Last week, the Delaware Supreme Court affirmed the Delaware Court of Chancery’s decision in Lebanon Cnty. Emps. Ret. Fund v. AmerisourceBergen Corp.,[1] a closely watched appeal in which the court clarified the circumstances in which stockholders are entitled to demand books and records to investigate allegations of mismanagement pursuant to Section 220 of the Delaware General Corporation Law.  In a decision that will likely continue the recent trend of an increasing number of Section 220 demands being made, particularly in the wake of allegations of corporate wrongdoing, the Delaware Supreme Court ruled that:

  • When a stockholder seeks to investigate credible allegations of mismanagement, the stockholder need not disclose “up-front” the stockholder’s “ultimate objective—that is, what [it] intend[s] to do with the books and records in the event that they confirm[] [its] suspicion of wrongdoing.” Although prior Delaware decisions had, for example, required stockholders demanding a stockholders list under Section 220 to identify the stockholder’s “intended communication” to the other stockholders, the court found that a demand to inspect books and records for an investigative purpose is “fundamentally different” because it is “in and of itself a legitimate matter of concern that is reasonably related to a stockholder’s interest as a stockholder.”
  • At least when a stockholder does not identify pursuing derivative claims as the sole objective of its investigation (and following this decision, few such demands will be so limited), the stockholder need not show a credible suspicion of any actionable mismanagement. Emphasizing that the credible basis standard is the “lowest possible burden of proof” and “reflects judicial efforts to maintain a proper balance” between stockholder inspection rights “and the rights of directors to manage” the corporation’s business “without undue interference from stockholders,” the court declined to find that the credible basis standard requires that any alleged wrongdoing be actionable.  Thus, even if it appears that there is no credible basis to allege that the directors acted in bad faith (as would be required to state an actionable claim for breach of fiduciary duty for companies with a 102(b)(7) exculpation provision), a stockholder may still be entitled to books and records to investigate mismanagement by the company.
  • At least in circumstances where the stockholder limits its investigative purpose to pursuing litigation, the court recognized that procedural obstacles that would be dispositive of any potential claims would be appropriate grounds for a company to refuse a Section 220 demand. The court distinguished procedural defenses—such as the expiration of applicable statute of limitations, which can be considered in determining whether a stockholder has a “proper purpose” for seeking books and records—from “merits” defenses, like Section 102(b)(7) exculpatory charter provisions and “Corwin cleansing,”[2] which the court indicated should not be considered in the context of a Section 220 demand.
  • The Court of Chancery has discretion to decide the appropriate scope of books and records that are necessary for the stockholder’s proper purpose. Notably, the court rejected the argument that its earlier holding in KT4 Partners LLC v. Palantir Technologies Inc.[3] that “books and records actions are not supposed to be sprawling, oxymoronic lawsuits with extensive discovery” “establish[ed] any bright line rules regarding discovery to be applied in all Section 220 actions.”  On the facts of this case, the court held that it was not an abuse of discretion for the Court of Chancery to grant the stockholder discovery into the types of corporate records that might be available to satisfy the stockholders’ demands.

This decision further underscores that the credible basis standard applicable to Section 220 demands seeking to investigate mismanagement is a low bar for plaintiffs to meet.  As this case and other recent decisions make clear, the mere existence of investigations, lawsuits, or other public accusations of wrongdoing by the company may be sufficient for Delaware courts to find a credible suspicion of possible wrongdoing for purposes of Section 220, even if there is no particular basis to suspect bad faith or disloyal conduct by the board.

More broadly, the decision suggests a willingness by Delaware courts to allow stockholder plaintiffs to use Section 220 to obtain “pre-lawsuit” discovery, even in cases where it appears that there is no credible basis to believe there are actionable claims.  In light of the discovery ordered in this case and the suggestion of fee-shifting in a recent Court of Chancery decision we discussed on this blog, the Delaware courts appear to be signaling to corporations that the preferred path when faced with Section 220 demands in these circumstances is constructive negotiation with stockholders.

In light of these developments, we expect an increasing number of Section 220 demands to come, and potentially more stockholder derivative lawsuits filed against directors and officers using the fruits of Section 220 investigations.  Boards should be cognizant of, and plan for, this growing risk by, among other things, ensuring the board’s records are complete and fairly and accurately reflect the board’s good faith discharge of its duties.

[1] AmerisourceBergen Corp. v. Lebanon Cnty. Emps. Ret. Fund, No. 60, 2020, 2020 WL 7266362 (Del. Dec. 10, 2020), https://www.courtalert.com/chancerypdf/602_202012101712602020.pdf, aff’g Lebanon Cnty. Emps. Ret. Fund v. AmerisourceBergen Corp., C.A. No. 2019-0527, 2020 WL 132752 (Del. Ch. 2020).

[2] See Corwin v. KKR Fin. Hldgs. LLC, 125 A.3d 304 (Del. 2015) (holding that business judgment protection applies to mergers that are not subject to entire fairness review and are approved by a fully informed and uncoerced vote of a majority of disinterested shareholders).

[3] 203 A.3d 738 (Del. 2019).