Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | June 13, 2012

Cases brought under Section 220 of the Delaware General Corporation Law reflect the Delaware General Assembly’s effort to balance the stockholder’s important right to seek inspection of books and records to investigate wrongdoing with the directors’ right to manage the business and affairs of the entity without undue interference from stockholders. In 2003, the Delaware General Assembly extended the right to demand inspection from stockholders of record to beneficial stockholders, but only if the beneficial holder states under oath with the demand that he or she is a beneficial holder, provides documentary evidence of beneficial ownership of the stock and states that such evidence is a true and correct copy of what it purports to be.

In Central Laborers Pension Fund v. News Corp., No. 682, 2011, 2012 WL 1925724 (Del. May 29, 2012), the Delaware Supreme Court affirmed the dismissal of a stockholder’s demand to inspect books and records because the stockholder failed to comply with these procedural requirements. The decision is important for at least three reasons: (1) the Supreme Court may decide an appeal on any ground argued in the lower court, even if not a ground for the decision of the court below; (2) the Supreme Court interprets strictly the procedural requirements of Section 220; and (3) whether a stockholder plaintiff who files a derivative action thereafter lacks a proper purpose to pursue a Section 220 demand while the derivative action is pending remains unresolved.

APPEAL DECIDED ON GROUND NOT CONSIDERED BY CHANCERY COURT

Central Laborers Pension Fund commenced a derivative action against News Corp. and its directors claiming that a transaction to acquire the Shine Group, an entity formed by Elisabeth Murdoch, the daughter of News Corp. CEO Rupert Murdoch, reflected an unfair process and unfair price. One hour later that same day, Central Laborers also filed its action to compel inspection of News Corp.’s books and records related to the Shine transaction. News Corp. moved to dismiss the Section 220 action on the grounds that the plaintiff had failed to comply with the procedural requirements of Section 220 by not attaching evidence of Central Laborers’ beneficial ownership and that the filing of the derivative action mooted the Section 220 action. The Court of Chancery dismissed the Section 220 action solely on the ground that Central Laborers lacked a proper purpose once it filed its derivative action.

On appeal, Central Laborers challenged the lower court’s holding by arguing that the time to evaluate a stockholder’s demand is when the stockholder makes the demand. Since Central Laborers made its demand before the filing of the derivative action, the filing of that action should not affect its proper purpose. Moreover, Central Laborers argued that "a Section 220 inspection demand should be deemed to have a proper purpose despite the pendency of a derivative action, so long as leave to amend has not been explicitly precluded," according to the opinion. The Supreme Court affirmed the Court of Chancery’s dismissal of the Section 220 action on a ground not considered by the court below; namely, that the plaintiff had failed to comply with the procedural requirements of Section 220 by not supplying proof of beneficial ownership. The court’s holding is a reminder to appellate litigants that the Supreme Court "may rest its appellate decision on any issue that was fairly presented to the Court of Chancery, even if that issue was not addressed by that court," as the court held in its opinion.

PLAINTIFFS SEEKING INSPECTION MUST COMPLY STRICTLY

The importance of strict compliance with the requirements of Section 220 is reflected in the Supreme Court’s adoption of the rationale of a 2000 Court of Chancery decision, Mattes v. Checkers Drive-In Restaurants, 2000 WL 1800126 (Del. Ch. Nov. 15, 2000). The Mattes court held that a corporation has a right to receive and consider a demand in proper form before a stockholder plaintiff may commence litigation. In Mattes, the stockholder plaintiff, Craig Mattes, attempted to cure his defective demand by submitting a corrective affidavit verifying the demand in the litigation. The Court of Chancery held that a stockholder must make a proper demand and then sue on it because "the express statutory requirements of Section 220 as to the form of a stockholder demand should be strictly construed." The Supreme Court adopted that rationale in Central Laborers, and thus rejected the plaintiff’s effort to cure its defective demand by submitting the necessary documentary evidence as to its status in response to the defendant’s motion to dismiss, rather than with a new or amended complaint delivered to News Corp.’s registered office or principal place of business.

UNANSWERED QUESTIONS

In King v. VeriFone, 12 A.3d 1140 (Del. 2011), the Delaware Supreme Court had reversed the Court of Chancery’s dismissal of an action seeking books and records brought by a plaintiff whose California action had been dismissed with leave to replead based on documents it might obtain if it chose to demand books and records. That case is factually dissimilar from Central Laborers because in VeriFone the derivative action was not pending when the demand was made. Moreover, the VeriFone court in reversing the Court of Chancery had noted without criticism two circumstances where the court had properly dismissed a Section 220 action, the first where a derivative action was pending and the second where a derivative action had been dismissed with prejudice. Because VeriFone involved a Section 220 demand after a derivative action was dismissed with a right to replead, the issue of a stockholder who makes a 220 demand while a derivative claim is pending remains unanswered. By ruling on the narrow procedural ground that Central Laborers had failed to provide evidence of beneficial ownership when it made its demand, the Supreme Court leaves for another day the question of whether the mere right to amend a derivative complaint may permit a stockholder plaintiff to establish a proper purpose.

LESSONS LEARNED

Central Laborers reminds appellate lawyers that the Supreme Court may decide an appeal on any ground fairly presented to the court below, even if the lower court does not consider such ground in its opinion. It also reaffirms that the procedural requirements of Section 220 of the DGCL are strictly construed. A stockholder plaintiff who mistakenly fails to include the required proof of beneficial ownership with its demand would be well-advised to make a proper demand with the appropriate documentation and then amend its complaint or file a new action. Finally, a stockholder plaintiff who seeks to demand inspection of books and records after filing a derivative action that is pending likely will find its complaint dismissed for lack of a proper purpose. If, unlike in Central Laborers, a plaintiff properly complies with the strict procedural requirements of Section 220 but sues while a derivative action is pending, has its case dismissed and then appeals the dismissal, the question of whether a plaintiff may have a proper purpose who files a derivative action and then makes a Section 220 demand while the derivative action is pending will be ripe for decision.