Locke Lord QuickStudy: Delaware Expands Stockholder Rights to Demand Information and Facilitates Caremark Claims

Delaware law usually protects directors in making good faith business decisions.  However, the recent Delaware Court of Chancery AmerisourceBergen¹ decision signals a two-part trend of (i) increased stockholder access to corporate information through Section 220 books and records demands and (ii) the willingness of Delaware courts to entertain Caremark claims for failures of oversight by a corporate board.² This trend suggests increased exposure of corporate directors to stockholder claims and therefore the importance of strategies to mitigate risk and respond to Section 220 demands.

Stockholders of Delaware corporations have the right under Section 220 of the Delaware General Corporation Law to inspect corporate books and records if they state a “proper purpose” that is “sufficiently tailored” to identify the books and records relevant to the demand.³  A basic purpose of the statute is to give stockholders access to information in order to uncover alleged corporate wrongdoing, although the statute has been used for other purposes, including obtaining information to support the filing of stockholder derivative and direct actions.

The types of materials generally available to stockholders pursuant to a Section 220 demand have also expanded—from formal board materials (meeting minutes and resolutions) to electronic records including emails,⁴ particularly when other traditional board materials are not available or do not accomplish a stockholder’s proper purpose.⁵

The decision in AmerisourceBergen goes one step further by lowering the burden on a stockholder to successfully make a Section 220 demand in the context of alleged failures of directors to adequately oversee corporate operations.  By rejecting past precedent requiring a stockholder to relate the information requested to the alleged “proper purpose,” AmerisourceBergen creates an issue regarding the threshold standard for Section 220 demands, which likely will need to be clarified by the Delaware Supreme Court.  In addition, AmerisourceBergen provides a roadmap for when internal emails exchanged among board members may be sought by stockholders.

Background Of The Case

Like other cases involving Section 220 demands, AmerisourceBergen deals with ‎stockholders alleging that a corporate board did not fulfill its duties to monitor and address ‎instances of corporate wrongdoing. AmerisourceBergen Corporation (“Amerisource”), a leading opioid distributer, faced the challenge of implementing a compliance program to address previous issues it had with unregulated or unapproved opioid distribution. Despite saying in public filings that it had a program in which senior officers and the board of directors played a significant role, Amerisource became ‎the target of a deluge of subpoenas, lawsuits, and government investigations alleging the ‎company’s failure to identify and report continued distribution to suspicious channels.‎

Shortly thereafter, stockholders of Amerisource made a Section 220 demand to ‎investigate mismanagement by the board of directors and officers (a basis for a ‎Caremark claim) and brought the action to enforce that demand.‎

section 220 demands

Under Section 220, a plaintiff must show a “proper purpose” to inspect a company’s books and records.  Case precedent has shown that this is a low hurdle to overcome.  To obtain books and records, a stockholder must show, by a preponderance of the evidence, a credible basis from which the Court of Chancery can infer that there is possible mismanagement that could warrant further investigation.  In AmerisourceBergen, Vice Chancellor Laster found that the plaintiffs met this standard due to the many reports detailing Amerisource’s alleged misconduct as well as evidence that Amerisource ignored reports of suspicious orders from rogue pharmacies.

Notably, the Court deviated from past precedent requiring plaintiffs to (i) explain what it would do with an investigation (a “purpose-plus-an-end-test”) and (ii) provide evidence of an actionable claim to state a proper purpose (or in this case, providing evidence showing  a failure of oversight on the part of Amerisource’s board) (an “actionable claim test”).  Because the plaintiffs’ demand was not limited to filing a lawsuit alleging a Caremark claim, they faced fewer hurdles when stating a “proper purpose.”  Specifically, the Court ruled that credible allegations of wrongdoing were sufficient without having to state an actionable claim or relate the requested information to proving the wrongdoing.

This reduced threshold could ultimately open the door to more Section 220 demands to prepare for litigation (including challenges to mergers before completion and damages claims after completion), to use in proxy contests and to gather information for an activist stockholder initiative.

accessing emails and other electronic records

Section 220 governs the scope and methods of stockholder demands for corporate books and records.  Unlike civil discovery, Section 220 limits the documents produced to those that are sufficiently and narrowly tailored to the specific books and records relevant to a stockholder’s purpose.  While electronic information, including personal exchanges, was previously believed to be beyond the scope of a Section 220 demand, the Delaware courts have emphasized the absence of a definitive rule limiting the types of documents within the scope of stockholder inspection.

