Inspection Rights and Delaware Law: Elevating Process Over Efficiency (Central Laborers Pension Fund v. News Corp.)
The Delaware courts constantly come up with new ways of denying shareholders the right to access documents under the right of inspection in Section 220. The credible basis standard is one. Central Laborers Pension Fund v. News Corp., 45 A.3d 139 (Del. 2012) provided another.
Plaintiffs sought documents from News Corp. They sent by overnight mail a request for documents on March 7. See Complaint, at p. 19 (noting that the letter was delivered to News Corp on March 8, 2011, at 10:09 a.m). According to the Complaint, the company did not respond within 5 business days and, as a result, they sought enforcement in the Chancery Court. See 8 Del. C. § 220(c) (where company "does not reply to the demand within 5 business days after the demand has been made, the stockholder may apply to the Court of Chancery for an order to compel such inspection.").
In considering the inspection request, the Chancery Court took into account that the plaintiffs had simultaneously filed a derivative suit. The filing of the suit rendered the information sought in the inspection request unnecessary. As the Chancery Court determined:
As a general matter, by filing its derivative complaint, Central Laborers acknowledged -- if, for no other reason than to satisfy its lawyers' rule 11 obligations -- that it had sufficient information to support its substantive allegations and its allegations of demand futility that would excuse prior demand on the News Corp. board -- both necessary to go down the path chosen by it to challenge the Proposed Transaction. In short, the stockholder plaintiff who files a Section 220 action immediately after its derivative action is acting inconsistently.
The trial court’s reasoning was neither based upon the purpose alleged by plaintiffs nor the paricular documents that could potentially be obtained. It was a per se rule that the filing of a derivative action cut off the right to inspect. The Supreme Court characterized the holding this way:
the Court of Chancery held "[b]ecause Central Laborers' currently-pending derivative action necessarily reflects its view that it had sufficient grounds for alleging both demand futility and its substantive claims without the need for assistance afforded by Section 220, it is, at this time, unable to tender a proper purpose for pursuing its efforts to inspect the books and records of News Corp.”
The reasoning was arguably inconsistent with the holding in King v. Verifone Holdings, Inc., 12 A.3d 1140 (Del. 2011), where the Supreme Court held that the filing of a derivative suit did not cut off inspection rights. The Chancery Court sought to distinguish the case. Rather than address the issue, however, the Supreme Court affirmed the denial of the inspection demand but on entirely different grounds.
The Court focused on the procedural aspects of an inspection demand, particularly the requirement in Section 220 that the demand “shall . . . be accompanied by documentary evidence of beneficial ownership of stock” and “shall be directed to the corporation at its registered office . . . “ The demand submitted by plaintiff contained a number of apparent errors. See Central Laborers Pension Fund v. News Corp., 45 A.3d 139 (Del. 2012) (“First, the Inspection Demand identified the wrong corporation, stating that it seeks "to inspect and copy the . . . books and records of Viacom and its subsidiaries," rather than that of News Corp. Second, the supporting materials filed in support of the Inspection Demand were inconsistent", with one affidavit referring to 14,110 shares beneficially owned and another to 14,110 shares owned as record owner).
But the discussion of these “errors” was mostly gratuitous. Only one mistake really mattered. The Court focused on the fact that the demand did not include the account statements that established beneficial ownership. The affidavit submitted with the demand referred to an “annexed document” but did not have the "annexed document" attached. Plaintiff described the failure as a “clerical error” and submitted a revised affidavit and the account statements with the brief opposing the motion to dismiss.
Despite the fact that there appears to have been no serious doubt about the ownership of the shares and despite the fact that the company at issue had five business days to raise the missing attachent, the Court found that the omission was a sufficient basis for denying shareholders the right to inspect. The statute, in the eyes of the Court, required that the documentary evidence of ownership be delivered with the demand, not later in the process.
Having not done so, according to the Court, Plaintiff had to redeliver the entire demand, with the requisite attachments. Delivering the omitted attachment once litigation had commenced wasn’t good enough. Id. (“The statute requires the documentary evidence to accompany the demand for inspection. Therefore, Central Laborers' subsequent filing would comply with the statute only if it was submitted with either a new or an amended demand, directed at News Corp’s registered office or principal place of business. That was not done here.”).
The holding elevates process to an untenable level. The Court made no mention of the requirement that the company respond within five business days (which it did not, according to the complaint). Had the company responded, it could have requested the requisite account statements rather than doing so after litigation had commenced. The holding provides companies with an incentive to withhold procedural concerns over inspection demands until after litigation has been commenced. In doing so, companies can use the concerns as an affirmative defense in the litigation.
It is an inefficient and rigid view of the statute. Moreover, it is a decision that decidedly favors management (no penalty for failing to respond within five days) over shareholders (for failing to include the requisite attachment).
Primary materials on this case are posted on the DU Corporate Governance web site.