The Chief Justice of the Chancery Court of Delaware is asking for more focus on the scope of board documents that plaintiff shareholders can request in breach of fiduciary duty lawsuits.
Disputes over requests to boards to produce documents and records have proliferated in recent years, ‘cluttering’ the court’s docket with ‘glorified discovery disputes’, Chancellor Kathaleen McCormick said in a recent speech on mergers and acquisitions litigation at a securities conference.
With the volume of so-called ‘Section 220 claims’ showing no signs of slowing down, corporate lawyers say more clarity from the court on what constitutes ‘books and records’ would benefit to all parties during the litigation process. One possible solution, proposed by McCormick, would be to automatically allow complainants access to certain types of documents that are not expensive or difficult for companies to produce.
Investors frequently use books and records requests, made under Section 220 of the Delaware General Corporations Act, as a fact-finding process to later sue directors for breach of fiduciary duty. Companies often try to avoid requests, which can be costly to satisfy, by challenging how shareholders intend to use the documents.
The focus on plaintiff intent has benefited no one, McCormick said in a Jan. 25 speech to the Securities Regulation Institute.
“One of the biggest obstacles to our current system has been litigants’ emphasis on entitlement to records, as opposed to scope,” McCormick said. The court should “better signal our expectations in this regard,” she said.
Look up definitions
There is no consistent understanding of what constitutes “books and records,” said Doru Gavril, a partner at Freshfields Bruckhaus Deringer LLP who specializes in shareholder disputes and corporate governance.
The scope of the books and records can be limited to board minutes, or as broad as sensitive emails or texts on personal accounts, Gavril said. The definition depends on whether shareholders have demonstrated that certain documents are “necessary and essential” at their request, he said.
“Perhaps one set of parameters won’t work in every conceivable circumstance. But the lack of metrics, as we currently know, leads to a level of concern and possibly dysfunction in how companies respond to 220 requests,” Gavril said.
McCormick has been a forceful voice in the Chancery Court in condemning the companies’ overzealous defenses in the docket cases.
Its most notable ruling came in 2020 against drugmaker Gilead Sciences Inc. It chastised the company for an “overly aggressive defense strategy” against investors seeking to investigate price-fixing and patenting allegations involving the HIV prevention drug Truvada.
One way to improve the system would be to classify documents that are inexpensive for companies to produce as “automatic data” to complainants who state an appropriate purpose and meet other requirements, McCormick said in his speech. Conversely, the court might seek to limit document production to formal board minutes in other situations, she said.
Striking a balance should help shareholders better weigh the benefits of litigating time-consuming and resource-intensive Section 220 lawsuits, she said.
Greater clarity is needed on whether shareholders can access electronic communications from independent outside directors, said Ned Weinberger, partner at Labaton Sucharow, who chairs the corporate governance and shareholder rights litigation practice. .
Outside directors — who are not stakeholders or employees of the company — can use their personal or work emails for communications with the board, Weinberger said. Shareholders may want these communications when more traditional board records are lacking, he said.
Court chancellors have offered differing views on the matter. Weinberger pointed to Jan. 7 comments by Vice Chancellor Joseph Slights, III in a lawsuit related to American Securities LLC’s $1.3 billion takeover of drywall distributor Foundation Building Materials Inc.
Slights said during oral argument that he would deny the pension fund plaintiffs’ motion seeking email communications from three of the Foundation’s outside directors who used their own work accounts to discuss the acquisition. He formalized his decision in a January 14 notice.
Vice-Chancellor Travis Laster offered a mixed view on the matter during a September 2015 lawsuit between Amalgamated Bank and Yahoo! Inc. Laster noted that electronic communications held by a third party, such as outside attorneys, consultants, or even IT service providers, could still be considered corporate records in certain circumstances.
Laster ultimately ruled against plaintiff Amalgamated Bank in a November 2015 notice, saying it didn’t convince him to allow Yahoo! external administrator emails or other documents.
It’s a matter the plaintiffs want clarification on, Weinberger said.
“If a director’s email is about a board matter, it’s a corporate document. It doesn’t matter where the email physically resides,” he said. “If the rule is that a document can only be obtained if it is physically on a company’s servers, then shareholder inspection rights become quite easy to circumvent.”
McCormick issued a notice on Jan. 31, just days after his speech, which laid new groundwork for book and document requests in a case involving Amazon.com Inc.’s 2020 acquisition of the car company zoox inc.
Investors in the private company Zoox were only entitled to internal files they could have obtained from Zoox if they had been publicly traded, McCormick said.
The new ruling is the first to address investors’ rights to use so-called valuation requests related to the valuation of a private company’s stock to investigate possible merger-related fiduciary breaches.
The investors initiated the valuation request after learning that they could not search for documents from a private company under the Documents Act, Section 220. The investors could not use their valuation request to conduct a broader investigation by accessing more sensitive documents, McCormick mentioned.
The Zoox decision reminds private companies “to maintain good corporate hygiene” similar to those listed on the stock exchange, said Suni Sreepada, M&A partner at Ropes & Gray LLP.
Private companies see far fewer than 220 requests and may have less experience keeping proper board records through minutes and resolutions, she said.
More plaintiffs can try to obtain the books and records of private companies through assessment requests when a 220 request is not procedurally available, Sreepada said. But private companies may be able to prevent plaintiffs from getting more than books and records by comprehensively documenting board decision-making in M&A transactions, she said. .
McCormick’s Zoox The decision provides insight into how courts weigh broader considerations, such as the dangers of uncontrollable litigation, when deciding registration applications, said Benjamin Edwards, associate professor at the William S. Boyd School of Law at the University of Nevada in Las Vegas.
Courts must also balance plaintiffs’ access to information with defendants’ costs in document management and production, he said.
Finding the right balance would help the Chancery Court and the state of Delaware maintain their reputations as desirable places of business, Edwards said.
“If merger or deal litigation gets too out of control, it will eventually prompt companies to incorporate in Nevada and elsewhere,” he said.
—With help from Mike Leonard