In Schnatter v. Papa John’s, in which Papa John’s founder sought to investigate alleged mismanagement by other board members after he was ousted from the company’s management, the Court of Chancery considered the scope of document production, addressing the founder’s request to inspect communications between company board members, including emails and text messages.  The Court stated that when considering requests for information from personal accounts and devices, it should apply its discretion on a case-by case basis “to balance the need for the information sought against the burdens of production and the availability of the information from other sources.”⁶

More recently, in KT4 Partners LLC v. Palantir Technologies Inc., the Delaware Supreme Court clarified when a company can be required to produce electronic documents.⁷ In reversing the Court of Chancery’s decision holding that a stockholder’s inspection should be limited only to formal board records, the Supreme Court explained that e-mails should be produced “[if] the only documentary evidence of the board’s and company’s involvement [in an alleged action] comes in the form of emails.”  Despite this expansion in scope, the Supreme Court noted “if a company observes traditional formalities, such as documenting its actions through board minutes, resolutions, and official letters, it will likely be able to satisfy a § 220 petitioner’s needs solely by producing those books and records.”

consequences of refusal to produce records in response to demand

Notwithstanding the holding in KT4 Partners, the Court of Chancery in AmerisourceBergen allowed the stockholder to conduct a deposition “to determine what other types of books and records exist and who has them.”  One likely reason for this expansion in scope is because Amerisource prevented the stockholders from obtaining any information about what types of books and records existed from the outset.  Although the stockholders demonstrated that they were entitled to some information in response to its Section 220 demand, Amerisource’s refusal to produce any information ultimately resulted in having to provide more information than might have been necessary in response to the Section 220 demand.

In its discussion, the Court outlined three levels of documents that stockholders may seek as follows:

Formal board materials are “board level documents that formally evidence the directors’ deliberations and decisions and comprise the materials that the directors formally received and considered” (i.e., board minutes, board resolutions and consents, official board declarations).

Informal board materials are “materials that evidence the directors’ deliberations, the information that they received, and the decisions they reached”, which may include information outside formal channels or between formal meetings, or director to director communications on non-corporate accounts.

Officer-level materials are “communications and materials that were only shared among or reviewed by officers and employees.”

While the Court explained that formal board materials are “the starting point” and “often the ending point" for an adequate inspection, it stated that an inspection may extend to “information materials” if a stockholder makes a proper showing.  In this case, the Court determined that there was an “absence in information about what types of records [Amerisource] maintains and who has them.”  Although the stockholders sought this information in discovery, Amerisource refused to produce it and, in view of  Amerisource’s denying the stockholders access to  any documents, the Court ordered it to produce formal board materials and allowed the plaintiffs to conduct a deposition to “explore what types of books and records exist and who has them,” which may include informal board materials and officer-level materials.

Takeaways

In view of these trends to increase stockholder access to information and to expand potential Caremark claims against directors for failure of oversight, the following are some actions companies can consider taking:

            Dealing with stockholder Section 220 demands:

• Responding to Section 220 demands in a timely manner and with records that reasonably fall within the proper purpose specified in the demand can foreclose access to other information.
• Because courts may allow discovery beyond formal meeting minutes in order to determine “what records exist,” it can be advantageous to maintain detailed and accurate formal board materials, including but not limited to minutes, consents, letters, and resolutions.
• Company board members can protect personal information by using company email platforms for board-related communications and other messaging platforms for personal emails and other communications.
  
  Mitigating exposure to Caremark claims:
  
  
• Companies should ensure that board-level policies and company compliance practices and procedures are well documented and that board meeting discussions are accurately and timely documented in board minutes.
• Company boards should regularly evaluate the company’s risk policies and should address and timely record discussions of risks pertinent to company operations.
• Companies in regulated businesses might consider having board members with special background and expertise to assess its mission-critical risks.