|Delaware courts continue to encourage stockholders to make Section 220 requests before filing a derivative suit and stockholders continue to heed that call. This week’s blog features a discussion by my colleague Lenin Lopez that outlines the latest buzz when it comes to books and records requests. – Priya Huskins
A books and records request is a tool used by stockholders to gather information in advance of filing a derivative lawsuit against officers and directors. These requests can also be used by activist investors to gather information in advance of making demands for corporate change, like demanding board seats, ousting the chief executive officer, or pushing for a change in business strategy. The frequency of these requests continues to rise and their scope continues to broaden. Companies are left facing a growing range of challenges, including increased litigation risks and costs associated with having to respond.
This article will:
- Provide a brief background on “Section 220 books and records requests,” as they are known under Delaware corporate law.
- Share a few noteworthy Section 220 requests-related court decisions.
- Offer related practice points.
Section 220 Books and Record Requests
Section 220 of Delaware General Corporation Law gives stockholders the right to examine certain corporate books and records, if the request is made for a “proper purpose.” One of the more common “proper purposes” is to investigate possible corporate mismanagement or wrongdoing. This is why Section 220 requests are typically viewed as the precursor to litigation.
Stockholders are only required to show some “credible basis” to support a suspicion of mismanagement or wrongdoing. While the “credible basis” standard of proof is the lowest recognized under Delaware law, it isn’t inconsequential. Delaware courts have generally held that stockholders cannot meet the credible basis standard simply by expressing disagreement with a particular business decision or speculating that directors or officers were engaged in wrongdoing. Rather, stockholders must make a “credible showing, through documents, logic, testimony or otherwise, that there are legitimate issues of wrongdoing.” For a discussion of recent applications by the Delaware courts of the credible basis standard, see this article from Jones Day.
Stockholders’ success in establishing a proper purpose by meeting the credible basis standard is the equivalent of passing Go in Monopoly, but in this case rather than collecting $200, they get those books and records that are “essential and sufficient” to the examination. In the past, the scope of these requests typically focused on formal board meeting minutes, as well as related materials, like presentations. However, company and personal emails and even personal text messages have become common asks. Consequently, it isn’t surprising that companies have resisted these requests by attempting to negotiate a narrower scope of items or, in some cases, welcoming litigation.
Recent Section 220 Decisions
We previously discussed how Delaware courts have not looked favorably on companies that have taken overly aggressive defense strategies in resisting Section 220 requests. Companies that decide to go that route may find themselves in a similar situation to Gilead Sciences, Inc. In that case, which we previously covered, the judge ordered Gilead to pay the stockholders’ legal bill associated with their Section 220 request. This was unusual and the amount, approximately $1.8 million, wasn’t insignificant. In its decision, the court noted that Gilead engaged in “glaringly egregious litigation conduct.” See this article from Clearly Gottlieb for a discussion of the Gilead case.
With the Gilead case in mind, how should a company think about responding to a Section 220 request? Two decisions help shed some light and reinforce the practice points that we discuss below.
The Walt Disney Company: Court Rejects Stockholder’s Section 220 Request Related to Florida’s HB 1557
In Simeone v. The Walt Disney Company (Del. Ch. June 27, 2023), Vice Chancellor Lori W. Will rejected a Disney stockholder’s Section 220 request stemming from Disney’s response to Florida House Bill 1557. The bill, commonly referred to as the “Don’t Say Gay” law, “limits instruction on sexual orientation or gender identity in Florida classrooms.” While initially remaining silent on the issue, Disney eventually spoke out against the legislation. Disney’s decision was met with swift action on the part of the Florida legislature, which voted to dissolve a special tax district encompassing the Walt Disney World Resort.
Afterwards, Disney was served with a Section 220 request. The basis for the request was to investigate whether Disney’s directors and officers breached their fiduciary duties by opposing
the legislation. The stockholder sought the following categories of documents covering the prior three years:
“(1) director independence questionnaires and “any other documents” reflecting ties among Disney directors; (2) Disney policies or guidelines about charitable or political contributions, or public positions on legislation or public policy issues; (3) meeting minutes and materials from the Disney Board or any Board committee about the Parental Rights Act, Disney’s March 28 press release, the dissolution of the [Reedy Creek Improvement District (RCID)], the economic benefits to Disney from the (RCID), and the policies and guidelines that were the subject of request; and (4) written correspondence “between or among any Disney directors (including [Chapek] in his capacity as CEO)” about the relevant issues.”
In response, Disney told the plaintiff that he lacked grounds to make the Section 220 request because its directors and officers didn’t engage in mismanagement. However, Disney still met with the stockholder and negotiated down the scope of items to produce. Disney shared documents responsive to category 2, as well as all formal board documents, specifically minutes, that were responsive to category 3. Disney did not produce director independence questionnaires (category 1) or email communications (category 4). Not satisfied, the stockholder filed suit to compel production of those documents.
In ruling in Disney’s favor, the court paid homage to the business judgement rule and noted that a stockholder cannot obtain books and records simply because they disagree with a board decision, even if the decision turned out poorly in hindsight. Even if the stockholder had presented evidence of a wrongdoing, the court explained that the stockholder hadn’t shown that the additional documents were essential to the stated purpose for inspection. The court reiterated that “[f]ormal board-level documents are often the beginning and end of a Section 220 production where a plaintiff aims to investigate” potential mismanagement. For more information on this case, see this article from Proskauer Rose.
