City of Westland v. Axcelis Technologies: The Myth of Majority Vote Provisions and the Further Need for Preemption of Delaware Law (Credible Evidence As An Excessive Pleading Standard)

Despite being the owners of the company, shareholders in Delaware are not allowed to examine the books and records unless they have a proper purpose.  A proper purpose, one might think, would merely require a good reason.  In fact, Delaware courts have interpreted the phrase to essentially require allegations of wrongdoing. See Seinfeld v. Verizon Communs., Inc., 909 A.2d 117  (Del. 2006)("It is well established that a stockholder's desire to investigate wrongdoing or mismanagement is a 'proper purpose.'  Such investigations are proper, because where the allegations of mismanagement prove meritorious, investigation furthers the interest of all stockholders and should increase stockholder return.").  In addition to the allegation, there must be "credible basis" of wrongdoing.  In other words, there must be some affirmative evidence that the board of directors violated its fiduciary obligations.

The requirement of wrongdoing and the credible  basis standard reflects a judicial graft onto the statute.  Moreover, the courts have used the grafts to effectively dismiss on procedural grounds efforts by shareholders to examine records that are unquestionably related to their role as owners and the exercise of the franchise.  By requiring what amounts to be affirmative evidence of a fiduciary duty violation, without allowing the facts themselves to be sufficient to justify inspection, the courts essentially insulate board actions from shareholder review and, more critically, from shareholder challenge.  We have described this effect before and been taken to task by the Delaware Chancery Court.

This case is an example of this approach in practice.  Plaintiffs wanted to understand the basis for the board's decision not to accept the resignation letters of the three directors who did not obtain majority approval by shareholders.  The shareholders did not seek to rummage around the confidential records of the company and expose trade secrets.  Instead, they asked for the following: 

• 6. All minutes of agendas for meetings (including all draft minutes and exhibits to such minutes and agendas) of the Board at which the Board discussed, considered or was presented with information concerning or related to the Board's decision not to accept the resignations of [the three directors].

• 7. All documents reviewed considered, or produced by the Board in connection with the Board's decision not to accept the resignations of [the three directors].

The request was narrow.  Moreover, such information, for an informed board, would ordinarily be readily available and do little more than show that the directors met and properly deliberated.  Results of such an inspection would likely prove embarassing only if there had been no meaningful meetings and no meaningful deliberations. 

Curiosity wasn't good enough.  Shareholders tried to meet the credible basis standard by alleging that the explanation given in the press release announcing the decision to retain the directors was inconsistent with the record.  Shareholders contended that the need to retain the directors to conduct merger negotiations was inconsistent because the bidder had disclosed that efforts to negotiate with Axcelis had been "repeatedly rebuffed."  The court found this insufficient because the press release provided other reasons for the decision to retain.

• Moving forward with negotiations with SHI was not the sole justification for the retention of the Three Directors. The Board also credited their experience and knowledge regarding the management of Axcelis, as well as the fact that they served on a number of key Axcelis committees.

In short, the court seemed to suggest that shareholders had to challenge all of the justifications in the press release as inconsistent with the record to provide the necessary "credible basis," a practical impossibility for justifications such as the need to retain directors due to experience and knowledge. 

The court also declined to give any weight to the apparent disparity between the need for the directors to negotiate and the statements by the bidder that negotiations had been rebuffed.

• The record demonstrates that, throughout the prior negotiations with SHI, the Board insisted on some form of confidentiality agreement before moving forward—a request SHI avoided.  Soon after the Board’s decision to retain the Three Directors was made, Axcelis and SHI entered into a confidentiality agreement and negotiations proceeded, albeit unsuccessfully. In short, the purported justifications for the retention of the Three Directors are not materially inconsistent with the record and do not demonstrate a credible basis from which to infer wrongdoing.

While it may have been true that negotiations proceeded, these occurred after the resignation letters were declined.  The only issue was whether plaintiffs had presented sufficient credible evidence to get access to the minutes and the materials presented to the board, not whethether they had conclusively proven wrongdoing.  The standard did not require that any discrepancy be resolved, only that a credible basis be presented.  Yet to Chancery Court credible apparently meant something closer to preponderance.  Another judicial graft, presumably.

There is more to this case and we will discuss it in the next post.

Primary materials on this case can be found at the DU Corporate Governance web site.