Stockholders Rejoice: The Changing Landscape of Section 220 of the Delaware General Corporation Law
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Delaware is king of the corporate world. More than half of all publicly traded companies on U.S. stock exchanges, including two-thirds of the Fortune 500, are incorporated under Delaware law; more than 300,000 of these companies, including corporate behemoths such as Coca-Cola and Verizon, list the same building as their address of incorporation. Though there is a robust body of scholarship exploring whether Delaware will be ousted from its throne of corporate dominance, the nation’s second smallest state remains, and will likely remain for the foreseeable future, the destination of choice for the vast majority of businesses seeking to incorporate in the United States.
Delaware likely would not maintain its position of corporate dominance were it not for the internal affairs doctrine. The internal affairs doctrine mandates that the internal affairs of a corporation—such as the way that a corporation’s shareholders vote on its board of directors—be governed by the laws of the state in which a corporation is incorporated. The judges who interpret the Delaware General Corporation Law (“DGCL”), the statute that sets the rules of corporate governance for the hundreds of thousands of corporations who call Delaware home, thus serve as some of the nation’s preeminent regulators of corporate governance. In other words, the decisions these judges hand down from Delaware’s supreme court and Delaware’s court of chancery—a court of equity consisting of one chancellor and four vice chancellors who settle corporate disputes without a jury—have major implications for the people running America’s largest corporations and for the stockholders who own equity in them.
One of the many important ways these arbiters of Delaware corporate law affect corporate governance is through their interpretation of Section 220 of the DGCL. Section 220 of the DGCL concerns a shareholder’s right to inspect a corporation’s books and records. A corporation’s shareholder list, stock ledger, and the various ways in which its board of directors formally documents its actions are some of the “books and records” traditionally subject to inspection; recent Delaware case law affirms, however, that even less informal communications among board members and directors, such as emails and text messages, may also constitute books and records.
Stockholders today frequently make “books-and-records demands” to obtain materials for lawsuits they intend to file against a corporation in which they have equity. These stockholders must, therefore, demonstrate that they have a proper purpose for requesting a 220 inspection. In Woods v. Sahara Enterprises Inc., Vice Chancellor Travis Laster noted that stockholders can state a proper purpose for a Section 220 inspection by seeking, among other reasons, “to investigate allegedly improper transactions or mismanagement;” “to investigate the possibility of an improper transfer of assets out of the corporation;” “to determine an individual’s suitability to serve as a director;” and “to discuss corporate finances and management’s inadequacies.” If a corporation denies a shareholder’s books-and-records demand, that shareholder can sue the corporation in chancery court to compel the records. Indeed, there now exists a pantheon of shareholder-initiated cases in which the judges on Delaware’s court of chancery and the Delaware Supreme Court address and grapple with the practical challenges raised by Section 220 of the Delaware General Corporation Law.
Over the past year, Section 220 jurisprudence has evolved in a way that suggests that stockholders will be increasingly successful in compelling corporations to comply with books-and-records demands. Two cases in particular best exemplify this stockholder-friendly development. Writing for the chancery court in Pettry v. Gilead Sciences Inc., Vice Chancellor Kathleen McCormick affirmed the rule that stockholders establish a proper purpose to compel a corporation’s books and records when they demonstrate that a credible basis exists to merely suspect the possibility of corporate wrongdoing. In other words, Vice Chancellor McCormick made clear that stockholders in Section 220 lawsuits are not required to furnish proof that any corporate wrongdoing actually occurred, nor must they demonstrate that suspected corporate malfeasance is more probable than not. Instead, stockholders need only establish by a preponderance of evidence that a credible basis exists to simply warrant investigation into suspected wrongdoing.
To establish a credible basis, Vice Chancellor McCormick noted that stockholders may furnish, and the court may consider, evidence such as “on-going lawsuits, investigations, circumstantial evidence, and even hearsay statements evincing possible wrongdoing.” In Paul v. ChinaMedia Express Hldgs., Inc., for example, the chancery court found that a stockholder had identified a credible basis for a Section 220 demand by bringing to the attention of the court numerous third-party media reports, the resignations of three board members, and a publicly-announced internal investigation. For their cause, the stockholders in Pettry v. Gilead Sciences, Inc., in an effort to investigate whether the company was complicit in a scheme to unlawfully extend patent protection on its blockbuster HIV drugs, established a credible basis by relying on allegations and information contained in pleadings filed by other parties suing Gilead in federal and state courts. The stockholders thereby established that a credible basis existed for them to inspect Gilead’s books and records for an investigation of the company’s allegedly tortious activity.
In AmerisourceBergen Corp. v. Lebanon Cty. Employees’ Ret. Fund, Delaware’s supreme court dealt an additional blow to corporations hoping that Delaware courts will sanction their efforts to stymie stockholders’ use of the Section 220 tool. AmerisourceBergen, one of the nation’s largest distributors of opioids, has been embroiled in a number of lawsuits and government investigations over the past few years, each one initiated in response to its role in allegedly perpetuating the opioid epidemic. In May 2019, stockholders of AmerisourceBergen made a Section 220 demand on the company, requesting inspection of Board materials relating to certain settlements, acquisitions, investigations, and other activities related to its alleged complicity in exacerbating the opioid crisis. To satisfy the credible basis standard, the stockholders highlighted the flood of ongoing government investigations and lawsuits in which AmerisourceBergen has been entangled for the past several years. The evidence was circumstantial, but as Vice Chancellor Laster made clear in chancery, that did not hurt the stockholders’ case: their burden was simply to establish that a credible basis existed to warrant investigation of AmerisourceBergen’s alleged involvement in the opioid crisis.
