March 23, 2017

Massachusetts Supreme Judicial Court Clarifies the Requirements for Shareholder Inspection Demands

In Chitwood v. Vertex Pharm. Inc., SJC-12101 (March 20, 2017), the Massachusetts Supreme Judicial Court (SJC) provided important guidance on the scope of the Massachusetts shareholder inspection statute, Mass. G.L. 156D § 16.02, as well as the requirements for a shareholder who makes a demand pursuant to the statute. The case is noteworthy as the SJC’s first-ever decision concerning the requirements of the Massachusetts inspection statute, and Massachusetts companies and practitioners will want to take careful note of the key distinctions between Massachusetts and Delaware law in this area, as highlighted by the Court’s opinion and briefly described below. Goodwin served as counsel to Vertex Pharmaceuticals Inc. (Vertex) in the case.

As background, the Plaintiff, Fred Chitwood, a shareholder of Vertex, made a demand to inspect corporate books and records pursuant to § 16.02, claiming that the records were needed to investigate alleged breaches of fiduciary duty by the Vertex board of directors with respect to Vertex’s financial reporting and certain insider stock sales. Plaintiff’s inspection demand sought seven categories of records, including the records and minutes of all meetings of the Vertex board and a special committee (the Special Committee) of independent directors that had been formed to investigate a previous demand from Plaintiff to commence directive litigation based on the same alleged misconduct; the Special Committee’s final report and any drafts of the report; all documents distributed at any meeting of the board or the Special Committee; and all documents concerning a separate internal review relating to the underlying events.

Vertex rejected Plaintiff’s inspection demand on the grounds that (among other issues) the demand was improper because the Vertex board, following a reasonable inquiry by the Special Committee, had rejected Plaintiff’s earlier derivative demand, and, moreover, that Plaintiff’s inspection demand vastly exceeded the scope of the inspection statute. Plaintiff filed suit to compel inspection of the requested records, and after a bench trial in the Business Litigation Session (BLS) of the Suffolk Superior Court, the judge dismissed the complaint with prejudice, concluding that Plaintiff had failed to meet his burden of showing a “proper purpose” under the inspection statute.

On direct appeal to the SJC, the issue was whether the trial judge applied the correct “proper purpose” standard. The Court concluded that she did not. Because the trial court applied a proper purpose standard that was “too demanding,” and because the scope of the demand made by the shareholder “far exceeded the authorized scope of inspection under § 16.02(b),” the Court vacated the judgment and remanded the case for further proceedings consistent with its opinion. (Op. at 3.)

The Court held that the trial court had misapplied the “proper purpose” standard, holding that the proper purpose standard is satisfied where the shareholder seeks to investigate board action with respect to allegations of insider trading after an allegedly inaccurate public announcement. The shareholder need not, as the trial court ruled, “provide evidence of wrongdoing beyond the timing of the press releases and the insider trades to obtain these excerpts of original minutes.” (Id. at 17.) (We also note that a companion shareholder class action brought against Vertex under the federal securities laws based on the same allegations was dismissed with prejudice by the United States District Court for the District of Massachusetts, and the dismissal was upheld on appeal by the United States Court of Appeals for the First Circuit, IBEW v. Vertex Pharm. Inc., 838 F.3d 76 (1st Cir. 2016).)  

The Court distinguished this from the standard applied to shareholder books and records requests under Delaware law, 8 Del. C. § 220, noting that the scope of corporate records that potentially may be inspected under Delaware law is far greater, because the Delaware statute—in contrast to the Massachusetts statute—does not specify the scope of records available for inspection, leaving that to the sound discretion of the trial judge. Delaware law requires a shareholder to show, by a preponderance of the evidence, a credible basis from which the court can infer there is possible mismanagement that would warrant further investigation. But the Court held that this burden “is more demanding than is appropriate for the limited scope of books and records subject to inspection under § 16.02.” (Id. at 19.)

The Court repeatedly emphasized the limited scope of the Massachusetts statute, and its conclusion that Plaintiff’s inspection demand far exceeded that scope. The Court held that under § 16.02, “a shareholder is entitled to inspect the original minutes of a board or committee meeting only to learn what action was taken at those meetings; it does not provide a right of inspection of the documents that were provided to board members for consideration of that proposed action or of the minutes memorializing the debate at the board or committee meeting as to whether to take that action.”  (Id. at 16.) The vast majority of records sought by Plaintiff—including the records and report of the Special Committee—were not available for inspection. The Court noted that “[t]hey are precisely the type of records that a plaintiff shareholder might seek in discovery in a derivative action in an attempt to show that the special committee’s inquiry into the allegations was not reasonable or that the independent directors did not act in good faith.” (Id. at 15.)  But these records are outside the scope of § 16.02, and therefore off limits to the shareholder here.

Thus, the Court in Chitwood provides greater clarity to Massachusetts corporations and shareholders moving forward: while there may be a low threshold to demonstrate a “proper purpose,” the scope of any shareholder inspection will be strictly limited to the excerpts of board meeting minutes specified in the statute. This provides welcome protection for the reports and other materials provided to directors, as well as records of directors’ discussions and deliberations. And it is a reminder for drafters of board meeting minutes to act with care when memorializing the actions taken by a board on sensitive topics.