Section 220 Books and Records Request and the Propriety of Imposing a Choice of Forum Requirement

Late last year, the Delaware Supreme Court reaffirmed its view as to the righteousness of a corporation’s right to adopt choice of forum selection bylaws in United Technologies Corp. v. Treppel . This case is especially interesting because of corporation in question imposed the choice of forum requirement on a plaintiff despite not having had this requirement in the corporation’s charter documents.

The events leading up to this decision began with a simple and common request by a shareholder under Section 220 of Delaware General Corporation Law – a  books and records request. Typically, this type of request to examine documents like board minutes, brought by a shareholder as is his or her right, is a precursor for litigation.

In this case, the plaintiff Lawrence Treppel sought to review the board minutes of United Technologies Corp. (“UTC”) to determine why the board had rejected a demand for UTC to commence litigation against certain directors and officers following a U.S. Department of Justice investigation.

From a report at The National Law Review:

Treppel then made a Section 220 inspection demand, purportedly to enable him to evaluate the board’s decision rejecting his litigation demand. United Technologies, as a condition to allowing the inspection, sought to negotiate terms by which Treppel would agree to commence any litigation arising out of the inspection in Delaware. Treppel refused and filed a Section 220 action in the Court of Chancery.

At the time of the books and records request, UTC did not have choice of forum selection bylaws in place.  As a reminder, choice of forum bylaws restrict certain types of litigation brought by shareholders to the state of incorporation. (UTC ultimately adopted choice of forum bylaws at a later date.)

According to the report at The National Law Review, the trial uncovered the fact that Treppel had a history of filing suits outside of a company’s state of incorporation. In the end, the Court of Chancery allowed the Section 22o request by Treppel, but said it lacked statutory authority to impose the restrictions requested by UTC on litigation solely in Delaware. UTC appealed.

In December 2014, the Delaware Supreme Court weighed in, stating that the Court of Chancery did indeed have authority to exercise discretion when ruling on limitations or conditions.

From a memo at Wachtell Lipton (PDF):

Chief Justice Strine’s decision held that “the Court of Chancery has wide discretion to shape the breadth and use of inspections under 220 to protect the legitimate interests of Delaware corporations,” including through use restrictions related to forum. In remanding to the Court of Chancery to exercise this discretion, the Supreme Court instructed that the Vice Chancellor should consider that a corporation has a “legitimate interest in having consistent rulings on related issues of Delaware law, and having those rulings made by the courts of this state,” and a similarly legitimate interest in avoiding undue expense in defending against duplicative derivative lawsuits.

Delaware courts have a history of protecting provisions intended to rationalize shareholder litigation, the prime example being choice of forum bylaws. In 2013, the Delaware Chancery Court sided with Chevron and FedEx when exercising the corporation’s right to adopt choice of forum provisions in its bylaws.

As a reminder, however, the proxy advisory firm ISS recently released its “2015 Benchmark Policy Recommendations,” effective Feb. 1, 2015, that states its stance on choice of forum, and says it will vote on a case-by-case basis on “bylaws which impact shareholders' litigation rights,” and will take into account the following when analyzing the choice of forum matter:

The company's stated rationale for adopting such a provision;

Disclosure of past harm from shareholder lawsuits in which plaintiffs were unsuccessful or shareholder lawsuits outside the jurisdiction of incorporation;

The breadth of application of the bylaw, including the types of lawsuits to which it would apply and the definition of key terms; and

Governance features such as shareholders' ability to repeal the provision at a later date (including the vote standard applied when shareholders attempt to amend the bylaws) and their ability to hold directors accountable through annual director elections and a majority vote standard in uncontested elections.

The (likely intended effect) of this pronouncement by ISS is to chill the unilateral adoption by boards of choice of forum bylaws provisions.  This is certainly something to keep in mind; however, as I pointed out in my post on the ISS guidelines (linked to previously), any good board member will do what he or she believes to be in the best interests of shareholders.

In the event that your corporation has received a Section 220 books and records request, and you haven’t yet adopted choice of forum bylaws, Treppel teaches us that you might consider imposing as part of the corporate response the requirement that any litigation brought by the shareholder based on the Section 220 request be brought in the corporation’s state of incorporation.

While we are on this topic, there are a few insurance housekeeping items to consider when a company receives a books and records request.

D&O Insurance Considerations for Section 220 Books and Records Requests

Section 220 book and records requests are a clear “get ready” signal for the legal department.  What is sometimes missed, however, is that it’s also a “get ready” signal that must be conveyed to your insurance broker.

Why? Because this type of request is typically a precursor to litigation. Your broker needs to assess if your D&O insurance carrier should be notified.

This conversation takes on a certain amount of gravity as you approach the D&O renewal cycle because the insured has a duty to inform insurance carriers if there’s a material change in risk. Pending books and records requests are the kind of thing a carried would expect to be told in most circumstances.

The bottom line: you don’t want your carrier to feel mislead if you are hit by litigation after a Section 220 request that you never mentioned to your carrier.  In a worst-case scenario, it could lead a carrier to attempt to rescind the policy.

In some companies, the general counsel is responsible for insurance matters.  One benefit of the putting responsibility for insurance (at least the D&O insurance) with the general counsel is that the same person who is on the frontlines of a books and records request is also the person who thinks about how insurance may respond.

On the other hand, in some companies it’s the finance department or risk management department that is responsible for the insurance coverage.  In these companies, there is a risk that finance or risk management may not be informed in a timely way that the corporation has received a Section 220 request unless the general counsel has been briefed to notify them.

In this case, it’s important that there is a clear understanding between legal and the team handling insurance that a books and records request is something that needs to be discussed with the insurance team.

In closing, even though Section 220 requests are commonplace for Delaware corporations, we learned in Treppel that the ordinary can give way to something unexpected – an opportunity to corral potential litigation to a company’s state of incorporation.

When dealing with Section 220 requests at your company, make sure you take the road of caution and thoroughly assess with your broker if the request is cause for having a conversation with your D&O insurance carriers before your next D&O insurance renewal.