The Increasing Role of Delaware Books and Records Demands in Compensation and Governance Disputes
Section 220 of the Delaware General Corporation Law ("DGCL") codifies the common law right of a stockholder to access the books and records of a Delaware corporation. While this right has existed for many years, recently stockholders have begun to use the statute in innovative ways. Indeed, recent developments suggest that stockholders have found a new frontier in Section 220 of the DGCL, specifically in matters surrounding executive compensation and proxy contests. Although historically Section 220 garnered little interest outside of the derivative litigation context, these recent developments suggest that stockholders are heeding the admonition of the Delaware Supreme Court to utilize the "tools at hand," including Section 220, in order to gather information that can be used to institute litigation challenging perceived excessive compensation or to assist in running proxy contests or "just vote no" campaigns against incumbent directors.
This article will explore the recent developments in Delaware surrounding the use of Section 220 of the DGCL. In particular, we will examine the decisional context behind this new trend and discuss recent examples of the innovative use of Section 220. Based upon this analysis, we conclude that the contours of this new frontier have not yet been fully explored, and it is likely that books and records demand under Section 220 will become a common feature in dissident shareholders' campaigns.
Section 220 of the DGCL provides stockholders of a Delaware corporation with a statutory right to inspect and copy a Delaware corporation's books and records. Although the Delaware courts have characterized the right of inspection as a fundamental stockholder right, both Section 220 and the cases interpreting it have imposed limits on both the availability and the scope of the right to inspection. Indeed, as the Delaware Supreme Court has noted, "[t]he Section 220 demand for books and records…serves many salutary goals in the corporate governance landscape, but the burden on the plaintiff is not insubstantial."
Under the statute, a "stockholder" is defined as either a record holder or a beneficial owner of the corporation's stock. The stockholder must make a written demand, under oath, spelling out the scope of its inspection and make copies and extracts of a corporation's stock list, its stock ledger, or other books and records. A stockholder making such a demand must have a proper purpose to seek inspection; that is, the stockholder must have a purpose "reasonably related to such person's interest as a stockholder."
A stockholder seeking inspection of books and records (other than the stock ledger or stockholder list) has the burden of demonstrating that he has a proper purpose for such inspection. There has been a long list of cases construing the "proper purpose" requirements. For example, "it is well established that investigation of mismanagement is a proper purpose for a Section 220 books and records inspection." It is important to note, however, that "[m]ere curiosity or a desire for a fishing expedition will not suffice." Rather, the demanding stockholder must have a "reasonable suspicion" of the wrongdoing to which the demand is based. In the stocklist context, communicating with fellow stockholders about matters of common interest has long been considered proper even where the requesting holder has not announced a proxy contest.
The other common area of dispute under Section 220 has been the scope of documents a corporation is required to make available in response to a books and records demand, and whether it my impose any restrictions upon the disclosure or use of such documents. The general rule as to scope is, however, that a Section 220 demand is not a license for wide ranging discovery. Rather, a stockholder seeking inspection of books and records pursuant to Section 220 must "make specific and discrete identification, with rifled precision, of the documents sought." Those documents must relate to the purpose of the demand.
With respect to the use of documents received pursuant to Section 220, Delaware courts have been sensitive to the legitimate needs of corporations to protect proprietary or confidential information. In addition, where the corporation can show that there is reason to be concerned about potential misuse of documents, the Court has not hesitated to impose additional restrictions tailored to meet the specific concern.
A stockholder submitting a proper demand has a statutorily enforceable right to the inspection requested. If a corporation refuses to permit inspection, or fails to respond to the demand for inspection within 5 business days after it is received, the stockholder may bring an action in the Court of Chancery seeking an order compelling such inspection. This action by the stockholder is a summary proceeding, and therefore typically will be resolved quickly.
A New Frontier in the Use of Section 220
A. Decisional Context
It has been more than ten years since the Delaware Supreme Court noted that stockholders had made surprisingly little use of Section 220 as an information-gathering tool prior to bringing derivative actions. Even after the court's admonition to utilize the "tools at hand" in order to gather facts to enable them to formulate complaints that will withstand motions to dismiss, stockholders remained somewhat reluctant to incur the cost and time associated with making and prosecuting stockholder demands prior to brining an action against a corporation. Recent developments suggest, however, that stockholders may be heeding the guidance of the Delaware Supreme Court and the Court of Chancery.
