have made a wrongfully refused demand of the relevant board that it institute litigation, or must proceed on a theory that making such a demand would have been futile to begin with.[1] Plaintiffs in Delaware, a leading jurisdiction for corporate disputes, tend to pursue a theory that the demand would have been futile for a variety of reasons, not least of which is the more onerous standard to show that a demand was wrongfully refused.[2] Yet stockholders face a heightened pleading standard even to prove that a demand would have been futile. That heightened pleading standard is necessary because derivative claims inherently belong to the company, not its stockholders. Nonetheless, the role of information in stockholder derivative suits is at times not only about winning on the merits but having a chance to litigate those merits at all.

For years, Delaware courts have urged stockholder plaintiffs to use all the “tools at hand” to gather information before filing a derivative complaint to strengthen their allegations to meet that heightened pleading standard.[3] One of those tools, Section 220’s inspection rights, has become all but a requirement for most successful derivative actions. Two recent shifts in the case law, however, present unique challenges for both corporate defendants and stockholder plaintiffs involving statutory inspection rights.

First, Delaware courts have expanded the scope of books and records available under Section 220 to include emails, text messages, and other electronically stored information (ESI) that otherwise would not have been accessible to prospective plaintiffs until the plenary discovery process.[4] The blurred distinction between pre-suit Section 220 inspections and post-pleadings discovery is burdensome for companies and can put corporate defendants in a tough spot to comply with wide-ranging demands under Section 220 without the well-developed rules and procedures that govern similar post-pleadings discovery. Second, since the Delaware Supreme Court’s decision in California State Teachers’ Retirement System v. Alvarez[5] – which found a stockholder plaintiff who pursued a Section 220 inspection and subsequent derivative action in Delaware precluded by the dismissal of a hastier, first-filed action in another jurisdiction – Delaware plaintiffs have become vulnerable to a risk of preclusion due to the extra time (often a few months, but sometimes years) required to exercise their inspection rights.

The first trend makes Section 220 more expensive and riskier to litigate for companies, with little perceived upside to the companies from the prior status quo of a more limited statutory inspection right. Whereas companies may have been willing to freely give certain formal books and records like minutes and board decks without fuss in the past, the current state of Section 220 makes it likely that stockholders will press for far more expensive and burdensome ESI records. This increases the incentive for companies to push back to try and narrow the scope, but that is made more difficult by the relative lack of guidelines and procedures when compared with plenary discovery disputes.[6] The second trend exposes stockholder plaintiffs to a risk of preclusion merely for doing what they have been asked to do. And because each trend both harms and benefits one side of the “v.” – stockholders likely enjoy and appreciate the increased scope of Section 220 demands, while companies likely enjoy the ability to preclude strong complaints in favor of weaker ones – a private ordering solution may be challenging to implement.

After examining these trends and the issues surrounding Section 220, we propose a novel way to preserve Delaware courts’ Section 220 policies while minimizing those concerns: limited, pleadings-stage discovery for derivative actions, or what we call “Tools at Hand Discovery.” By merging pre-suit Section 220 inspections into pleadings-stage discovery, parties could conduct those inspections under the auspices of court rules and oversight, with more certain boundaries and rules surrounding their scope and process. And stockholder plaintiffs in Delaware could bring their plenary suit from the start, with an amendment if needed after discovery, to limit the risk of preclusion posed by multi-forum litigation.

Our proposal for Tools at Hand Discovery introduces a number of benefits. Companies, stockholders, and the public could all benefit from a streamlined procedure taking place entirely within the courthouse doors, rather than partially through extra-judicial negotiations and demands, and which would comport with Delaware courts’ recent policy of generally ushering Section 220 litigation towards issues of scope and away from disputing the purpose of the stockholder seeking an investigation. Defendant companies benefit from greater structure and guidance, and potentially reduced costs, in the expanding use, collection, and production of ESI as part of the Section 220 inspection (or analogous Tools at Hand Discovery). And stockholder plaintiffs benefit from reduced reliance on technical demand compliance and risk of preclusion by first-filers in other jurisdictions. These benefits merit a reexamination of Section 220’s role in derivative litigation – and an examination of Tools at Hand Discovery as a potential replacement.

ENDNOTES

[1] Wood v. Baum, 953 A.2d 136, 140 (Del. 2008).

[2] See Raj & Sonal Abhyanker Fam. Tr. ex rel. UpCounsel, Inc. v. Blake, C.A. No. 2020-0521-KSJM, 2021 WL 2477025, at *5 (Del. Ch. June 17, 2021).

[3] See generally Rales v. Blasband, 634 A.2d 927, 934 n.10 (Del. 1993); White v. Panic, 783 A.2d 543, 556-57 (Del. 2001); Frederick Hsu Living Tr. v. ODN Holding Corp., C.A. No. 12108-VCL, 2017 WL 1437308, at *2 (Del. Ch. Apr. 14, 2017) (corrected Apr. 24, 2017).

[4] See AmerisourceBergen Corp. v. Leb. Cnty. Emps.’ Ret. Fund, 243 A.3d 417, 437-440 (Del. 2020); KT4 Partners LLC v. Palantir Techs. Inc., 203 A.3d 738, 752-53 (Del. 2019); Inter-Local Pension Fund GCC/IBC v. Calgon Carbon Corp., C.A. No. 2017-0910-MTZ, 2019 WL 479082, at *17-18 (Del. Ch. Jan. 25, 2019), aff’d, 237 A.3d 818 (Del. 2020); Schnatter v. Papa John’s Int’l, Inc., C.A. No. 2018-0542-AGB, 2019 WL 194634, at *16 (Del. Ch. Jan. 15, 2019); Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 791-93 (Del. Ch. 2016).

[5] 179 A.3d 824 (Del. 2018).

[6] Corporate defendants have also recently been left vulnerable to fee-shifting to discourage what the Court of Chancery has found to be overly aggressive defensive strategies in Section 220 litigation.  Pettry v. Gilead Scis., Inc., Consol. C.A. No. 2020-0132-KSJM, C.A. No. 2020-0138-KSJM, C.A. No. 2020-0155-KSJM, C.A. No. 2020-0173-KSJM, 2020 WL 6870461, at *30 (Del. Ch. Nov. 24, 2020).  That may both galvanize the aggressiveness of stockholders pursuing demands and dampen the willingness of corporate defendants to pursue even potentially meritorious defenses against Section 220 demands, at least until the extent of what constitutes an overly aggressive defense is better defined by further litigation.

This post comes to us from Professor Geeyoung Min at Michigan State University College of Law and Alexander M. Krischik, an associate at Richards, Layton & Finger, P.A.  It is based on their recent article, “Realigning Stockholder Inspection Rights,” available here. The views expressed herein are those of the authors and are not necessarily the views of Richard, Layton & Finger, P.A. or its clients.

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