Access to Corporate Books and Records Under Delaware Law: Can Shareholders Obtain Privileged Documents Too?

       

_{From left to right: Gregory A. Markel, Paul Ferrillo, and Sarah Fedner}

Requests for the inspection of books and records pursuant to Section 220 of the Delaware General Corporation Law is an important part of corporate litigation in Delaware. One important issue for these types of proceedings is the scope of documents that these types of requests can reach, particularly when it comes to privileged documents and other pre-discovery material. The following was published by The D&O Diary on May 17, 2021.

This article provides a summary of recent Delaware decisions on the permissible scope of shareholder books and records demands pursuant to Section 220 of the Delaware General Corporation Law (“Section 220”), including whether shareholders may use Section 220 to obtain pre-complaint discovery and/or privileged corporate documents. In short, there has been a significant uptick in Section 220 demand litigation in recent years and shareholders are frequently using Section 220 as an alternative method of obtaining discovery for ongoing or potential future fiduciary litigation. This article summarizes where shareholders have been permitted to proceed with such demands and where Delaware courts have drawn the line.

Section 220 Procedure

Section 220 provides shareholders with the right to inspect the books and records of a Delaware corporation where the shareholders have demonstrated a proper purpose. Procedurally, Section 220 requires shareholders to first serve a demand for inspection on a corporation and, if the demand is rejected, shareholders may initiate an action in Delaware Chancery Court to compel the production of the sought records. Section 220 actions are summary proceedings, which are supposed to be litigated in a more expeditious manner than regular lawsuits. These cases are quickly moved to a trial before a judge in the Court of Chancery. Sometimes, the parties forgo trial and instead, merely submit papers and hold oral argument.

Proper Purpose of Investigating Wrongdoing

There has been an explosive growth in Section 220 demand litigation in recent years with many shareholders using Section 220 as a tool for obtaining pre-complaint discovery to build cases against corporations and their officers and directors. This has led to many recent Delaware decisions evaluating whether shareholders were actually seeking books and records for a proper purpose under Section 220.

Delaware courts have held that a proper purpose can include investigating possible mismanagement, waste, improper transactions, self-dealing, etc. Where documents are sought for investigatory purposes, shareholders “must present some evidence to suggest a credible basis from which a court can infer that mismanagement … or wrongdoing may have occurred.”[i] This is the “lowest possible burden of proof” and “does not require a stockholder to prove that the wrongdoing actually occurred.”[ii] Because of this low standard, shareholders generally are permitted to proceed with their sought after review of corporate records.

However, this standard is not without limitations. For example, in 2017, in Wilkinson v. A. Schulman, Incorporated,[iii] the Delaware Chancery Court found there was no proper purpose where the shareholder conceded that his reasons for seeking the documents were substantially different from those set forth in the document demand drafted by his attorneys. Although the shareholder verified the complaint, he did not confirm the accuracy of the allegations contained therein, did not review the company’s answer, and was not otherwise involved in efforts to obtain the documents. In this case, the Court held that the shareholder’s “purported purposes were not his actual purposes” and, instead, “were his counsel’s purposes.”[iv] In subsequent rulings, Delaware courts have declined to extend Wilkinson, noting that the case “involved extreme facts” and “blunders.”[v] Indeed, following Wilkinson, Delaware courts have generally deferred to a shareholder’s asserted purpose unless it is obvious that the shareholder “[i]s a passive conduit in a purely lawyer-driven inspection effort.”[vi]

Recent Delaware decisions have affirmed the very low standard for establishing a proper purpose and have permitted shareholders to proceed with Section 220 demands, even where it appears shareholders are using this inspection tool solely to pursue future litigation.[vii] For example, in a late 2020 decision in AmerisourceBergen Corporation v. Lebanon County Employees’ Retirement Fund, the Delaware Supreme Court made two rulings favorable to shareholders pursuing Section 220 demands.[viii] First, the Court held that “when the purpose of an inspection of books and records under Section 220 is to investigate corporate wrongdoing, the stockholder seeking inspection is not required to specify the ends to which it might use the books and records.”[ix] However, the Court did note that shareholder’s “intended uses” were not entirely “irrelevant.”[x] Next, the Court held that a shareholder is not required to establish that the alleged wrongdoing it seeks to investigate is legally actionable in order to demonstrate a proper purpose.[xi] Yet, the decision indicated that “a court may be justified in denying inspection” in the “rare case” where a shareholder’s “sole reason for investigating mismanagement or wrongdoing is to pursue litigation and a purely procedural obstacle, such as standing or the statute of limitations, stands in the stockholder’s way.”[xii] This decision reaffirms that shareholders can generally use Section 220 demands as a means of obtaining pre-complaint discovery.

