Much has been written of late about the growing prevalence of books and records demands by stockholders under Section 220 of the Delaware General Corporation Law, and the increased willingness of Delaware courts to expand the boundaries of stockholders’ inspection rights conferred by that statute.[1]  A recent decision from the Delaware Court of Chancery exemplifies this trend and introduces an additional risk that companies should consider when determining how to respond to a Section 220 demand.  Specifically, the court’s suggestion that it would consider awarding attorneys’ fees to plaintiffs’ counsel for its costs to litigate the Section 220 action adds a new twist to the already delicate balance that companies must strike when deciding whether (and to what extent) to comply with a stockholder’s Section 220 demand.

Background

In Pettry v. Gilead Sciences, Inc.,[2] stockholders of Gilead Sciences Inc. (the “company”), a pharmaceutical company that, among other things, revolutionized HIV therapy, demanded books and records purportedly to investigate claims of wrongdoing by the company that were made by certain private plaintiffs and regulatory bodies in a series of pending lawsuits and investigations . In particular, five stockholders sent Section 220 demands to the company purporting to seek books and records for the purpose of investigating possible mismanagement, wrongdoing, or waste in connection with the misconduct alleged in the lawsuits and investigations.  The company refused to produce any books and records, and the stockholders brought suit in the Delaware Court of Chancery to compel the company to respond to their demand.  In defense, the company argued that plaintiffs had failed to allege a credible basis to suspect wrongdoing, the Section 220 demands were impermissibly lawyer-driven, and plaintiffs lacked standing because any shareholder derivative claims they could potentially bring against the company challenging the alleged wrongdoing would be dismissed as barred by, among other things, a charter provision exculpating directors for breaches of the duty of care pursuant to Section 102(b)(7).

The Court’s Decision

After a months-long discovery period during which the company moved to compel discovery from plaintiffs, while simultaneously moving for a protective order against plaintiffs’ discovery requests, and pre- and post-trial briefing by the parties, Vice Chancellor McCormick granted almost all of plaintiffs’ books and records requests, including their requests for formal board materials, certain of the company’s policies and procedures, materials that were circulated to management prior to their meetings (limited to those that were stored in a centralized location), the company’s communications with government regulators concerning the alleged wrongdoing, and director and officer questionnaires.  The court, however, denied plaintiffs’ request for emails from two former management directors that had been collected and produced in connection with some of the earlier investigations and lawsuits because plaintiffs failed to show that the production of such emails was necessary and essential to plaintiffs’ stated purposes, as required by statute, rejecting plaintiffs’ argument that the directors’ status as members of management or highly influential board members, without more, provides a sufficient basis for inspecting those directors’ emails.

Emphasizing that it was applying the “lowest possible burden of proof” under Delaware law that applies to Section 220 demands – the “credible basis” standard – the court relied exclusively on allegations from the other pending lawsuits and the government investigations to find a credible basis to suspect possible wrongdoing by the company.  The court rejected the company’s argument that plaintiffs served merely as “passive conduit[s] in a purely lawyer-driven endeavor and thus lack[ed] a proper purpose,”[3] finding, as other Delaware courts have, that even though the vast majority of Section 220 cases are “lawyer-driven,” this will only create a defense to an otherwise proper Section 220 demand when there are “unusual facts” suggesting that the plaintiff’s lawyers were not acting in their client’s interests.[4]  The court also rejected the company’s argument that the scope of each plaintiff’s inspection should be limited to the documents requested in their demands, explaining that the “general rule” that a stockholder’s inspection rights are limited by the scope of the demand letter need not be followed where judicial and litigant efficiency would be furthered by allowing plaintiffs to streamline and refine their requests through the course of the litigation (including by coordinating their requests).

Finally, Vice Chancellor McCormick rejected the company’s argument that plaintiffs lacked standing because any potential shareholder derivative claims would not be viable, citing Vice Chancellor Laster’s decision in Lebanon Cnty. Emps. Ret. Fund v.  AmerisourceBergen Corp.,[5] which held that “a defense to a future derivative claim affects a stockholder’s ability to invoke Section 220 only where the stockholder identifies pursuing a derivative claim as its sole purpose,” and finding that plaintiffs had not so limited themselves (despite the fact that the plaintiffs had not identified any other purpose for their books and records demand).  Notably, the AmerisourceBergen decision is currently on appeal to the Delaware Supreme Court.

