Delaware Chancery Mulls Fix for Record Demands ‘Larding Up’ Court

The top judge for Delaware’s Chancery Court is calling for a greater focus on the scope of board documents that shareholder plaintiffs can seek in pursuing fiduciary duty breach suits.

Litigation of demands on corporate boards to produce documents and records has proliferated in recent years, “larding up” the court’s docket with “glorified discovery disputes,” Chancellor Kathaleen McCormick said in a recent speech on M&A litigation at a securities conference.

With the volume of so-called “Section 220 demands” showing no signs of abating, corporate attorneys said more clarity from the court on what constitutes “books and records” would benefit all parties during the litigation process. One possible solution, proposed by McCormick, would be to automatically allow plaintiffs access to certain types of records that aren’t costly or difficult for companies to produce.

Investors frequently use books and records demands, made under Section 220 of the Delaware General Corporation Law, as a fact-finding process to later sue directors for fiduciary duty breach claims. Companies often try to stave off demands, which can be costly to comply with, by challenging how shareholders intend to use the records.

The focus on plaintiffs’ intent hasn’t benefited anyone, McCormick said in a Jan. 25 speech to the Securities Regulation Institute.

“One of the greatest impediments to our current system has been the focus of litigants on entitlement to records, as opposed to scope,” McCormick said. The court should “better signal our expectations in this regard,” she said.

Seeking Definitions

There isn’t a consistent understanding of what constitutes “books and records,” said Doru Gavril, a partner at Freshfields Bruckhaus Deringer LLP specializing in shareholder litigation and corporate governance.

The scope of books and records can be limited to board minutes, or as broad as sensitive emails or texts on personal accounts, Gavril said. The definition depends on whether shareholders have shown that certain documents are “necessary and essential” to their demand, he said.

“Perhaps one set of parameters will not work for every imaginable circumstance. But having no parameters as we know right now is leading to a certain level of concern and perhaps dysfunction in how companies respond to 220 demands,” Gavril said.

McCormick has been a forceful voice at the Chancery Court in condemning overzealous defenses by companies in records cases.

Her most notable ruling came in 2020 against drugmaker Gilead Sciences Inc. She berated the company for an “overly aggressive defense strategy” against investors seeking to probe price-fixing and patent gamesmanship allegations involving the HIV prevention drug Truvada.

One way to improve the system would be to categorize documents that are inexpensive for companies to produce as “automatic gives” to plaintiffs who state a proper purpose and meet other requirements, McCormick said in her speech. Inversely, the court could look to limit document production to formal board minutes in other situations, she said.

Striking a balance should help shareholders better evaluate the benefits of litigating time- and resource-intensive Section 220 lawsuits, she said.

Outside Directors

Greater clarity is needed on whether shareholders can access the electronic communications of independent outside directors, said Ned Weinberger, a partner at Labaton Sucharow, who chairs the firm’s corporate governance and shareholder rights litigation practice.

Outside directors—who aren’t stakeholders or employees in the company—may use their personal or work emails for board communications, Weinberger said. Shareholders may want to obtain those communications when more traditional board records are lacking, he said.

The court’s chancellors have offered different views on the issue. Weinberger pointed to Jan. 7 comments by Vice Chancellor Joseph Slights, III in a shareholder suit related to American Securities LLC’s $1.3 billion buyout of drywall distributor Foundation Building Materials Inc.

Slights said during oral arguments that he would deny the pension fund plaintiffs’ motion seeking the e-mail communications of three of Foundation’s outside board directors who used their own work accounts to discuss the acquisition. He formalized his ruling in a Jan. 14 opinion.

Vice Chancellor Travis Laster offered a mixed view on the issue during a September 2015 trial between Amalgamated Bank and Yahoo! Inc. Laster noted that electronic communications held by an outside party—such as outside counsel, consultants or even IT service providers—could still be regarded as corporate records in some circumstances.

Laster ultimately ruled against plaintiff Amalgamated Bank in a November 2015 opinion, saying it hadn’t convinced him to permit the search of Yahoo! outside directors’ emails or other records.

It’s a question that plaintiffs want clarity on, Weinberger said.

“If a director’s email concerns a board matter, then it’s a corporate record. It shouldn’t matter where the email physically resides,” he said. “If the rule is that a document is only obtainable if it’s physically located on a corporation’s servers, then stockholder inspection rights become pretty easy to circumvent.”

Zoox Ruling

McCormick issued an opinion Jan. 31, just days after her speech, that laid new ground for books and records demands in a case involving Amazon.com Inc.'s 2020 acquisition of self-driving car company Zoox Inc.

Investors in privately-held Zoox were only only entitled to internal files they could have gotten from Zoox if it were publicly traded, McCormick said.

The novel ruling is the first to address investor rights to use so-called appraisal demands related to stock valuation of a private company to investigate potential fiduciary breaches tied to a merger.

The investors launched the appraisal demand after learning that they couldn’t seek records from a private company under the records statute, Section 220. The investors couldn’t use their appraisal demand to conduct a wider-ranging investigation by accessing more sensitive documents, McCormick said.

The Zoox ruling serves as a reminder to private companies “to maintain good corporate hygiene” similar to publicly traded ones, said Suni Sreepada, an M&A partner at Ropes & Gray LLP.

Private companies see far fewer 220 demands and may have less experience keeping proper board records through minutes and resolutions, she said.

More plaintiffs may try to get private companies’ books and records through appraisal demands when a 220 demand is procedurally unavailable, Sreepada said. But private companies may be able to prevent plaintiffs from getting more than books and records by comprehensively documenting the board’s decision-making process in M&A transactions, she said.

McCormick’s Zoox ruling offers a glimpse into how courts weigh broader considerations—such as the dangers of runaway litigation—when deciding records requests, said Benjamin Edwards, associate professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas.

Courts must also balance plaintiffs access to information with defendants’ costs in document management and production, he said.

Striking the right balance would help the Chancery Court and the state of Delaware maintain their reputations as desirable venues for business, Edwards said.

“If merger or deal litigation gets too out of hand, it will eventually drive business to incorporate in Nevada and elsewhere,” he said.

—With assistance from Mike Leonard