Derivative lawsuits continue to be one of the most concerning exposures that directors and officers face, especially given that we are starting to see a number of massive settlements. The good news is that this type of litigation doesn’t come out of the blue.
Delaware courts want company stockholders to gather information before filing a derivative suit. As a result, plaintiffs will first file a request to inspect a company’s books and records. Receiving a “Section 220 books and records request,” as they are known under Delaware corporate law, is a signal that a breach of fiduciary duty lawsuit could be on the horizon.
Responding to Document Requests from Shareholders
Section 220 of Delaware General Corporation Law gives stockholders the right to examine corporate documents when investigating potential wrongdoing by directors or officers. Unfortunately, some plaintiffs have taken advantage of this right and are using Section 220 as a fishing expedition. The result is ever broader books and records requests.
Books and records requests are no longer confined to things like board meeting minutes. Books and records requests now include asking for broad documentation, including other corporate documents, as well as company and personal emails (Yahoo was a landmark case here) and even personal text messages.
Unsurprisingly, companies are not eager to start turning over anything and everything shareholder plaintiffs may request. Instead, defense counsel will attempt to negotiate down the request. If that fails, litigation over the Section 220 request may ensue.
A 2019 research paper outlines the potential problems that arise from this, however, saying that plaintiffs’ lawyers believe “books and records cases are no longer summary proceedings,” and that “defendants have turned books and records litigation into a surrogate proceeding to litigate the possible merits of the suit where they place obstacles in the plaintiffs’ way to obstruct them from employing it as a quick and easy pre-filing discovery tool.”
A November 2020 Delaware court opinion also viewed this behavior by defense counsel as problematic. In Deborah Pettry, et al. v. Gilead Sciences, Inc., Chancellor Kathaleen McCormick found that Gilead Sciences, Inc. deployed an “overly aggressive defense strategy” in response to a books and records request by stockholders.
Gilead defense attorneys had attempted to limit the scope of expensive and, in their view, overreaching discovery requests pursuant to Section 220. The Delaware court was not impressed. Chancellor McCormick stated that Gilead’s defense strategy was one to “launch a number of peripheral attacks designed to chip away at the plaintiffs’ proper purposes.”
One such strategy included Gilead arguing that the plaintiffs “had not met the credible basis requirement to investigate wrongdoing—a requirement that imposes ‘the lowest possible burden of proof’—even though plaintiffs had ample support for their proposition.”
The judge pointed out that:
Gilead exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights. Gilead’s pre-litigation failure to provide any Plaintiff with even a single document despite the ample evidence of a credible basis and the obvious responsiveness of certain categories of documents amplifies the court’s concerns.
The judge then called for fee shifting to cover the plaintiff’s expenses linked to the books and records request, which was later approved. In a highly unusual move, Gilead Sciences was required to pay $1.8 million in litigation costs to plaintiffs.
How low is the standard that plaintiffs must meet to obtain records? As one law firm put it, “stockholders need not identify any particular course of action they intend to take with the books and records obtained or explain whether any suspected wrongdoing is actionable.”
- It seems likely that the Gilead decision will embolden plaintiffs to continue to serve companies with aggressive Section 220 requests. Given how clear it is that the Delaware court is keeping a close eye on what they regard as frivolous defenses to these requests, a strategy of “deny, deny, deny” will not be effective. This doesn’t mean that plaintiffs are always entitled to receive everything they request. You will want to work with defense counsel to understand what defenses remain viable in the face of broad requests.
- Remember that emails can be part of a corporation’s books and records, particularly if the email is not privileged. I’ve written about this recently in an article that highlights how you can accidentally destroy attorney-client privilege using work email.
- If you are dealing with a sensitive topic, consider avoiding casual texts and emails in favor of meeting in person and creating board meeting minutes. The value of minutes is that they are the formal record of what happened and what was decided. This is certainly superior to a group chat that includes shorthand and emojis.
- Complying with a Section 220 request is expensive. D&O insurance policies for public companies usually have limited (if any) coverage for books and records requests. Your D&O insurance policy may have a sublimit for books and records requests, which means that coverage is restricted to an amount less than the full limits of your insurance. For example, the sublimit of a $5 million policy might be something like $250,000 for books and records requests. In some cases, a company may be able to stack sublimits from different layers of insurance; in other instances, the rest of the insurance will provide no coverage at all.
Remember that not all books and records requests lead to litigation. It can be the case that a robust response shows a potential shareholder plaintiff that the board did its job, making the pursuit of future litigation unnecessary.
This, then, is yet another reason to adhere to corporate formalities when it comes to the exercise of a board’s fiduciary duties as well as the documentation of this activity. Knowing that a potential Section 220 request may one day arrive should provide an incentive for boards to be rigorous when it comes to board meeting minutes. This includes providing some level of detail in formal board documentation, including appropriate exhibits to board minutes and actions by written consent.
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