Perhaps the most interesting aspect of this trend (if indeed it can be classified as such) is that the developments have taken place outside of the derivative litigation context. In other words, stockholders are beginning to use the "tools at hand" not only as a means of animating complaints in the derivative litigation context, but also as a means of gathering information for other purposes. It appears that the impetus for this new use of Section 220 was the Delaware Supreme Court's decision in Saito v. McKesson HBOC, Inc.
In McKesson, after the revelation of certain accounting irregularities, several stockholders challenged a stock-for-stock merger between McKesson Corporation and HBO & Company. The Court of Chancery granted McKesson's motion to dismiss the initial stockholder lawsuit, and in doing so the Court suggested that the plaintiffs "use the 'tools at hand,' most prominently §220 books and records actions, to obtain information necessary to sue derivatively." Saito was the only plaintiff to follow the Court's suggestion. He filed a books and records inspection demand the stated purpose of which was to investigate purported corporate wrongdoing. The corporation rejected his demand, and litigation ensued. The Court of Chancery held that, while Saito stated a proper purpose for the demand, the scope of inspection "only extended to potential wrongdoing after the date on which Saito acquired his McKesson stock." The Delaware Supreme Court reversed the Court of Chancery's determination of the scope of inspection. In particular, the Supreme Court held that, while there may be some interplay between a stockholder's standing to bring a derivative suit and his right to seek inspection of books and records pursuant to Section 220, Section 327 of the DGCL did not "defin[e] the temporal scope of a stockholder's inspection rights under §220."
In so holding, the Court reasoned that a stockholder could make use of information gathered via Section 220 in ways outside the derivative litigation context. In particular, the Court noted that "[stockholders] may seek an audience with the board to discuss proposed reforms or, failing in that, they may prepare a stockholder resolution for the next annual meeting, or mount a proxy fight to elect new directors." Accordingly, Saito was permitted to inspect and copy books and records covering time periods before he became a stockholder. The Supreme Court's statement as to the use of Section 220 outside the litigation context set the stage for more recent novel uses of Section 220.
B. The Use of Section 220 in "Just Vote No" Campaigns
The 2004 Annual Meeting of Stockholders of The Walt Disney Company ("Disney" or the "Company") provided the context for an innovative use of Section 220 building on the McKesson decision. In late 2003, two former directors, including Roy Disney, the nephew of the Company's founder, began a public campaign to oust Disney's long-serving CEO, Michael Eisner. In addition, to the use of the press and internet, among other media, the dissidents also made use of a Section 220 books and records demand in an interesting and creative way.
In January 2004, Mr. Disney made a books and records demand pursuant to Section 220 seeking various documents related to matters of executive compensation (the "Compensation Matters"). The stated purpose of the demand was to "investigate possible mismanagement, waste of corporate assets, improper influence or conduct, improper conflicts of interest between directors and officers and the Compensation Committee and lack of due care with respect to the Compensation Matters." Importantly, the demand did not mention communicating with stockholders as a purpose. While Disney agreed to produce documents responsive to many of the requests, it insisted that these documents be made available on a confidential basis. When the parties were unable to reach agreement on the scope of the confidentiality designations, the matter was submitted to the Court of Chancery. At least in part because of the absence of a communication purpose, the Court denied the dissidents' request for immediate relief prior to Disney's then-imminent annual meeting. In doing so, the Court noted that it was customary in Section 220 books and records cases for a final order to be conditional on a confidentiality order that "can reasonably be expected to be quite tight." The parties subsequently submitted the matter for briefing. In a decision rendered on August 6, 2004, Vice-Chancellor Lamb sided with the Company in refusing to permit public dissemination of the documents the Company had asserted were confidential. In doing so, the Court made several important points.
First, the Court began its analysis "with the presumption that the production of non-public corporate books and records to a stockholder making a demand pursuant to Section 220 should be conditioned upon a reasonable confidentiality order." The Court found this principle to be equally applicable to public and non-public corporations, recognizing that non-public corporations "possess enormous amounts of internal information that is not, in the ordinary course, required to be publicly disclosed."
Second, the Court noted that, if the records initially received on a confidential basis form the basis for a stockholder suit for breach of fiduciary duty or disclosure violations, many of those records would eventually be made public even if the initial complaint is filed under seal.