SharpSpring, Inc.: Court Awards Access to Informal Board Materials and Officer-Level Materials
In Hightower v. Sharpspring, Inc., C.A. No. 2021-0720-KSJM (Del. Ch. Aug. 31, 2022), Chancellor Kathaleen McCormick ordered production of certain informal board materials and officer-level materials where the stockholder cited inconsistencies between board minutes and the proxy materials related to a merger. The stockholder made a Section 220 request to investigate possible wrongdoing in connection with SharpSpring’s merger agreement to be acquired. The stockholder expressed concern that the transaction was tainted by conflicts on the part of SharpSpring’s CEO who negotiated the transaction. SharpSpring produced certain formal board materials relating to meetings leading up to the execution of the merger agreement but declined to produce other requested documents.
The stockholder filed suit to compel SharpSpring to produce the other documents. At trial, the stockholder showed that the board minutes that they reviewed included descriptions of key events that didn’t match up with the proxy materials’ descriptions of those events in important ways.
The court explained that the “inconsistent accounts” of the events related to the merger included in the formal board materials and the proxy materials gave the stockholder “the foothold to argue for broader inspections.” To reconcile the inconsistencies, the court stated that the stockholder should be granted the option to review informal board materials (e.g., communications between directors and the corporation’s officers and senior employees) and officer-level materials (e.g., communications and materials that were only shared among or reviewed by officers and employees).
Maintain Robust Processes for Board-Level Documents.
As noted above, formal board-level documents are often the beginning and end of a Section 220 production when a stockholder aims to “investigate” potential mismanagement. One important element of a robust process for board-level documents is to draft, review, and approve meeting minutes promptly after the meeting. This will allow directors to review drafts while meeting discussions and decisions are still fresh in their minds, thus avoiding omissions and inaccuracies. In addition, this type of timing will bolster the proposition that the company follows good minute-keeping practices and, as a result, there isn’t a need to look beyond the minutes to understand what transpired during the meeting. The alternative runs the risk of a company having to produce informal board materials, like emails, texts, and other electronic messages. See this article for more information as to why corporate formalities, like corporate record keeping, are important.
Make Certain the Corporate Record Is Consistent.
The SharpSpring case serves as a reminder that corporate records need to be consistent. Board-level documents may be written clearly, but that won’t do much good if those documents fail to align with other company disclosures. This isn’t to say that companies should create a false narrative. Rather, there should be a concerted effort to avoid inconsistencies or information gaps since these can be the foothold a stockholder needs to successfully requestg a broader scope of documents. See this article for a few points to keep in mind when reviewing committee and board minutes.
Avoid “Glaringly Egregious Litigation Conduct.”
Recalling the Gilead case, it’s unlikely that the company’s intention was to engage in, as the court described it, “glaringly egregious litigation conduct” in response to the Section 220 request they received. Instead, there was likely a desire by Gilead to push back on an overly broad Section 220 request. However, this approach will, at best, likely just draw out the timeline for the company’s ultimate production of board-level documents. At worst, the approach will result in the company receiving a court order to pick up a stockholder’s legal fees in addition to producing board-level documents. Companies may be better served to take a page out of Disney’s book by negotiating down a Section 220 request and voluntarily producing certain formal board-level documents. That way, if the Section 220 request should make its way into court, the company can point to having made a good faith effort to respond to the request and argue that they already shared responsive documents.
Expect That All Electronic Communications May Be Reviewable by Stockholders.
In the context of litigation, the general rule is to assume that everything that you send or receive electronically will be discoverable. The same has increasingly become true for Section 220 requests. In general, it is best to conduct corporate business over corporate email versus personal email, text, or instant message. Even better, leave the discussion of significant matters to live discussions. This article provides a few best practices for outside directors to keep in mind when communicating sensitive information.
Remain Mindful of Costs and Consider Your D&O Insurance Policies.
As discussed, the scope of Section 220 requests can go well beyond formal board-level documents. At times, these requests seek the production of emails, texts, and other electronic messages. For those that appreciate the time and expense associated with producing information in the context of litigation, the process of responding to Section 220 requests can be just as costly. In both cases, companies will want to engage outside counsel, review and redact documents for privilege, and all that after aggregating the universe of potentially producible documents.
D&O insurance policies for public companies typically have limited (if any) coverage for Section 220 requests. For example, your D&O insurance policy may have a sublimit for books and records requests. To illustrate this, a D&O insurance policy may have a $5 million limit, but the company may only have $250,000 available to respond to a books and records request. In some cases, there can be ways to increase coverage by structuring your coverage to stack sublimits from different layers of insurance. If you are unclear as to what your D&O insurance policy covers in response to a Section 220 request, it would be good to confirm with your insurance broker and/or outside counsel. In advance of your next policy renewal, we recommend developing a game plan to enhance the current level of coverage to the extent that there is room to do so.
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Board and committee meeting minutes are an important part of a company’s internal record-keeping process and critical in helping mitigate litigation risk for directors.