Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | October 24, 2012

In light of the dismissal risk to plaintiffs who do not use the tools at hand to inspect books and records prior to bringing a claim for management failure to oversee a corporation’s business and affairs, guidance regarding the standard necessary to support a demand for inspection is important. The recent decision of Louisiana Municipal Police Employees’ Retirement System v. Lennar, 2012 WL 4760881 (Del. Ch. Oct. 5, 2012), indicates that newspaper articles reflecting an industrywide government investigation of compliance with the Fair Labor Standards Act and prior lawsuits alleging violations of the FLSA will not suffice.

The plaintiff’s demand for books and records pursuant to Section 220 of the Delaware General Corporation Law followed publication in The Wall Street Journal of articles describing an investigation by the U.S. Department of Labor, the IRS and state regulators into compliance by large homebuilders with the FLSA and state law. The defendant’s 2011 10-K acknowledged that failure by its employees or subcontractors to comply with state or federal labor law could cause financial and reputational harm to the company. The plaintiff demanded documents, including board minutes, relating to the company and its subcontractors’ compliance with federal and state labor, tax and immigration laws. The defendant declined to provide any documents on the ground that the evidence relied upon by the plaintiff — solely the newspaper articles — did not reflect "a credible basis for thinking there has been wrongdoing." The plaintiff sued, claiming that the newspaper articles and the prior lawsuits provided sufficient credible evidence of wrongdoing.

The court explained that a stockholder seeking books and records pursuant to Section 220 of the DGCL must state a purpose reasonably related to his or her interest as a stockholder and then show by a preponderance of the evidence a credible basis from which the court could infer mismanagement sufficient to warrant further investigation. The court found proper the plaintiff’s purpose to investigate ongoing mismanagement regarding compliance with labor law. Nonetheless, the court found the plaintiff could not meet the low standard of showing a credible basis to believe there were legitimate issues of wrongdoing.

The prior litigation did not suffice because all prior lawsuits had been settled without any admission of wrongdoing by the company. No similar lawsuits had been filed since 2009. The court noted that the plaintiff did not even mention the prior lawsuits in its demand, nor did it argue there was any basis to believe that the number of lawsuits against the defendant was unusual vis-à-vis the industry or comparably sized companies. Therefore, the prior lawsuits showed no credible basis from which to infer ongoing wrongdoing.

The court reached the same conclusion for the newspaper articles that described actions by regulators, not wrongdoing by the defendant. Thus, a mere report that a company is under investigation will not suffice to demonstrate wrongdoing. And where both the prior lawsuits and the newspaper articles are of negligible probative value, combining the two will not suffice to demonstrate anything more than speculation as opposed to a credible basis that ongoing wrongdoing is occurring. The bottom line is that a Delaware corporation will not be forced to provide books and records based on the existence of settled lawsuits where there was no admission of wrongdoing and newspaper reports of a subsequent industrywide investigation by federal and state agencies that contain no mention of wrongdoing by the company.