Third, the Court made it clear that it would entertain applications for relief from confidentiality restrictions in the context of a proxy solicitation. However, the burden on the party seeking disclosure in this context would be "heavy," such as a showing of "compelling circumstances" indicating that disclosure of the confidential information was necessary to prevent or cure a material misstatement in a corporation's proxy material. Absent such circumstances, documents produced pursuant to a Section 220 demand will likely remain confidential unless the stockholder files a complaint based on the information provided in the documents provided by the corporation.
Mr. Disney utilized Section 220 in another novel way in the aftermath of the Disney annual meeting. Mr. Disney submitted a new demand to inspect the proxies and ballots submitted at the annual meeting and filed a second Section 220 complaint to, among other things, obtain the right to publish the votes of certain groups of stockholders. While this case was not pressed because the most relevant information became publicly known, the potential remains for other stockholders to make use of Section 220 to examine voting results in particular situations.
Section 220 of the DGCL has emerged from the "backwaters" of corporate governance as an interesting new tool in a stockholder's arsenal. As the recent developments discussed above suggest, stockholders may continue to utilize the "tools at hand" in ways perhaps not envisioned by the Delaware Courts when they exhorted stockholders to use Section 220 as an information gathering tool. Even so, mere curiosity will not suffice, and regardless of the information sought (and the ultimate use to which the stockholder puts the information) there must be a reasonable suspicion of corporate wrongdoing, or some other proper purpose for the demand. In addition, the confidentiality standard cited by Vice Chancellor Lamb in the Disney opinion is likely to be the subject of future case law development. Practitioners should be aware of the potential innovation in the area of Section 220, and be prepared to address a stockholder's use of Section 220 in uncommon circumstances.
1 Mr. Grossbauer is a partner of, and Mr. Williams is associated with, Potter Anderson & Corroon LLP, Wilmington, Delaware. The views expressed herein are those of the authors only, and may not represent the views of Potter Anderson & Corroon LLP or any of its clients, some of whom the firm represented in some of the matters discussed in this article.
2 8 Del. C. § 220.
3 See, e.g., Donald J. Wolfe, Jr. & Michael A. Pittenger, CORPORATE AND COMMERCIAL PRACTICE IN THE DELAWARE COURT OF CHANCERY, §8-6 at 8-53 (2004) ("Wolfe & Pittenger").
4 See, Security First Corp. v. U.S. Die Casting and Dev. Co., 687 A.2d 563, 565 (Del. 1997).
5 8 Del. C. §220(a)(1). The statute was amended in 2003 to make Section 220 available to those who beneficially own stock through either a voting trustee or a nominee who holds stock of record on behalf of such person. Prior to that time, only record owners could utilize the inspection rights afforded by Section 220. The record ownership requirement proved to be cumbersome for typical "street name" holders, whose demands had to be made on their behalf by their broker (or, more specifically, the broker's nominee). However, if a demand is made by a beneficial owner, the demand must be accompanied by documentary evidence of that ownership (such as a brokerage statement).
6 The statute was amended in 2003 to provide that the phrase"[u]nder oath' includes statements the declarant affirms to be true under penalty of perjury under the laws of the United States or any State." 8 Del. C. §220(a)(3). Thus, notarization is not necessarily required for a demand to be valid (although the common practice is to continue to submit sworn demands).
7 8 Del. C. §220(b).
9 See, Wolfe & Pittenger, §8-6[e].
10 See, Security First Corp., 687 A.2d at 567.
11 Id. at 568. See also Mattes v. Checkers Drive-In Restaurants, Inc., 2001 WL 337865 (Del. Ch.) (must demonstrate credible basis for wrongdoing).
12 8 Del. C. §220(c). It is important to note, however, that where the person seeking inspection is a director of the corporation, such director's purpose is presumed to be proper, and the burden is on the corporation to demonstrate an improper purpose. See 8 Del. C. §220(d).
13 See, e.g., Sack v. Cadence Indus. Group, C. A. No. 4747, 1975 Del. Ch. LEXIS 213 (Apr. 9, 1975) (communications regarding settlement of derivative suit); Vista Resources, Inc. v. Camelot Indus. Corp., C. A. No. 6744, 1982 Del. Ch. LEXIS 569 (Mar. 30, 1982) (tender offer); Redwick Pty., Ltd. V. Medical, Inc., C. A. No. 7610, 1984 Del. Ch. LEXIS 570 (Nov. 7, 1984) (communication regarding potential purchases and sales of stock).
