Court of Chancery Expands Stockholder Right to Corporate Books and Records
In a recent post-trial opinion, Vice Chancellor Laster of the Delaware Court of Chancery issued an important decision regarding stockholder books and records demands under Section 220(b) of the Delaware General Corporation Law. This decision, which is likely to be appealed to the Delaware Supreme Court, is a departure from recent Court of Chancery precedent that imposes stricter requirements for the stockholder’s purpose in making the demand, and thus the decision could potentially lower the burden on a stockholder’s ability to obtain books and records from a Delaware corporation. The decision may also be another signal from the Delaware Court of Chancery on its willingness to entertain Caremark claims, i.e., claims for the breach of the duty of loyalty by directors and officers when there has been a failure of corporate oversight.
In a recent post-trial opinion, Vice Chancellor Laster of the Delaware Court of Chancery issued an important decision regarding stockholder books and records demands under Section 220(b) of the Delaware General Corporation Law (“Section 220”). Lebanon County Employees’ Retirement Fund v. AmerisourceBergen Corp., C.A. No. 2019-0527-JTL (Del. Ch. Jan. 13, 2020). Notably, the holding rejects certain Section 220 precedent that imposes stricter requirements for the stockholder’s purpose in making the demand, and thus the decision could potentially lower the burden on a stockholder’s ability to obtain books and records from a Delaware corporation. However, the decision likely will be appealed to the Delaware Supreme Court.
AmerisourceBergen Corp. (the “Company”), one of the world’s largest distributors of opioid pain medication, is subject to federal laws and regulations requiring the maintenance of systems and controls to prevent illegitimate diversion of opioids and to report suspicious orders. Due to prior compliance issues, the Company adopted robust compliance programs to detect and prevent diversion of opioids, including a system by which the Company’s directors and officers actively oversaw and reviewed the effectiveness of these compliance programs. In the years following the initial implementation of these programs, the Company was alleged to have failed to identify and address suspicious orders of opioids, and became the target of numerous subpoenas, government investigations and lawsuits, including multi-district litigation brought by cities, counties, Indian tribes, union pension funds and the attorneys general of virtually all states.
In light of the foregoing, stockholders of the Company sued under Section 220 for the purpose of investigating whether the Company’s directors and officers committed any wrongdoing or mismanagement or breached their fiduciary duties. Under Section 220, a plaintiff must establish by a preponderance of the evidence (i) its status as a stockholder, (ii) compliance with the statutory demand requirements and (iii) a proper purpose for the demand. The plaintiff must then show, again by a preponderance of the evidence, that each category of books and records is essential and sufficient for the articulated purpose. The issue before the court in this case was whether the plaintiffs stated a proper purpose, and, if so, the scope of the books and records to be provided by the Company.
What constitutes a “proper purpose” for a Section 220 demand—stated in the statute as a purpose reasonably related to such person’s interest as a stockholder—is very broad and includes investigating alleged wrongdoing or mismanagement. Mere allegations of general wrongdoing or mismanagement will not suffice. A plaintiff must show, by a preponderance of the evidence, a credible basis from which the court can infer possible wrongdoing or mismanagement that would warrant investigation. This burden can be met by showing credible circumstantial evidence of legitimate issues of wrongdoing or mismanagement. Generally, when there is a credible basis to suspect that a corporation has been violating positive law or failing to comply with applicable regulations, and when those potential violations appear to have contributed to a corporate trauma, Delaware courts have held that some level of investigation under Section 220 is warranted.
In this case, the court found there was strong circumstantial evidence that the Company may have: (i) ignored indications of suspicious orders, failed to halt and investigate suspicious orders and failed to report suspicious orders to relevant authorities; (ii) ignored indications that it was distributing opioids to rogue pharmacies and that it chose to continue doing business with these pharmacies rather than cutting them off; and (iii) pushed opioids into the distribution chain under circumstances where it knew or should have known that they would be diverted for improper uses. Accordingly, the court held that the plaintiffs were entitled to their Section 220 demand to explore whether the Company violated positive law and whether its directors and officers were involved in the violation, condoned it, consciously ignored indications that it was going on, or consciously failed to establish and monitor the necessary information and reporting systems that would have enabled them to identify and address the violations of positive law.
In granting the plaintiffs’ Section 220 demand, the court departed from Court of Chancery precedent that appeared to require a plaintiff to commit in advance to what it would do with an investigation (the purpose-plus-an-end test), and to introduce evidence from which a court could infer the existence of an actionable claim if the purpose of the investigation was to file a derivative lawsuit against the corporation’s directors or officers (the actionable claim test).
The purpose-plus-an-end test arose originally from two cases where the stockholder’s only purpose was to bring litigation. The court reasoned that the test had been transformed into a general requirement that goes beyond what Section 220 and Delaware Supreme Court precedent require. The court held that although a stockholder may choose to state what it will do with the fruits of its Section 220 demand, it does not need to both articulate a proper purpose for inspection and commit in advance to the ends to which it will put the fruits of that inspection. The only requirement is that the stockholder state a proper purpose.
