Delaware Court of Chancery Holds Credible Basis to Infer Wrongdoing by One Director Sufficient to Satisfy Burden of Proof Under Section 220
In Rodgers v. Cypress Semiconductor Corporation, C.A. No. 2017-0070-AGB (Del. Ch. April 17, 2017), the Court of Chancery held that shareholder plaintiff T.J. Rodgers (“Rodgers”) had established several proper purposes for his demand to inspect certain books and records of Cypress Semiconductor Corporation (the “Company”), along with a credible basis to infer wrongdoing by at least one of the Company’s directors. The Court granted Rodgers’ Section 220 action and directed the parties to meet and submit an order for production of all responsive documents.
Rodgers, former President and CEO of the Company, owned 2.35% of the Company’s common stock. After Rodgers’ resignation, the Company’s board of directors (the “Board”) appointed a new President and CEO, and created a new “Executive Chairman of the Board” position for Ray Bingham (“Bingham”), formerly Chairman of the Board. The position was created to assist the new CEO in his transition by allowing Bingham to function as both an executive officer of the Company and Chairman of the Board.
Shortly thereafter, one of the Company’s previous potential acquisition targets announced that it was to be acquired by Canyon Bridge Capital Partners, Inc. (“Canyon”). The press release identified Bingham as a “founding partner” of Canyon. Rodgers responded by emailing Bingham, with the Board copied, suggesting that he work to eliminate the Executive Chairman position because the costs to the Company outweighed any benefit the Company might be receiving. Additionally, Rodgers sent a letter to the Board, detailing his concern that Canyon competed with the Company for acquisition opportunities and that Bingham had violated the Company Code of Business Conduct and Ethics (the “Code”) by serving as a founding partner of Canyon.
Rodgers eventually served a demand to inspect certain books and records on the Company, identifying 18 categories of requested information. The Company agreed to provide stocklist materials and bylaws information requested by Rodgers but denied the remainder of the demand, stating that Rodgers “ha[d] set forth no credible basis to infer that a non-exculpated breach of fiduciary duty ha[d] occurred.” Rodgers responded by filing his complaint to compel the Company to produce the requested books and records. Rodgers then announced his intention to nominate two new individuals to the Board and initiated a proxy contest in order to do so.
The Company, in defending the action, claimed that Rodgers did not establish a proper purpose for his demand to inspect the requested documents. The Court noted that, in order to establish a proper purpose to investigate possible mismanagement, stockholders must establish “a credible basis from which the Court of Chancery can infer there is possible mismanagement that would warrant further investigation.” The Court went on to hold that Rodgers had satisfied this burden of proof. In support of this holding, the Court found that evidence presented by Rodgers established that a credible basis existed to infer that Bingham had potentially violated the Code’s prohibitions on simultaneous employment with the Company and any of its competitors and on engaging in activity in conflict or in perceived conflict with the Company. Additionally, the Court found that a credible basis existed to infer that Bingham had potentially violated the Code’s conflict of interest disclosure requirement.
The Company challenged this purpose by arguing that, similar to the company in Southeastern Pennsylvania Transportation Authority v. AbbVie, the Company’s certificate of incorporation contained a Section 102(b)(7) exculpatory clause, which required Rodgers to establish a credible basis to believe that the entire Board breached its duty of loyalty or acted in bad faith, rather than one director. The Court rejected this argument. In doing so, the Court observed that the AbbVie court expressly found that derivative litigation was the sole motivation for the requested investigation in that case, and found that that, unlike in AbbVie, Rodgers’ demand stated other purposes that demonstrated Rodgers’ “genuine desire to pursue corrective actions outside derivative litigation.” In this reasoning, the Court mentioned that Rodgers’ stated purposes for the inspection included “to communicate with stockholders of the company regarding matters of common interest,” “to evaluate the suitability of all current members of the Board to continue serving as directors of the Company” and “to evaluate possible litigation or other corrective measures.” The court held that, because Rodgers had stated several proper purposes and established a credible basis to infer wrongdoing by Bingham, he had satisfied his burden of proof under Section 220.
The Company additionally argued that the proper purposes set forth by Rodgers were not his actual purposes, and that his demand was actually motivated by a desire to exact revenge against Bingham and aid in Rodgers’ proxy contest. The Court rejected this argument, stating that such a defense would only be successful where “the plaintiff’s actual, predominating purpose is something unrelated to the plaintiff’s purpose as a stockholder,” and found that the Company did not sustain its burden to prove that Rodgers’ purpose for his demand was improper. The Court further held, however, that because Rodgers was subject to the confidentiality order the parties had previously entered into, he could not freely use the Company’s confidential information in his proxy contest.
Finally, the Court addressed the scope of the documents to be produced. First, over the Company’s objection, the Court held that Rodgers was entitled to receive documents provided to the Company’s CFO in addition to the documents provided tothe directors, as documents provided to the CFO were also relevant to his stated purposes. Second, the Court did not allow Rodgers to expand the scope of his inspection from documents “provided to” the board, its members and/or the CFO, to include “communications involving” the directors and/or CFO with respect to the topics identified in the demand. The Court entered judgment in Rodgers’ favor and directed the parties to meet and form an order, in accordance with the Court’s rulings on the continued application of the confidentiality order and on the scope of documents to be produced, for the production of the Company’s documents responsive to Rodgers’ demand.