Section 220 Demands for Privileged Documents and the Garner Doctrine

Shareholders sometimes seek privileged or attorney work product protected documents in their Section 220 demands, a topic that has been litigated with some frequency since a 2014 Delaware Supreme Court opinion finding that shareholders are permitted do so in certain situations (the “IBEW decision”).[xiii] In the IBEW decision, the Delaware Supreme Court, for the first time, formally recognized the Garner doctrine, “which allows stockholders of a corporation to invade the corporation’s attorney-client privilege in order to prove fiduciary breaches by those in control of the corporation upon showing good cause”[xiv] Prior to this decision, the Delaware Chancery Court had applied the Garner doctrine to Section 220 litigation, even though it had not been expressly recognized by the Supreme Court.[xv]

In determining whether the Garner “good cause” exception to the attorney-client privilege applies, a court considers multiple factors, including:

(1) the number of shareholders and the percentage of stock they represent;

(2) the bona fides of the shareholders;

(3) the nature of the shareholders’ claim and whether it is obviously colorable;

(4) the apparent necessity or desirability of the shareholders having the information and the availability of it from other sources;

(5) whether, if the shareholders’ claim is of wrongful action by the corporation, it is of action criminal, or illegal but not criminal, or of doubtful legality;

(6) whether the communication related to past or to prospective actions;

(7) whether the communication is of advice concerning the litigation itself;

(8) the extent to which the communication is identified versus the extent to which the shareholders are blindly fishing;

(9) the risk of revelation of trade secrets or other information in whose confidentiality the corporation has an interest for independent reasons.[xvi]

Since the IBEW decision, Delaware courts have found that: (1) “the colorability of the claim,” (2) “the extent to which the communication is identified versus the extent to which the shareholders are blindly fishing,” and (3) the necessity and availability of the sought information are the three most important factors in determining whether the Garner exception is applicable.[xvii] Delaware courts have been particularly reluctant to apply the Garner doctrine where necessity and unavailability have not been established.[xviii]

The applicability of the Garner doctrine has been evaluated in several Delaware decisions following IBEW.[xix] These cases involved a fact intensive analysis of the Garner factors. There has been only one decision, subsequent to IBEW, in which the Garner exception was found to apply and a company was ordered to produce privileged documents.[xx] This is somewhat unsurprising since the Garner exception is intended to be “narrow,” “exacting,” and “very difficult to satisfy.”[xxi]

Most recently, on May 4, 2021, a Delaware Chancery Court refused to apply the Garner exception in a derivative case involving the 2018 approval of Tesla’s CEO Elon Musk’s compensation plan.[xxii] In that case, the derivative plaintiff sought privileged communications between Tesla’s outside legal counsel, in-house counsel and compensation committee regarding the committee’s independence from Musk. Although the Court found that the plaintiff had established a colorable claim and was not fishing, the Court ultimately held that “plaintiff’s showing [of necessity and unavailability] falls well short of the narrow and exacting mark set by Garner and its Delaware progeny.” The court rejected plaintiff’s conclusory assertions that the information sought was necessary and unavailable and noted that plaintiff “provide[d] no meaningful explanation as to why [the information sought] [wa]s not or will not be adequately addressed in the nonprivileged discovery available to plaintiff.”

Conclusion

In sum, recent Delaware case law reflects the challenges of opposing Section 220 demands. Although a shareholder must establish a “credible basis” for a demand, Delaware courts have reaffirmed that this is the “lowest possible burden of proof” and that shareholders do not need to show legally cognizable wrongdoing. On the other hand, Delaware courts have been more conservative in permitting shareholders access to privileged documents. Unless a shareholder can set forth non conclusory reasons as to why the privileged documents are necessary and unavailable from other sources, among other items, they will not be permitted to inspect privileged documents.

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[i] See, e.g., Pettry v. Gilead Sciences, Inc., C.A. No. 2020-0132-KSJM, 2020 WL 6870461, at *10 (Del.Ch. Aug 26, 2020).

