So where does Espinoza leave us?
The lower court decision more or less conceded that the Report could be "helpful to plaintiff ("It might be helpful to the plaintiff in that it is something the board considered in making its decision") but ultimately concluded that plaintiff had not made a sufficient showing to justify setting aside privilege. The Chancery Court specifically found that “[b]ecause I find that the interim report is protected by the attorney-client privilege and work product doctrine, it’s not necessary for me to reach the [statutory] issue of whether it also would be necessary and essential to the plaintiff’s stated purpose.”
While the decision can be criticized (and we have done so on this Blog), it was in some respect narrow. It imposed a high burden on plaintiffs seeking to invoke their inspection rights but only when privilege was implicated.
The Supreme Court, however, took the "opposite approach", see note 23. Unlike the Chancery Court, the Court did not "reach or address the separate question of whether inspection of the Report is precluded under the attorney-client privilege or the work product immunity doctrine." Instead, the very issue that the Chancery Court did not reach, whether the Report was "essential to the plaintiff's stated purpose," was the basis for the Supreme Court's decision.
In so doing, the Court issued a decision that is likely to have a much broader impact on the ability of shareholders to enforce their inspection rights. Espinoza provides companies with an expanded ability to resist inspection requests. Companies already could argue that shareholders had not set out a proper purpose or lacked a credible basis. Espinoza allows companies to assert that the sought after documents are not "essential" or "central" to the stated purpose, a standard that will often be difficult to meet at the pleading stage. Moreover, since shareholders have the burden, companies can argue that shareholders have not met the burden even when they know that the documents are in fact essential or central. They also have expanded ability to successfully argue that "essential" documents need not be disclosed since plaintiffs were informed of any "critical findings."
The decision, therefore, discourages transparency and will, at least in some cases, make it more difficult for shareholders to acquire information about board activity, even when they have presented a credible basis for misconduct. Moreover, this will likely force shareholders to litigate inspection rights more often. Because they are not automatically entitled to fees when they win, only those who can afford to absorb the costs of a legal action will be in a position to vindicate their rights.
The decision will likely contribute toward the trend in the federalization of corporate governance. SOX preempted state law by adopting clawback provisions, regulating audit committees, and prohibiting loans to executive officers. It was, however, an initial and tentative intrusion into the governance area. Dodd Frank went much further. It regulated compensation committees, strengthened clawbacks, allowed the SEC to define factors in determining director independence, provided for shareholder access, and gave shareholders an advisory vote on executive compensation. The boards of large banks must have risk committees and financial regulators have the substantive authority to prohibit compensation practices that result in excessive risk.
All of this shows that Congress no longer considers the role of states in the governance process as a significant barrier to intervention. To the extent that the law in Delaware is not sufficiently balanced, further appeal to Congress and federal regulators will result. Espinoza provides shareholders with an argument that inspection rights are not adequate to provide them with the information they need to monitor management and that this type of information ought to be mandated as part of the federal disclosure regime.
Primary materials for the case at the trial level can be found at the DU Corporate Governance web site.