Delaware’s supreme court went beyond simply affirming what is required of stockholders in making a Section 220 demand. Indeed, in AmerisourceBergen’s argument that stockholders need to demonstrate both to what end they plan to use the corporate documents requested and whether the suspected wrongdoing is even actionable, the court further undermined Delaware corporations’ prospects of succeeding in future Section 220 lawsuits. Addressing the first of AmerisourceBergen’s arguments, the court stated simply that a stockholder is “not required to specify the ends to which [she] might use” the books and records requested. It therefore does not matter whether the stockholders plan to pursue litigation with the documents they request or whether they simply want to check up on the performance of their corporate agents to ensure they will continue receiving healthy dividends.
The court next disposed of AmerisourceBergen’s argument that the suspected wrongdoing for which the stockholder is seeking books and records must be actionable. For a party’s claim to be actionable, there must exist sufficient facts or circumstances underlying the claim to enable that party to file a legitimate lawsuit against the party it suspects of wrongdoing. Such facts here might include, for example, proof that AmerisourceBergen conspired with CVS to distribute more opioids than were medically necessary. Fortunately for future stockholder-plaintiffs, Justice Traynor, writing for Delaware’s supreme court, agreed with the chancery court’s holding that stockholders making Section 220 demands are not required to prove that wrongdoing actually occurred and thus that their claims are actionable. He instead made clear that a stockholder need only demonstrate that there is “possible mismanagement that would warrant further investigation.”
Gilead and AmerisourceBergen mark a consequential development in Section 220 jurisprudence and have major implications for the plaintiffs and defendants involved in Section 220 lawsuits. The decisions in these cases likely will affect, for example, the way that corporations handle stockholders’ books-and-records demands when anticipating litigation. Elite corporate law firm Wachtell, Lipton, Rosen, and Katz neatly summarized the way in which corporate litigants should respond to these decisions in Columbia Law School’s CLS Blue Sky Blog. In the post, the firm cautions corporations confronted with Section 220 requests to consider carefully whether it might be prudent to simply comply, constructively yet strategically, with shareholders’ books-and-records demands rather than retain an expensive law firm to mount an aggressive defense in the suit. The firm’s advice is informed by its prediction that Delaware courts will continue interpreting Section 220 to permit stockholders to begin conducting discovery, the process by which parties gather information in preparation for a trial, before the stockholders even begin formal proceedings against a corporation. In short, the firm thinks that because stockholders will likely succeed in their quest to gain access to requested materials, corporations might be better suited by simply cooperating with their demands. The decisions do indeed continue the trend of Delaware’s courts undermining the defenses that corporate litigants mount when confronted with Section 220 demands.
The takeaways of these decisions are not, however, all bad for prospective corporate litigants. In addressing AmerisourceBergen’s actionability argument, Justice Traynor did clarify that a procedural roadblock to anticipated litigation does constitute a valid defense to a Section 220 suit if the stockholders make clear that litigation is the sole objective for their investigation. A procedural roadblock to anticipated litigation might take the form of the statute of limitations expiring on the stockholders’ claim before any litigation can conceivably commence. So, if a group of stockholders acknowledges that they are making a Section 220 books-and-records demand solely to pursue a lawsuit in which the statute of limitations on the claim underlying the lawsuit will shortly expire, the corporation may raise this a defense to not cooperate with the stockholders. The stockholders could, of course, avoid demonstrating that no procedural obstacles exist to a potential lawsuit simply by refusing to acknowledge or suggest that litigation is their sole objective. Nevertheless, Justice Traynor’s clarification that the court of chancery can consider this component of actionability as a relevant factor in assessing a stockholder’s stated purpose does prevent stockholders from carrying out fishing expeditions to expose a corporation’s activities.
In spite of this minor victory, AmerisourceBergen and Gilead should give prospective corporate litigants pause when considering whether to wage into Section 220 battle. In fact, in Gilead, Vice Chancellor McCormick even encouraged the stockholder-plaintiffs to file a motion for attorneys’ fees, arguing that Gilead’s refusal to cooperate with its stockholders served no purpose other than “obstructing the exercise of Plaintiffs’ statutory rights.” Thus, in addition to running the very real risk of having to eventually cooperate with books-and-records demands after a lengthy and expensive process of litigation, corporate litigants now run the risk of having to cover the costs of stockholders’ attorneys’ fees as well. It thus appears that corporations ought to take Wachtell’s counsel and proceed cautiously when confronted with a Section 220 lawsuit.
About the Author: Trevor Thompson is a 2L at Cornell Law School. He graduated from Columbia University with a Bachelor of Arts in Political Science. He is an online associate for the Journal of Law and Public Policy. In his free time, he enjoys reading, writing, and hiking with his miniature goldendoodle, Cornelius, who is very proudly featured on Cornell Law’s Instagram.
Suggested Citation: Trevor Thompson, Stockholders Rejoice: The Changing Landscape of Section 220 of the Delaware General Corporation Law, Cornell J.L. & Pub. Pol’y: The Issue Spotter (May 17, 2021), https://live-journal-of-law-and-public-policy.pantheonsite.io/stockholders-rejoice-the-changing-landscape-of-section-220-of-the-delaware-general-corporation-law/.