Vice Chancellor McCormick did not stop there, however.  In reaching her decision, Vice Chancellor McCormick decried what she viewed as the “massive resistance” by defendant corporations generally to Section 220 demands and criticized what the court viewed as the company’s “overly aggressive defense strategy” in this case as “epitomiz[ing] a trend” of defendants “increasingly treating Section 220 actions as surrogate proceeding[s] to litigate the possible merits of the suit and plac[ing] obstacles in the plaintiffs’ way to obstruct them for employing it as a quick and easy pre-filing discovery tool.”  In light of these concerns, Vice Chancellor McCormick sua sponte granted leave for plaintiffs to seek an order compelling the company to pay their attorneys’ fees in pursuing the Section 220 case.

Key Takeaways

• At least until the Delaware Supreme Court issues its decision in the AmerisourceBergen case, companies that are the subject of litigation or investigations (even if they have not resulted in any settlements or judgments) should carefully weigh the benefits and drawbacks of refusing to produce any documents in response to a Section 220 demand on the grounds that there is no credible basis to suspect wrongdoing. This case is another example of a decision holding that the mere existence of investigations, lawsuits, or other public accusations of wrongdoing by the company is sufficient to support 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.[6]  The Gilead case suggests that, in these circumstances, companies that refuse to produce any documents risk not only being ordered to produce documents over their objection, but also potentially incurring liability for the plaintiff’s attorneys’ fees.
• That said, this decision confirms that companies can, and should, continue to resist producing emails and other electronic communications on the grounds that more formal board materials are sufficient to satisfy the plaintiff’s demand, notwithstanding some recent decisions ordering companies to produce such communications in limited circumstances.[7]
• Companies must, however, weigh the risk that handing over formal board materials at the outset—which would likely mitigate the risk that the court would shift fees—could provide plaintiffs with additional ammunition to then persuade the court that there are “gaps” in those formal materials, thus providing a basis to order the company to produce emails and text messages.
• It remains to be seen whether the threat of fee-shifting catches on in other cases (indeed, the court in Gilead has not yet decided whether to shift fees in that case). Although the court in Gilead referred to broader trends and suggested fee-shifting might be applied in other cases, the court’s reasoning suggests that fee shifting should be limited to extreme cases where the court finds that the company engaged in “overly aggressive litigation strategies,” such as “taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights.”

[1] We previously discussed this trend on this blog here.

[2] C.A. No. 2020-0132-KSJM; C.A. No. 2020-0138-KSJM; C.A. No. 2020-0155-KSJM; C.A. No. 2020-0173-KSJM (Del. Ch.).

[3] See Wilkinson v. A. Schulman, Inc., 2017 WL 5289553 (Del. Ch. Nov. 13, 2017) (declining to grant a stockholder books and records demand because “an entrepreneurial law firm initiate[d] the process, draft[ed] a demand to investigate different issues than what motivated the stockholder to respond to the law firm’s solicitation, and then pursue[d] the inspection and litigate[d] with only minor and non-substantive involvement from the ostensible stockholder principal.”).

[4] See, e.g., Inter-Local Pension Fund GCC/IBT v. Calgon Carbon Corp., 2019 WL 479082, at *9 (Del. Ch. Jan. 25, 2019).

[5] 2020 WL 132752, at *6-24.

[6] See, e.g., AmerisourceBergen, 2020 WL 132752, at *9 (“Ongoing investigations and lawsuits can provide the necessary evidentiary basis to suspect wrongdoing or mismanagement warranting further investigation.  This type of evidence is strong when governmental agencies or arms of law enforcement have conducted the investigations or pursued the lawsuits.”).

[7] See, e.g., KT4 Partners LLC v. Palantir Techs. Inc., 203 A.3d 738 (Del. 2019).