- Statutory Inspection Rights
Alongside the rights to vote and sell shares, the ability to inspect corporate books and records is an important stockholder right. This type of action is frequently used to allow stockholders to investigate corporate mismanagement, prepare for a proxy fight, or possibly serve as a precursor to derivative litigation.[1] To mitigate potential stockholder abuse of this right, statutes and courts demand a showing of a “proper purpose” for the inspection.[2] Many courts, including ones in Delaware, require that stockholders present “some evidence” to suggest a “credible basis” for corporate mismanagement or a breach of fiduciary duty to constitute a proper purpose.[3] While this is a very low standard,[4] courts have not been hesitant to reject inspection demands with improper purposes.[5] Delaware inspection rights are codified in Delaware General Corporation Law (“DGCL”) Section 220 which defines proper purpose as “a purpose reasonably related to such person’s interest as a stockholder.”[6]
- Hoeller v. Tempur Sealy Int’l Inc. Reiterates the Governing Standard
In Hoeller v. Tempur Sealy Int’l Inc., the Delaware Chancery Court recently rejected a stockholder inspection claim. Tempur Sealy International (“Tempur Sealy”) supplied mattresses, furniture, and related products to Mattress Firm Holding Company (“Mattress Firm”), one of its largest retail customers.[7] After Mattress Firm was acquired in August 2016 by another company that had its own product line, the Tempur Sealy CEO stated that Tempur Sealy will be affected but remained optimistic about the long-term relationship between the companies.[8] Risks pertaining to this acquisition that could impact Tempur Sealy were also outlined in numerous SEC filings.[9] In January 2017, Mattress Firm informed Tempur Sealy that it wanted to modify its contract otherwise it would terminate.[10] While the parties appeared to agree to a wind-down contract, this plan was short-lived as breach of contract litigation commenced in various state and federal courts.[11] A Tempur Sealy stockholder sent a Section 220 demand to the company, seeking documents in order to evaluate a possible breach of fiduciary duty claim given the loss of a major customer and the public statements made by the CEO regarding the company’s financial well-being.[12] Tempur Sealy rejected the demand but produced four documents to the stockholder asserting that they show that the company believed it would continue its business relationship with Mattress Firm.[13] The stockholder nonetheless proceeded with the Section 220 action.[14]
The Delaware Chancery Court, in rejecting the stockholder’s claim, found that there was no evidence of mismanagement, bad faith, or conflicted transaction.[15] It also noted that there was no material misrepresentations made by the CEO or the Tempur Sealy directors and officers.[16] The Court stated that the company had sufficiently disclosed the business risks from losing its largest customer in its SEC filings and that was no “temporal relationship” between the CEO’s statements and the termination of the Sealy agreement.[17] The Court was also concerned about the credible basis standard becoming essentially meaningless if such types of broad allegations can be sustained without “even a scintilla of evidence.”[18]
- Implications
Delaware courts have recently granted inspection rights for claims involving newer types of documents and communications such as text messages and personal email accounts, recognizing that companies are more frequently using these forms of communication to conduct formal business.[19] Thus, while Section 220 may be construed somewhat more broadly when the types of corporate records themselves are changing, Hoeller reinforces the importance of properly satisfying the fundamental credible basis standard – one that is low but not a “mere speed bump.”[20] In light of the constant back-and-forth in the granting or rejecting of Section 220 claims based on the “proper purpose” element,[21] this requirement is vitally important for the ability to use inspection rights. The Court in Hoeller also reconfirmed the deferential standard granted for corporations that make good faith business decisions as a protection to avoid an ex post ‘second-guessing’ of an unsuccessful business action.[22] Disagreement with a business decision or a desire for a ‘better deal,’ largely by itself, is not going to be a successful basis for access to the corporate books and records otherwise a company could face unbounded Section 220 actions.[23]
[1] See Saito v. McKesson HBOC, Inc., 806 A.2d 113, 117 (Del. 2002).
[2] See, e.g., Del. Code Ann. Tit. 8, § 220(b) (2019); N.J. Rev. Stat. § 14A:5-28(3) (2013); Wash. Rev. Code § 23B.16.020 (2019)
[3] See Seinfeld v. Verizon Commc’ns, 909 A.2d 117, 118 (Del. 2006) (noting that this standard “achieves an appropriate balance between providing stockholders who can offer some evidence of possible wrongdoing with access to corporate records and safeguarding the right of the corporation to deny requests for inspections that are based only upon suspicion or curiosity”). New York courts also reject speculative allegations of corporate mismanagement. See e.g., Lapsley v. Sorfin Int’l Ltd., 43 A.D.3d 1113, 1114 (2d Dep’t 2007) (refusing to grant inspection rights where shareholder’s claim of corporate waste was unsupported and conclusory).
[4] See Seinfeld, 909 A.2d at 123.
[5] See, e.g., Skouras v. Admiralty Enters., Inc., 386 A.2d 674, 679 (Del. Ch. 1978) (noting that harassing a corporate defendant is improper); Tatko v. Tatko Bros. Slate Co., Inc., 173 A.D.2d 917, 918 (3d Dep’t 1991) (listing some improper purposes including pursuing a personal social or political agenda, instituting strike suits, and promoting personal business).
[6] Del. Code Ann. Tit. 8, § 220(b) (2019).
[7] Hoeller v. Tempur Sealy Int’l, Inc., C.A. No. 2018-0336-JRS, 2019 WL 551318, at *1 (Del. Ch. Feb. 12, 2019).
[8] Id. at *4.
[9] Id. at *3.
[10] Id. at *4.
[11] Id. at *5.
[12] Id. at *6.
[13] Id. at *7.
[14] Id. at *6.
[15] Id. at *8–9.
[16] Id. at *9.
[17] Id. at *13–14.
[18] Id. at *9.
[19] See KT4 Partners LLC v. Palantir Techs. Inc., No. 281, 2018, 2019 WL 347934, at *2 (Del. Jan 29, 2019) (noting that if a company conducts its formal corporate business “largely through informal electronic communications, it cannot use its own choice of medium to keep shareholders in the dark” about their inspection rights under Section 220); Schnatter v. Papa John’s Int’l, Inc., C.A. No. 2018-0542-AGB, 2019 WL 194634, at *16 (Del. Ch. Jan. 15, 2019) (stating that “the utility of Section 220 as a means of investigating mismanagement would be undermined if the court categorically were to rule out the need to produce communications in these formats”).
[20] Hoeller, 2019 WL 551318, at *1.
[21] See, e.g., Caspian Select Credit Master Fund Ltd. v. Key Plastics Corp., C.A. No. 8625-VCN, 2014 WL 686308 (Del. Ch. Feb. 24, 2014) (granting the Section 220 inspection claim); La. Mun. Police Emps.’ Ret. Sys. v. Lenner Corp., 2012 WL 4760881 (Del. Ch. Oct. 5, 2012) (rejecting the Section 220 inspection claim); Allen Sparkman, Information Rights—A Survey, 2 Bus. Entrepreneurship & Tax L. Rev. 41, 117 –18, 129 (2018) (compiling cases across jurisdictions).
[22] Hoeller, 2019 WL 551318, at *10.
[23] Id.
