As regular readers know, I have been blogging regularly about the SB 21 bill currently pending before the Delaware legislature. I've focused solely on the provisions amending DGCL section 144 as it relates to conflicted interest transactions by directors, officers, and controlling shareholders. In this post, I turn to the provisions of SB 21 governing inspections of books and records.
I should make clear here that the version of SB 21 I am working with here is the one from the DSBA Corporation Law Council not the original text.
As I explain in my book, Corporate Law (Concepts and Insights):
DGCL § 220 provides that shareholders have the right to inspect a corporation’s books and records, subject to a variety of limitations:
(b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from:
(1) The corporation's stock ledger, a list of its stockholders, and its other books and records; ....
A proper purpose shall mean a purpose reasonably related to such person's interest as a stockholder. ...
As the Delaware Supreme Court has explained, for example, inspection rights can be very useful in a variety of contexts:
Section 220 provides stockholders of Delaware corporations with a “powerful right.” By properly asserting that right under section 220, stockholders are able to obtain information that can be used in a variety of contexts. Stockholders may use information about corporate mismanagement, waste or wrongdoing in several ways. For example, they may: institute derivative litigation; “seek an audience with the board [of directors] to discuss proposed reform or, failing in that, they may prepare a stockholder resolution for the next annual meeting, or mount a proxy fight to elect new directors.”
More than a decade ago, we noted that “[s]urprisingly, little use has been made of section 220 as an information-gathering tool in the derivative [suit] context.” Today, however, stockholders who have concerns about corporate governance are increasingly making a broad array of section 220 demands. The rise in books and records litigation is directly attributable to this Court’s encouragement of stockholders, who can show a proper purpose, to use the “tools at hand” to obtain the necessary information before filing a derivative action. Section 220 is now recognized as “an important part of the corporate governance landscape.”
SB 21 makes a number of significant changes to Section 220 that will substantially limit or even eliminate its utility for such purposes.
Perhaps most importantly, SB 21 adopts a much narrower definition of the books and records that are subject to inspection. Under current law, where a shareholder seeks to prove director or officer mismanagement in connection with a particular transaction or event, the shareholder is entitled to inspect relevant contracts, correspondence, and the like. See, e.g., Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 791 (Del. Ch. 2016) ("This court has the power to order production of documents prepared by officers and employees as part of a Section 220 inspection."); see also KT4 Partners LLC v. Palantir Techs. Inc., 203 A.3d 738, 752–53 (Del. 2019) (holding “that the Court of Chancery should not order emails to be produced when other materials (e.g., traditional board-level materials, such as minutes) would accomplish the petitioner’s proper purpose, but if non-email books and records are insufficient, then the court should order emails to be produced”).
In contrast, SB 21 creates a new statutory definition of books and records that largely limits the materials a shareholder may inspect to board-level materials. Emails and other correspondence between managers, contracts, and similar materials seemingly are not subject to inspection under the new provisions.
But then we come to new section 220(b)(4), which provides that "This section does not affect: ... b. The power of a court, independently of this chapter, to compel the production of corporate records for inspection and to impose reasonable restrictions as provided in paragraph (b)(3) of this section, provided that, in the case of production of books and records described in paragraph (a)(1) of this section at the request of a stockholder, the stockholder has met the requirements of this subsection." The bill's synopsis cryptically explains that "preserves whatever independent rights of inspection exist under the referenced sources and does not create any rights, either expressly or by implication." It's unclear what the "referenced sources are," but under existing law a shareholder may have inspection rights granted by the corporation’s certificate of incorporation, its bylaws, or a shareholder agreement. In addition, under pre-DGCL Delaware law, shareholders had a common law right to inspect books and records. Shareholders have sometimes argued that those common law rights continue to exist independently of section 220. But the law here is not clear. See, e.g., King v. DAG SPE Managing Member, Inc., No. CIV.A. 7770-VCP, 2013 WL 6870348, at *7 (Del. Ch. Dec. 23, 2013) ("Section 220(d) at least arguably preempts a director's common law right to inspect corporate books and records. As the relevant authorities demonstrate, Delaware courts enforced this right at common law only until 1981, when the General Assembly enacted 8 Del. C. § 220(d).").
In sum, it is unclear what work new Section 220(b)(4) is intended to do.
But now we come to new section 220(g). (Note that the original version of SB 21 lacked this provision, which would leave access to below board level documents to the tender mercies of (b)(4).) It provides that:
(g) In any proceeding brought by a stockholder under subsection (c) of this section to compel the inspection of book and records, the Court of Chancery may order the corporation to produce, in addition to any books and records or other records ordered to be produced pursuant to subsection (e) of this section, other specific records of the corporation only if and to the extent: (1) such stockholder has met the requirements of subsection (b) of this section; (2) such stockholder has made a showing of a compelling need for an inspection of such records to further the stockholder’s proper purpose; and (3) such stockholder has demonstrated by clear and convincing evidence that such specific records are necessary and essential to further such purpose.
Subsection (e) provides in pertinent part that "the Court of Chancery may not order the corporation to produce any records of the corporation other than the books and records set forth in paragraph (a)(1) of this section." It's not clear why subsection (g) doesn't simply jump straight to (a)(1), but let's pass over that issue.
Although subsection (g) preserves a limited right to access materials like emails, contracts, and other below board level documents, it imposes quite high burdens on the shareholder to get access to such documents. The shareholder must identify specific documents.
Consider, for example, the documents at issue in Yahoo Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 791 (Del. Ch. 2016), where the stockholder was using a Section 220 inspection to gather the information necessary to bring a derivative suit challenging the hiring and compensation of Yahoo's COO. Those documents included "emails to and from the directors from management or the compensation consultant, emails among the directors themselves, and documents and communications prepared by Yahoo officers and employees about the Board's deliberations." Id. The court limited the documents subject to inspection to documents possessed by the members of the Compensation Committee "including their email communications."
Will it be enough under subsection (g) for the stockholder to say "I want all emails related to the hiring of the COO"? Or would the stockholder have to specify "the email from CEO Jane Smith" to Compensation Committee Chair Helen Doe on February 28, 2025"? Or something in between?
Once the stockholder achieves the required--albeit uncertain--level of specificity, the stockholder must prove that it has a "compelling need" for the documents. How does the stockholder do that?
Last, the stockholder must demonstrate "by clear and convincing evidence that such specific records are necessary and essential to further such purpose." "Clear and convincing evidence is evidence that produces an abiding conviction that the truth of the contention is 'highly probable.'” Matter of Koyste, 111 A.3d 581, 588 (Del. 2015). This "is a much more difficult standard of proof than the ordinary preponderance of the evidence standard applied in most civil contexts." Miranda v. Delaware State Lottery Commn., No. CIV.A. K10A10008 WLW, 2011 WL 3329282, at *2 n.8 (Del. Super. Aug. 1, 2011).
In addition, one wonders whether a plaintiff who shows a "compelling need" for purposes of (g)(2) has shown that such records "are necessary and essential to further such purpose"?
To sum up, the amendments to Section 220 substantially undermine the Delaware Supreme Court's repeated insistence that shareholder books and records inspections be used routinely as a way of satisfying the requirement that derivative suits be plead with particularity. Worse yet, the new provisions contain multiple ambiguities that are going to require much litigation to resolve.
