Tilting at Windmills: Fee Shifting in Section 220 Litigation
Stockholders in Delaware corporations carry a default right of access to corporate books and records. Corporations that choose to incorporate in Delaware, however, try to have their cake and eat it, too. A growing trend in Delaware corporate law sees Delaware corporations waging war on reasonable stockholder requests for books and records despite the stockholder’s statutory right of access to key materials in order to carry out purposes reasonably related to the stockholder’s need. The Delaware courts are taking note of this trend, and beginning to imply that Delaware corporations should pay attorneys’ fees and costs for stonewalling reasonable demands for books and records.
Overview – Stockholder Demands for Inspection of Books and Records
Delaware is corporate home to nearly a 1.5 million corporations big and small.[i] The Delaware General Corporation Law, which sets the ground rules for these corporations, establishes a statutory right (“Section 220”) for stockholders to obtain “books and records” of the company for purposes reasonably related to the stockholder’s need for these materials. Examples of materials are the list of stockholders and their holdings, board meeting minutes and presentations, and even informal (e.g., e-mail) correspondence in limited circumstances.
Why would a stockholder use this route to gain access to corporate books and records? Often times, when a stockholder uses Section 220, she has been blocked by company management from obtaining these materials informally. Companies—especially private companies—tend to keep their cards close to their vest. A request for books and records might set off alarm bells at the company. If the demand comes from a consortium of individuals or institutional stockholders, it may be a five-alarm fire at the company. Add in allegations of suspected fraud or mismanagement and a company might strategically choose to block all information demands, biding their time to retain and prepare outside counsel all the while hoping the stockholder is just bluffing.
A stockholder who chooses this route must first make a written demand on the company in strict compliance with the statute. This primarily includes a statement of the stockholder’s purpose for making the request, the documents or materials requested, and an affidavit signed by the stockholder affirming that he or she is a stockholder of the company.
The Company has five business days to respond in writing. If the Company does not respond, or responds rejecting all or some of the request, the stockholder may then file suit in the Delaware Court of Chancery to compel the information requested.
Actions Under Section 220
A suit to compel the company under Section 220 is meant to be a “summary proceeding.” In essence, the case should proceed to a brief bench (i.e., non-jury) trial, on a paper record or with minimal oral testimony, within 60-90 days. The Court may accept additional briefing after the trial before issuing its opinion within 90 days of the final submission. Discovery—the phase of a case dedicated to oral and written requests and responses by either side—is typically short and limited to issues relevant to the 220 matter. It may include an oral deposition of the stockholder and a company representative.
At trial, the stockholder is put to a low burden of proof: a credible basis standard. For instance, a stockholder who seeks records to investigate wrongdoing must show that there is “some evidence” to suspect wrongdoing—something more than “mere suspicion.” So long as the stockholder meets this standard, the Court will assess what records are necessary and essential to carry out her purpose. The Court does so with “rifled precision,” i.e., the Court looks to narrowly define the scope of materials for production. The Court may also take additional steps to prohibit the dissemination of confidential company materials in its final order and retain jurisdiction to police any disputes that arise from the company’s production.
Defenses to Section 220 Actions
While the company should restrict its defense to certain limited bases, such as the stockholder’s failure to adhere to the requirements of the statute, the trend in Delaware has skewed towards scorched-earth, merits-based defenses. The company—now viewing its stockholder as a real litigation threat—might take the opportunity to air dirty laundry and make the stockholder’s life miserable (and expensive). For instance, a company foreseeing the stockholder’s actions as a risk for a future lawsuit using the demanded documents may try and short circuit the future lawsuit, thus litigating the follow-on “plenary” action in the current “summary” 220 action. The Court is accustomed to this merits-based drift and typically rebuffs such attempts in all but the exceptional case.
Attorneys’ Fees and Costs
Section 220 and the Court of Chancery’s inherent equitable powers permit fee shifting where the Court views a litigation position—such as a company’s heavy-handed defense in a summary matter—as taken in bad faith. More and more these days, the Court has implied that fee shifting is an appropriate retributive and deterrent punishment for such bad faith defenses. Additionally, the Company—who knows what information it does and does not possess—must be transparent with the Court and the stockholder about what kinds of materials it has that are responsive to the stockholder’s demands. If it does not, needless time may be expended litigating over categories of documents that do not exist at the end of the day. This, too, may be an appropriate situation for fee shifting.
The Court has increasingly put Delaware corporations on notice that full-throated defenses to reasonable demands under Section 220 may subject the corporation to fee shifting. Expect the Court to increasingly entertain stockholder requests for fees and costs in the near future as a means of deterring a pernicious trend in Delaware corporate litigation.
D&A represents stockholders of Delaware corporations and alternative entities seeking to vindicate their information rights.