A recent decision of the Delaware Court of Chancery, Wilkinson v. A. Schulman, Inc., represents an important judicial effort to balance (i) allowing stockholders of a Delaware corporation that have a “proper purpose” to demand access to the corporation’s books and records, with (ii) ensuring the purpose asserted is actually that of the stockholder, as opposed to the purpose of an entrepreneurial lawyer.
Although Delaware courts encourage stockholders to seek legal counsel when pursing inspection of a corporation’s books and records, the Court of Chancery made clear that a stockholder seeking inspection of a corporation’s books and records, and retaining counsel to carry out the stockholder’s wishes, is “fundamentally different” from having an entrepreneurial law firm pursue inspection “with only minor and non-substantive involvement” from the stockholder. Stockholders seeking inspection of books and records should be actively involved in determining the purpose(s) for which inspection is sought, and remain involved in the process to secure inspection of the corporation’s records, including both prior to litigation and during litigation.
Section 220 of the Delaware General Corporation Law, 8 Del. C. § 220, permits stockholders of Delaware corporations to inspect the corporation’s books and records by delivering to the corporation a written “demand,” under oath, asserting a proper purpose.1 Section 220 defines a “proper purpose” as “a purpose reasonably related to such person’s interest as a stockholder.”2 A stockholder’s proper purposes include, among other things, (i) valuing the stockholder’s interest in the company, (ii) communicating with other stockholders about matters relating to the company (e.g., governance matters), and (iii) evaluating potential breaches of fiduciary duty, mismanagement or wrongdoing committed by the corporation’s directors and/or officers.
The Delaware Supreme Court “has admonished stockholders repeatedly to use Section 220 … to obtain books and records to investigate their claims before filing suit.”3 In many cases, a stockholder-plaintiff’s failure to conduct pre-suit investigation using Section 220 results in the stockholder being unable to adequately plead causes of action sufficient to survive a motion to dismiss.
Although Section 220 is an important tool for stockholders, and its use is strongly encouraged, Delaware courts recognize that “entrepreneurial plaintiffs’ counsel” sometimes find a stockholder to make a demand to investigate misconduct that the stockholder is not actually concerned about (or sometimes not even aware of). The decision in Schulman represents an important effort to try to balance, on the one hand, allowing stockholders to use the important tool of Section 220 and, on the other hand, ensuring it is actually the stockholder’s purpose, as opposed to entrepreneurial plaintiffs’ counsel.
In Schulman, the Delaware Court of Chancery found, after trial, that “the purposes for the inspection belonged to [the stockholder’s legal counsel] and not to [the stockholder] himself.”4 Legal counsel for the stockholder initially sent the corporation a demand letter, on behalf of the stockholder, pursuant to Section 220 seeking specified categories of books and records with the stated purpose of investigating possible breaches of fiduciary duty in connection with the corporation’s board of directors accelerating the vesting of shares of restricted stock worth more than $3.9 million.5 After the corporation refused to produce documents in response to the demand, the plaintiff filed an action in the Court of Chancery.6 During the court proceedings, the stockholder-plaintiff was deposed.7
The Court of Chancery extensively relied on the stockholder-plaintiff’s deposition testimony when concluding the stockholder-plaintiff failed to state a proper purpose for his demand.8 Specifically, the Court of Chancery found that counsel for the stockholder (rather than the stockholder himself) had come up with the issues identified in the demand.9 The stockholder testified the event that prompted him to pursue the demand was his unhappiness with the corporation’s financial results—an event entirely unrelated to the compensation issues identified in the demand letter and lawsuit.10 Indeed, the stockholder testified that “he [wa]s not aware of any facts suggesting wrongdoing, mismanagement, or waste relating to the compensation decision....”11
The Court of Chancery found the stockholder-plaintiff had “lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel.”12 After emphasizing that there is nothing improper with employing counsel to prosecute a Section 220 action (indeed, the court explained it is advisable to retain legal counsel),13 the Court of Chancery observed that “a stockholder seeking an inspection and retaining counsel to carry out the stockholder's wishes is fundamentally different than having an entrepreneurial law firm initiate the process, draft a demand to investigate different issues than what motivated the stockholder to respond to the law firm’s solicitation, and then pursue the inspection and litigate with only minor and non-substantive involvement from the ostensible stockholder principal.”
The court’s opinion serves as useful guidance to both legal counsel representing parties in seeking inspection of books and records, as well as counsel representing companies responding to or litigating such demands, in the future. At bottom, stockholders seeking inspection of books and records should be actively involved in determining the purpose(s) for which inspection is sought, and remain involved in the process to secure inspection of the corporation’s records, including prior to litigation and during litigation.
Reed Smith has significant experience, on the one hand, representing stockholders seeking inspection of books and records and, on the other hand, representing Delaware companies responding to books-and-records requests.
- The demand must be delivered to either (i) the corporation’s registered office in Delaware or (ii) the corporation’s principal place of business. As a practical matter, by delivering the demand to the corporation’s registered office in Delaware, the demanding stockholder can avoid arguments regarding whether a certain location constitutes the corporation’s principal place of business. See 8 Del. C. § 220(b).
- See id.
- South v. Baker, 62 A.3d 1, 6 (Del. Ch. 2012) (citing Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1056 (Del. 2004); White v. Panic, 783 A.2d 543, 556-57 (Del. 2001); Brehm v. Eisner, 746 A.2d 244, 266-67 (Del. 2000); Scattered Corp. v. Chi. Stock Exch., 701 A.2d 70, 79 (Del. 1997); Sec. First Corp. v. U.S. Die Casting & Dev. Co., 687 A.2d 563, 567 n.3 (Del. 1997); Rales v. Blasband, 634 A.2d 927, 934 n.10 (Del. 1993)).
- See Wilkinson v. A. Schulman, Inc., No. 2017-0318-VCL, slip op. at 4 (Del. Ch. Nov. 13, 2017).
- See id. at 1-2.
- See id. at 3.
- See id.
- See id. at 4-7.
- See id. at 4-5.
- See id. at 5.
- See id. The court also noted that the stockholder-plaintiff was involved in at least seven other lawsuits (prosecuted by the same law firm) in which he had had minimal involvement. See id. at 7 (describing the stockholder’s role as that of a “nominal plaintiff”).
- See id. at 4.
- See id. at 7 (“[G]iven the complexity of Delaware’s sprawling Section 220 jurisprudence, a stockholder is well-advised to secure counsel’s assistance.”).
Client Alert 2017-281