[ii] Id. at *11 (quotations omitted).

[iii] C.A. No. 2017–0138–VCL, 2017 WL 5289553, at *3 (Del.Ch. Nov. 13, 2017).

[iv] Id.

[v] See, e.g., Pettry., 2020 WL 6870461, at *15; Gross v. Biogen Inc., C.A. No. 2020-0096-PAF, 2021 WL 1399282, at *6 (Del.Ch. Apr. 14, 2021).

[vi] Pettry, 2020 WL 6870461, at *1.

[vii] Delaware courts have also awarded plaintiffs fees where Defendants have acted in an “overly aggressive” manner in defending Section 220 actions. See, e.g., Pettry, 2020 WL 6870461, at *29 (“defendants have turned books and records litigation into a surrogate proceeding to litigate the possible merits of the suit where they place obstacles in the plaintiffs’ way to obstruct them from employing it as a quick and easy pre-filing discovery tool”); See also Gross, 2021 WL 1399282, at *5.

[viii] In AmerisourceBergen, the shareholders sought materials “from May 1, 2010 to date concerning certain settlements, acquisitions, investigations, and other events related to AmerisourceBergen’s operations and its potential involvement in the opioid crisis.” 243 A.3d 417, 423 (Del. Supr. 2020)

[ix] Id. at 430.

[x] Id. at 429.

[xi] Id. at 437.

[xii] Id.

[xiii] Wal-Mart Stores, Inc. v. Indiana Elec. Workers Pension Trust Fund IBEW, 95 A.3d 1264, 1278-79 (Del. Supr. 2014).

[xiv] Id. at 1276.

[xv] See, e.g., id. at 1278. In the IBEW decision, the Delaware Supreme Court found that the Garner exception applies in both “plenary stockholder/corporation proceedings” and “Section 220 actions.” Id. Since then, one Delaware Chancery Court decision has suggested that it may also apply in cases where shareholders assert direct claims for breach of corporate fiduciary duties. Buttonwood Tree Value Partners, L.P. v. R.L. Polk & Co., Inc., Civil Action No. 9250–VCG, 2018 WL 346036, at *3 (Del.Ch. Jan. 10, 2018).

[xvi] Salberg v. Genworth Financial, Inc., C.A. No. 2017–0018–JRS, 2017 WL 3499807, at *4 (Del.Ch. July 27, 2017).

[xvii] Id. at *5. See also Buttonwood, 2018 WL 346036, at *3.

[xviii] Employees’ Retirement System of Rhode Island v. Facebook, Inc., C.A. No. 2020-0085-JRS, 2021 WL 529439, at *9 (Del.Ch. Feb. 10, 2021)

[xix] See, e.g., Employees’ Retirement System of Rhode Island, 2021 WL 529439, at *10 (holding that the production of privileged documents should not be compelled where non-privileged documents will “likely” provide the relevant information sought by plaintiffs); In re Facebook, Inc. Section 220 Litigation, No. 2018-0661-JRS, 2019 WL 2320842, at *18, n. 184 (Del.Ch. May 30, 2019) (“Plaintiffs have not met their heavy burden under Garner because, on this record, they have not demonstrated that the privileged information they seek ‘is both necessary to prosecute the action and unavailable from other sources.’”); Buttonwood, 2018 WL 346036; Elow v. Express Scripts Holding Company, C.A. No. 12721–VCMR, 2018 WL 2110946, at *2 (Del.Ch. Apr. 27, 2018) (conclusory statements that the privileged documents sought are “not available from any other source” are insufficient to satisfy Garner); Salberg, 2017 WL 3499807, at *7 (denying Plaintiff’s Section 220 demand for privileged documents under Garner, because the communications contained advice regarding a separate ongoing derivative action and “Plaintiffs cannot achieve via Section 220 what they could not achieve via discovery in the Derivative Action”); In re Lululemon Athletica Inc. 220 Litigation, C.A. No. 9039–VCP 2015 WL 1957196 (Del.Ch. Apr. 30, 2015).

[xx] See In re Lululemon Athletica Inc. 220 Litigation, WL 1957196, at *15

[xxi] IBEW, 95 A.3d at 1278.

[xxii] Tornetta v. Musk, Case No. 2018-0408-JRS, Entry # 87553543 (Del.Ch. May 4, 2021).