The Delaware Court of Chancery has held, apparently for the first time, that the requisite “proper purpose” in a books and records action must be the stockholder’s own purpose and not one devised by the stockholder’s lawyers. Based on the Court’s ruling in Wilkinson v. A. Schulman, Inc., C.A. No. 2017-0138-JTL, 2017 Del. Ch. LEXIS 798 (Del. Ch. Nov. 13, 2017), stockholder plaintiffs in books and records actions will be required to have “substantive involvement” in the litigation – a requirement that does not exist in stockholder class-action and derivative cases.
The Delaware Supreme Court has urged stockholder plaintiffs to use the “tools at hand,” in particular the right to inspect and copy corporate books and records under Section 220 of the Delaware General Corporation Law, to investigate potential claims before bringing plenary actions challenging corporate transactions. See Rales v. Blasband, 634 A.2d 927, 934 n.10 (Del. 1993); Grimes v. Donald, 673 A.2d 1207, 1216 & n.11 (Del. 1996). However, where a stockholder in a Delaware corporation seeks inspection of the corporation’s books and records, other than its stock ledger or list of stockholders, Section 220 requires the stockholder to establish that the inspection sought is “for a proper purpose,” defined as “a purpose reasonably related to such person’s interest as a stockholder.” In Wilkinson, the Delaware Court of Chancery has found that the required proper purpose must be the stockholder’s own purpose and not one devised by the stockholder’s counsel.
Based on a stockholder plaintiff’s admission that his stated purpose for inspection was his counsel’s invention and not his own, the Court granted judgment in favor of the corporate defendant and against the stockholder following a bench trial. In Wilkinson, Vice Chancellor J. Travis Laster rejected the plaintiff’s books and records demand based on his finding that the plaintiff’s stated purpose for inspection was not his true purpose.
The plaintiff, represented by the New York firm Levi & Korsinsky, LLP (“L&K”), sought inspection of the books and records of plastics maker A. Schulman, Inc. for the stated purpose of investigating a decision by the corporation’s board of directors to accelerate the vesting of shares of restricted stock, valued at more than $3.9 million, for the corporation’s president and chief executive officer upon his retirement at the end of 2014. However, the plaintiff testified that he contacted L&K because he was concerned with the corporation’s November 2016 announcement of a loss of $365 million following the acquisition of another plastics company. The plaintiff testified that he was not aware of any impropriety concerning the 2014 compensation award.
The Court found that “Wilkinson simply lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel” and that he “did not take any steps to confirm the accuracy of the allegations in the complaint,” did not read the corporation’s answer to the complaint, and did not participate in drafting answers to interrogatories, but rather verified the complaint and interrogatory answers in reliance on his counsel.
The Court may have been influenced by the fact that Wilkinson was a serial plaintiff. The Court noted that Wilkinson had been a plaintiff in at least seven L&K lawsuits, “most of which challenged mergers,” that he “did not do anything to verify the factual allegations in those lawsuits, other than to read the complaints that L&K drafted,” that he “agreed to serve as a plaintiff reflexively after seeing the press releases L&K issued announcing investigations into the transactions,” and that he participated “because he wanted more money for his shares, regardless of whether the deal price was fair,” that he “never received a dime of additional consideration,” and that “most, if not all, of the cases settled for supplemental disclosures.” The Court did not, however, suggest that Wilkinson had been found to be an inadequate stockholder representative in any of those seven cases.
The Court emphasized that it is advisable for stockholders seeking inspection of corporate books and records to retain experienced counsel, but stated that “retaining counsel to carry out the stockholder’s wishes is fundamentally different than having an entrepreneurial law firm initiate the process, draft a demand to investigate different issues than what motivated the stockholder to respond to the law firm’s solicitation, and then pursue the inspection and litigate with only minor and non-substantive involvement from the ostensible stockholder principal.”
The Court’s decision in Wilkinson reflects some of the obstacles that may confront a stockholder bringing a books and records action. The opinion suggests that stockholder plaintiffs in books and records actions must act on their own initiative with a proper purpose in mind and that they must have substantive involvement in the litigation. In a plenary class or derivative action, there is no “proper purpose” requirement, and the only statutory requirement under Delaware law is that the plaintiff in a derivative action must have held shares at the time of the challenged transaction. See 8 Del. C. § 327. The Court has never required class-action or derivative plaintiffs to be self-motivated or have substantive involvement in litigation. Thus, based on Section 220’s “proper purpose” requirement, the Court of Chancery would appear to require more from a books and records plaintiff seeking to use the “tools at hand” to investigate a transaction than it would require of the same plaintiff bringing a plenary action challenging the same transaction without first bringing a Section 220 action.
James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit hfk.law.