City of Westland Police & Fire Retirement System v. Axcelis Technology, Inc., No. 594 (Del. Aug. 11, 2010) (Jacobs, J.)
This opinion, written by Justice Jacobs for the Delaware Supreme Court sitting en banc, affirmed the Court of Chancery’s dismissal of a books and records action under Section 220 of the Delaware General Corporation Law seeking materials concerning alleged management wrongdoing relating to the rejection of a takeover proposal and the failure to accept director resignations. However, in doing so, the Court also provided guidance as to how a stockholder can establish a “proper purpose” for demanding inspection under Section 220 where a board has unilaterally adopted a “plurality plus” voting policy and has refused to accept directors’ resignations offered in accordance with that policy.
According to the “plurality plus” policy of defendant Axcelis Technologies (“Axcelis”), a director standing for reelection who received a greater number of withheld votes than affirmative votes was required to offer a letter of resignation to the Axcelis Board of Directors (the “Board”). The Board could either accept or reject the resignation at its discretion. Notably, Axcelis’s plurality plus policy had been adopted by board resolution rather than by a bylaw or certificate amendment, meaning that the company’s stockholders had not been permitted a vote regarding its adoption.
Two events occurred in 2008 that precipitated Plaintiff’s eventual filing of this action. First, a prospective acquirer failed to offer a final bid after the Board rejected two earlier bids and refused to extend a due diligence period. Second, the Board rejected resignations offered by three directors who failed to garner sufficient “yes” votes at the company’s annual meeting to survive the requirements of the plurality plus policy.
Following these events, Axcelis announced in early 2009 that it had failed to make certain required debt payments and had sold its stake in a longstanding joint venture to the same company with which it had recently engaged in merger negotiations. Plaintiff filed this action shortly after Axcelis’s share price fell below $1. Plaintiff claimed a “proper purpose” to demand inspection of the company’s books and records, as required by Section 220, in that it sought “to investigate possible management wrongdoing.”
Plaintiff based its allegations of wrongdoing on two “suspect” incidents. First, Plaintiff argued that the Board’s decision to reject the offered resignation letters, in and of itself, gave rise to an inference of impermissible “entrenchment” motivation. Invoking the Blasius standard, Plaintiff claimed that this inference was sufficient to support its burden under Section 220 unless the Board could establish a “compelling justification” for its actions. Second, Plaintiff argued that the Board’s rejections of the acquisition proposals had constituted impermissible defensive measures under Unocal, which created “a credible suspicion of wrongdoing (i.e., board entrenchment).” The parties stipulated to the essential facts upon which the Court rested its decision.
The Court of Chancery granted dismissal, holding that Plaintiff failed to demonstrate a proper purpose and that Plaintiff, “had failed to present any evidence that the Board’s refusal to accept the three directors’ resignations thwarted the will of the shareholders or impeded their voting franchise.” The Court also found no basis to support Plaintiff’s Unocal claims, quoting Gantler v. Stephens to hold that “[r]ejecting an acquisition offer, without more, is not [a] ‘defensive action’ under Unocal.”
On appeal, Plaintiff conceded that the Court of Chancery applied the proper standard to its books and records demand – that is, Plaintiff was required to show a “proper purpose” by presenting “some evidence . . . to suggest a credible basis from which the Court of Chancery could infer that wrongdoing may have occurred.” Plaintiff argued, however, that the Court of Chancery misapplied the standard by requiring it “to provide affirmative evidence of wrongdoing.” Instead, Plaintiff argued, the undisputed facts themselves should be sufficient to give rise to the necessary inference. Plaintiff also argued that the Court of Chancery should have examined the Board’s allegedly entrenching actions under the Blasius standard.
The Supreme Court found that Plaintiff had failed to satisfy its burden. Plaintiff’s entire argument, the Court found, was based on inferences it drew from the undisputed facts. That Plaintiff drew from these facts different inferences than did the Court of Chancery was insufficient to support its burden. Nothing in the record suggested that the Board’s reaction to the merger proposals had been the product of anything other than “good faith business decisions.”
The Court also rejected Plaintiff’s argument that the Blasius standard should apply to the failure to accept the director resignations. Application of that standard would have impermissibly shifted the burden in the case, from a requirement that Plaintiff show a proper purpose for its Section 220 demand to one that the Board must show a “compelling justification” for its decision to reject the resignations. The Court thus held that the Blasius standard does not apply to a review of “a board of directors’ discretionary decision to reject director resignations in cases where a ‘plurality plus’ governance policy is triggered and requires that resignations be tendered.”
Although it affirmed the trial court’s decision, the Supreme Court concluded that “further elaboration of the ‘proper purpose’ requirement,” in the context of stockholder voting rights was required. The Court first affirmed the holding of Pershing Square, L.P. v. Ceridian Corporation, in which the Court of Chancery had held that investigation of whether a director is suitable for his or her office constitutes a proper purpose under Section 220.
The Court further affirmed Pershing Square to the extent it established requirements that must be met before a plaintiff may receive relief under Section 220 based on an alleged proper purpose of investigating director suitability. That is, the defendant must not be able to prove that plaintiff’s justification for inspection is pretextual and plaintiffs must “present some evidence to establish a credible basis from which the Court of Chancery could infer there are legitimate concerns regarding a director’s suitability.” Plaintiff must also show that the information sought is “necessary and essential” to evaluate the director’s suitability. In addition, access to the requested documents must not be overridden by “the need to protect confidential board communications.”
The Court then stated its belief that the Pershing Square decision suggested a basis upon which a plaintiff could articulate a proper purpose to demand inspection based on a board’s rejection of director resignations offered under a plurality plus policy that had been adopted by unilateral board resolution. Under these circumstances, where a board has “confer[red] upon itself the power to override an exercised shareholder voting right without prior shareholder approval,” it is appropriate to ask whether the board’s decision was based on its proper business judgment, or on “some different, ulterior motivation.” That is, a failure of a director to receive a majority vote may call into question the director’s suitability to retain office. A board’s accountability to this inquiry, the Court held, “should take the form of being subject to a shareholder’s Section 220 right to seek inspection of any documents and other records upon which the board relied in deciding not to accept the tendered resignations.”