In addition to litigation, a stockholder could use the investigation to seek corporate reforms, prepare a stockholder resolution for the next annual meeting or mount a proxy fight. The court stopped short of holding that a stockholder’s intentions are irrelevant: if a corporation challenges whether the stockholder’s proper purpose is bona fide, then a stockholder can point to how it plans to use the materials as evidence that its claimed purpose is its actual purpose. If a stockholder cannot identify a credible potential end use, the court may infer that the stockholder’s stated purpose is not its actual purpose. However, as a threshold matter, the court held that there is no requirement for a plaintiff to state how it intends to use the Section 220 demand to be granted access to corporate books and records.
The plaintiffs in this case did not limit their purpose only to bringing litigation, and, in any event, the court held that the plaintiffs were not required to state what they intended to do with the investigation in order to state a Section 220 demand.
Actionable Claim Test
Following its rejection of the purpose-plus-an-end test, the court held that the actionable claim test—arising from precedent that applied a standard that, in effect, replicated the standard used to judge dismissal of a derivative claim—was contrary to Section 220 precedent.
In the view of the court, since Delaware courts have repeatedly urged stockholders to use Section 220 before filing derivative lawsuits (recognizing that without doing so plaintiffs typically lack the facts necessary to plead an actionable claim against the board that can survive a motion to dismiss), it would be illogical to impose the same onerous standard when plaintiffs seek to obtain the very books and records necessary to support a derivative claim. According to the court, the operative question is whether a stockholder has shown a credible basis to suspect possible corporate mismanagement or wrongdoing, and not whether the foundation of that credible basis can be tied to an actionable claim.
The court explained that, although evaluating whether a stockholder has shown a credible basis to suspect wrongdoing or mismanagement requires a judgment grounded in the facts of a particular case, when a corporation has suffered a trauma and there is a credible basis to suspect that it has violated positive law or government regulations, some level of investigation is likely warranted.
The court also rejected the Company’s related argument that the plaintiffs needed to show evidence of non-exculpated claims (in essence, an actionable claim) against directors or officers in order to be granted their Section 220 demand. In light of recent Delaware cases addressing Caremark claims, e.g., Marchand v. Barnhill, 212 A.3d 805 (Del. 2019), the court provided an interesting analysis of the potential Caremark claims the plaintiffs here may have against the Company’s directors and officers. In the Vice Chancellor’s estimation, the evidence surrounding the volume of the Company’s distribution of opioids through rogue pharmacies, the minimal levels of reporting of suspicious orders and the changes over time in reporting levels was sufficient to support an inference that the Company’s directors and officers may have breached their fiduciary duties. They may have done so either (i) by consciously failing to monitor a mission-critical source of regulatory risk (because if they were actively monitoring a compliance system they would have detected regulatory issues and taken action) or (ii) by knowingly failing to respond to red flags (because they were engaged in monitoring, identified the issues and ignored them, such as by failing to implement additional compliance measures in response to gaps in the compliance program or by consciously failing to take remedial steps in response to problems that the compliance system revealed).
Scope of Investigation
The court also provided a helpful discussion of the scope of the materials—which must be essential and sufficient for the stated purpose—that can be provided in a Section 220 demand. These typically fall into three categories:
Formal board materials, meaning materials that formally evidence director deliberations and decisions, and materials received and reviewed by directors in connection therewith.
Informal board materials, meaning communications between directors and officers and senior employees, such as information distributed to directors outside of formal channels, in between formal meetings or in connection with other types of board gatherings (may also include emails and communications among directors, even on non-corporate accounts).
Officer-level materials, meaning communications and materials only shared among or reviewed by officers and employees.
Which category of materials is appropriate will depend on the context of the demand, but wide-ranging mismanagement would justify a more wide-ranging inspection—although, at a minimum, plaintiffs will be able to access formal board materials. Furthermore, plaintiffs are entitled to obtain discovery into what types of books and records are maintained by the corporation and how they are maintained, including through interrogatories and depositions.
This decision, which is likely to be appealed to the Delaware Supreme Court, is a departure from recent Court of Chancery precedent that imposes stricter requirements for the stockholder’s purpose in making the demand, and thus the decision could potentially lower the burden on a stockholder’s ability to obtain books and records from a Delaware corporation.
The decision may be another signal from the Delaware Court of Chancery on its willingness to entertain Caremark claims, e., claims for the breach of the duty of loyalty by directors and officers when there has been a failure of corporate oversight, either in establishing oversight mechanisms or by failing to address red flags of corporate wrongdoing, when previously such stockholder claims were infrequently asserted because they were regarded as the most difficult on which to prevail.