Background
This decision arose out of demands to inspect corporate books and records under 8 Del. C. § 220 (section 220) of the Delaware General Corporation Law. The stockholders’ demands for inspection alleged that the NVIDIA Corp. (the Company), through its executives, made false or misleading statements about the level of interest for its products. After making those statements, certain executives sold their stock at allegedly inflated prices before the “truth” was revealed to the market and the stock price fell. The Company also faced securities litigation involving allegations based on anonymous testimony from a former employee that the same executives had specific knowledge of the threats to the Company’s financial performance.
The Company refused to allow inspection and claimed that (i) the stockholders had not shown a proper purpose, (ii) the stockholders had not established a credible basis to infer wrongdoing, and (iii) the inspection requests were overbroad. The Court of Chancery overruled the objections and ordered production of certain documents.
The Company appealed the decision, and the Delaware Supreme Court, claiming in part that the stockholders had improperly relied on hearsay evidence and – through their inspection demands and responses to interrogatories – had failed to demonstrate and investigate corporate wrongdoing (including insider trading).
Analysis
The Delaware Supreme Court began its analysis by observing that a stockholder seeking to investigate some kind of corporate malfeasance must “show, by a preponderance of the evidence, a credible basis from which the Court of Chancery can infer there is possible [wrongdoing] that would warrant further investigation.” The court also observed that the Delaware Rules of Evidence apply to all actions in Delaware courts, including Rule 802, which bars the use of hearsay evidence unless there is an exception.
All parties agreed that the inspection demands and interrogatories used to establish the purpose for the stockholders’ inspection demands constituted hearsay. Therefore, the Supreme Court looked to the 1996 decision, Thomas & Betts Corp. v. Leviton Manufacturing Co., 681 A.2d 1026 (Del. 1996), for an exception to the hearsay rule in section 220 cases.
The court concluded that Thomas & Betts “created an exception in the 220 context that allows the use of sufficiently reliable hearsay in books and records actions.” The court noted that NVIDIA did “not argue that Thomas & Betts was wrongly decided and d[id] not ask us to revisit that decision”; also, the court was “not inclined to reconsider Thomas & Betts when neither party has asked [it] to do so.” Thus, the court held that “hearsay is admissible in a Section 220 proceeding when that hearsay is sufficiently reliable.”
The court’s analysis did not end there, however. Instead, the court reversed and remanded the Court of Chancery’s ruling on the propriety of the stockholders’ purpose because the stockholders had deprived NVIDIA of the right to test the reliability of their hearsay evidence. The stockholders had “refus[ed] to cooperate with the Company regarding the identification of trial witnesses or affiants” and had effectively prevented NVIDIA from taking depositions. Thus, the court held that “[i]f stockholders are going to introduce sufficiently reliable hearsay to establish a proper purpose, they must communicate honestly and early with companies regarding their intent so as to allow companies to decide whether to depose the stockholders or to identify their own witnesses for trial.”
Takeaways
Stockholders of Delaware corporations are permitted to base a books-and-records demand on “reliable” hearsay in order to establish a proper purpose for the inspection. However, stockholders must be “upfront about their plans regarding witnesses” so that “companies can choose whether to depose the stockholders during discovery or call the stockholders as witnesses at trial.”
Client Alert 2022-244