14 In the stocklist context, the documents required to be produced are fairly well-known at this point. For example, the corporation is required to provide a so called "Cede breakdown" showing broker position listings, see, e.g., Hatleigh v. Lane Bryant, Inc., 428 A.2d 350 (Del. Ch. 1981) but is not required to request a list of non-objecting beneficial owners (a "NOBO" list) under SEC Rule 14d-1 under the Securities Exchange Act of 1934, see Shamrock Assoc. v. Texas Am. Energy Corp., 517 A.2d 658 (Del. Ch. 1986).
15 See Security First, 687 A.2d at 570 (noting that discovery under Chancery Court Rule 34 "should not be confused" with a Section 220 order permitting inspection of certain books and records); see also Saito v. McKesson HBOC, Inc., 806 A.2d 113, 114 (Del. 2002) (noting that Section 220 "does not open the door to wide ranging discovery that would be available in support of litigation").
16 See, Brehm, 746 A.2d at 266.
18 See Roy E. Disney v. The Walt Disney Co., C.A. No. 234-N (Del. Ch. Aug. 6, 2004), discussed infra.
19 Henshaw v. American Cement Corp., 252 A.2d 125 (Del. Ch. 1969) (prohibiting documents delivered in inspection by director to be provided to attorneys opposing corporation in connection with the subject matter of the inspection).
20 8 Del. C. §220(c).
21 Id.; See also, Brehm, 746 A.2d at 267 (noting that a proceeding under Section 220(c) "is a summary one that should be managed expeditiously.").
22 Rales v. Blasband, 634 A.2d 927, 934 n.10 (Del. 1993) (dismissing complaint for failure to plead sufficient facts to overcome demand requirement); see also Grimes v. Donald, 673 A.2d 1207, 1216 n.11 (Del. 1996).
23 See Guttman v. Jen-Hsun Huang, 823 A.2d 492, 504 (Del. Ch. 2003).
24 806 A.2d 113 (Del. 2002).
25 Id. at 115-116 (the combined entity hereinafter referred to as "McKesson"). The derivative action was filed under the caption Ash v. McCall, and Saito was one of the four plaintiffs in the Ash complaint. id. at 115; see also, Ash v. McCall, 2000 Del. Ch. LEXIS 144, * (Sept. 15, 2000).
26 Ash, 2000 Del. Ch. LEXIS 144, at *55 n.56.
27 McKesson, 806 A.2d at 115.
28 Id. at 116.
30 Id. at 117.
31 McKesson, 806 A.2d at 117.
32 Compensation Matters were defined in the demand as "(i) the awarding of bonuses or other performance-based compensation to the top-five executive officers of the Company for fiscal years 2002, 2003 and 2004; (ii) the most recent extension and modification of Robert Iger's employment contract with the Company; and (iii) any changes or proposed changes to director compensation for fiscal years 2003 and 2004."
33 Mr. Disney's demand is attached as an exhibit to the publicly filed complaint in this matter.
34 C.A. No. 234-N, Trans. of Feb. 23, 2004 Teleconference at p. 32.
35 Roy E. Disney v. The Walt Disney Co., C.A. No. 234-N (Del. Ch. Aug. 6, 2004).
36 Id., Mem. Op. at p.6 (citing CM & M Group, Inc. v. Carroll, 453 A.2d 788, 793-94 (Del. 1982). See also 8 Del. C. § 220(c)(3) (authorizing Court to "prescribe any limitation or conditions with respect to the inspection" as the Court deems proper).
37 Id. Mem. Op. at p.8.
38 Id. Mem. Op. at p.9.
39 Plaintiffs also utilized Section 220 to form the basis for a challenge to compensation payments by Cendant Corporation, a case that was ultimately settled after Cendant and its chairman agreed to certain modifications to its compensation practices. See Leonard Loventhal Account v. Silverman, et al., C. A. No. 306-N (filed Mar. 10, 2004).
40 This type of claim could become more common if the SEC's final stockholder nomination rules contain a "trigger" based on percentage of withheld votes for directors. See Sec Release Nos. 34-48626, IC-26206 (Oct. 14, 2003).