Pomerantz LLP

How Bad Does the Behavior Have to Be Before Shareholders Can Investigate It?

ATTORNEY: Anna Karin F. Manalaysay
Pomerantz Monitor January/February 2016

As the Monitor has previously reported, shareholders of Delaware corporations have a right to demand access to books and records of their company, provided that they have a “proper purpose” for doing so. One proper purpose is to investigate whether corporate officers and directors have violated their fiduciary duties. But merely expressing a desire to investigate such a possibility is not enough; the shareholder has to show that there are reasonable grounds to suspect that such a breach may have occurred. Many cases have explored the question of how much smoke there has to be to create a reasonable suspicion that there may well be a fire worth investigating.

Recently corporations have ratcheted up the argument. Now, they say, not only must there be grounds for suspicion of a breach, but that breach must be of the type that is compensable in damages. Since a books and records complaint is filed before there is any claim on file for breach of fiduciary duty, this argument requires that the court forecast the type of claim that might be made in the future.

Delaware law provides broad protections for directors against damage claims based merely on violations of the duty of care; only much more serious violations, such as breaches of the duty of loyalty, are compensable in damages. To escalate a claim of carelessness into a duty of loyalty claim, the shareholder must be able to show extreme misconduct -- the type of conduct that is hard to plead without company records to provide the crucial details. Those, of course, are the very details that the inspection provisions of Delaware law were intended to provide. It is to obtain such information that the shareholders bring a books and records proceeding in the first place. This question is now being considered by the Delaware Supreme Court in a case involving the AbbVie corporation, in which oral argument was heard on November 4, 2015.

In the action, Southeastern Pennsylvania Transportation Authority (“SEPTA”), a shareholder of AbbVie, sought access to AbbVie’s books and records relating to AbbVie’s failed $55 billion merger with Shire. Plaintiff claimed that it had a proper purpose because it wanted to investigate whether the AbbVie directors breached their fiduciary duties in connection with the approval of that merger.

The goal of the merger was to allow AbbVie to take advantage of Jersey’s more favorable tax laws, since Shire is incorporated in Jersey, a tiny island principality off the coast of Normandy that is controlled by England. If the merger had been consummated, AbbVie’s tax rate for 2016 would have dropped from about 22 percent to roughly 13 percent. About two months after the announcement of the merger, the Treasury Department and Internal Revenue

Service, alarmed over the possible drop in tax revenues from such “inversion” transactions, vowed to take action to deter American companies from acquiring foreign competitors to avoid domestic taxes. The AbbVie board responded by withdrawing its recommendation that stockholders vote in favor of the deal. The AbbVie board ultimately terminated the deal and paid Shire a $1.6 billion contractual termination fee.

SEPTA argued that it had a right to investigate the question of whether AbbVie would not have had to pay $1.6 billion if the AbbVie board had properly evaluated the risks of the merger, as required by their fiduciary duty. SEPTA demanded that AbbVie produce board minutes, correspondence, and other documents to investigate potential corporate wrongdoing.

In denying the books and record demand, Vice Chancellor Glasscock inferred that they were seeking an investigation to aid in future derivative litigation against the directors.

The court then held that if a plaintiff’s sole purpose for seeking inspection was to decide whether to bring derivative litigation to recover for alleged corporate wrong- doing, a proper purpose exists only if the plaintiff has demonstrated that the possible wrongdoing would be compensable in damages, and was not barred by the “raincoat” protections of Delaware law. Because SEPTA did not show that the conduct it was investigating could possibly rise to the level of a duty of loyalty claim, the court dismissed the inspection demand.

On appeal, SEPTA argued that the lower court’s decision essentially puts stockholders in the impossible situation of having to show exactly how serious the potential breaches of fiduciary duty might be before they could gain access to the records they would need to make that decision. AbbVie countered that without such detailed information, SEPTA was engaged in a mere fishing expedition, which the books and records statute does not allow.

Even if the appeal is denied, however, the Vice Chancellor, on several occasions, specifically noted that SEPTA sought inspection solely to investigate whether to bring derivative litigation, and that in order to state a proper purpose the claims must be non-exculpated. An exculpatory provision, however, does not bar all derivative litigation, and, accordingly, even in the face of an exculpatory provision, under certain circumstances investigating potential derivative litigation may still be a proper purpose. For example, claims seeking injunctive relief, such as an order barring consummation of a merger, or requiring additional disclosures, are not exculpated and therefore could be explored in a document inspection. At the early stage where a books and records case is filed, the plaintiff shareholder has not yet made any specific claims of actual wrongdoing, and can posit that, depending on what the documents may show, all sorts of non-exculpated relief could be possible.