Recent Delaware decisions have hampered the use and utility of “books and records” requests under Section 220 of the Delaware General Corporate Law. These developments could have major long-term effects on stockholder litigation.
Under Section 220, a stockholder is entitled to examine a company’s “books and records” in furtherance of a “proper purpose.” What constitutes a proper purpose depends upon the circumstances, but in any event it must be reasonably related to the person’s status as a stockholder. Moreover, if a stockholder advances multiple purposes, only one must be deemed proper in order for the stockholder to be able to inspect the specified documents. Once a proper purpose is established—and the Delaware courts have recognized numerous proper purposes—the stockholder may obtain documents in the company’s possession reasonably related to the stated purpose.
Procedurally, the stockholder first makes a written demand for the books and records. The stockholder and the company often resolve the books and records demand at this stage without any further proceedings. However, if the demand is refused, in whole or in part, the stockholder may bring a lawsuit to acquire the documents. These proceedings are typically relatively brief, compared to broader, full-blown litigation. What happens next depends upon the purpose of the Section 220 demand as well as the results of the stockholder’s review of any documents produced.
Traditionally, one of the most compelling reasons to request books and records has been to investigate potential wrongdoing that could give rise to stockholder derivative litigation, in which a stockholder may act on the company’s behalf because its board of directors is unable to do so, generally due to some conflict of interest or lack of independence. In order to maintain a derivative suit, however, the stockholder must first establish the board’s incapacity to act disinterestedly and independently. Because of the difficulty in making this showing, Delaware’s courts have urged stockholders to use the “tools at hand” by requesting documents pursuant to Section 220. This is especially so in so-called Caremark cases (named after a Delaware Supreme Court decision involving that company), which allege that inadequate board oversight led to serious company problems.
Although it is certainly possible to bring a successful derivative suit solely in reliance upon publicly available information, certain Delaware judges have admonished plaintiffs whose pleadings were found inadequate for failing to pursue books and records under Section 220. The courts in those instances have sometimes posited that the cases might have survived initial scrutiny if the plaintiffs had acquired books and records to bolster allegations against the directors. Thus, the prevailing view for many years was that, in order to bring a Caremark case as well as certain other types of derivative cases, a plaintiff must first obtain books and records under Section 220.
Yet, recent developments have plagued even those litigants who diligently pursued books and records using the “tools at hand.”
In late 2011, Wal-Mart Stores, Inc. disclosed in its annual report that the company had launched an internal investigation into potential instances of bribery relating to its operations in Mexico. In the spring of 2012, The New York Times published a lengthy article revealing extensive information about both the investigation and the underlying misconduct. Shortly thereafter, several Wal-Mart stockholders commenced stockholder derivative lawsuits in Arkansas, where the company is headquartered, and at least one institutional stockholder pursued books and records under Section 220. The Arkansas litigation was eventually dismissed because the complaint did not contain enough information about the board’s interestedness or lack of independence.
By contrast, following extensive litigation, the institution obtained many documents after making a demand and then filing a lawsuit under Section 220. The institutional investor then filed a stockholder derivative action in the Delaware Court of Chancery against certain directors and officers of Wal-Mart, alleging breaches of fiduciary duty and incorporating facts learned through the Section 220 process.
Despite the institution’s efforts, on May 13, 2016, Chancellor Andre G. Bouchard of the Delaware Court of Chancery ruled that the dismissal of the Arkansas litigation had res judicata (i.e., claim preclusion) effect and, thus, precluded any further litigation on the alleged fiduciary duty breaches. Accordingly, the institution, which had spent considerable time investigating claims before filing suit, was foreclosed from litigating potentially meritorious claims because of the lackluster efforts of the Arkansas plaintiffs. And while Chancellor Bouchard suggested that the Arkansas plaintiffs should have availed themselves of the “tools at hand” under Section 220, their failure to do so did not render them “inadequate” for claim preclusion purposes.
In a similar case involving alleged misconduct at lululemon athletica inc., stockholders similarly pursued books and records in Delaware. However, once the documents had been reviewed and a derivative suit using those documents had been filed in Delaware Court of Chancery, the same Delaware Chancellor who issued the Wal-Mart decision dismissed the Delaware derivative case on the grounds that it was precluded by a related derivative suit New York federal court that was dismissed on demand futility grounds.
The Wal-Mart and lululemon cases are both currently on appeal before the Delaware Supreme Court. Accordingly, they could get reversed, which would restore vitality to the merits of pursuing books and records through Section 220. Nonetheless, they have chilled efforts to pursue books and records under Section 220 to investigate potential wrongdoing that might give rise to a stockholder derivative lawsuit.
The Wal-Mart and lululemon decisions deter stockholders from pursuing books and records when the actions of unrelated, hasty, fast-filing stockholders threaten to scuttle more diligent efforts to present well-researched claims. This will continue unless the decisions are reversed.