Delaware Code § 220 gives stockholders the right to inspect a corporation’s books and records, but that right is subject to certain important limitations that have developed in the Delaware caselaw. When a corporation is served with an inspection demand, the corporation needs to understand those limitations to avoid needlessly producing documents that are not properly subject to inspection. Yet a corporation also needs to use good judgment in determining whether the production of additional books and records, even beyond those strictly required by the statute, is in the corporation’s best interest under the particular circumstances.
Delaware Code § 220
Under § 220, “[a]ny stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from … [t]he corporation’s stock ledger, a list of its stockholders, and its other books and records.” The Delaware Court of Chancery has exclusive jurisdiction over disputes concerning stockholder inspection demands.
Who is a Stockholder?
A “stockholder” is “a holder of record of stock in a stock corporation, or a person who is the beneficial owner of shares of such stock held either in a voting trust or by a nominee on behalf of such person.” Members of nonstock corporations are also considered stockholders under the statute. If the stockholder is not a record holder of stock, the inspection demand must “state the person’s status as a stockholder, be accompanied by documentary evidence of beneficial ownership of the stock, and state that such documentary evidence is a true and correct copy of what it purports to be.” If an attorney or agent seeks to inspect books and records on behalf of a stockholder, the demand must include a power of attorney or similar authorization.
What is a “Proper Purpose”?
A “proper purpose” is a purpose that is related to the stockholder’s legitimate interests as a stockholder. Generally, curiosity, harassment, an attempt to gain leverage in negotiating an employment claim where the stockholder is a former employee, or a stockholder’s interest in conducting a fishing expedition will be insufficient. In determining whether a stockholder meets the proper-purpose requirement, the stockholder has the burden of proof if he or she demands records other than the corporation’s stock ledger and shareholder list.
Several purposes are well established as being proper. One is to investigate corporate mismanagement. But even where this is the stockholder’s purpose, the stockholder must still show that there is a “credible basis” to infer that mismanagement has occurred. Valuing one’s shares generally is also a proper purpose. Other proper purposes include investigating corporate waste, self-dealing, or improper transactions.
Even when the stockholder satisfies the proper-purpose requirement, however, the inspection demand must still be limited to only those books and records that are necessary to satisfy the proper purposes. The stockholder’s demand must therefore identify the requested documents with “rifled precision.”
Finally, with respect to nonstock corporations, corporate directors and members of the corporation’s governing body may inspect the corporation’s books and records “for a purpose reasonably related to the director’s position as a director.”
Issues to consider when responding to a stockholder inspection demand
When determining whether to produce books and records, a corporation should consider all potential grounds for resisting or limiting the demand, as compared to the potential benefit of making a more fulsome production. Nonetheless, while shareholders have certain basic rights to information, certain demands can be improper or excessive. A corporation that receives a stockholder inspection demand has several potential grounds for seeking to limit the scope of the inspection, or to avoid it altogether, including the following:
- Does the demand comply with all of the procedural requirements of § 220? Strict compliance with the statute is required.
- Does the demand properly identify the corporation?
- Does the stockholder have a proper purpose for making the inspection demand?
- Is the stockholder’s primary purpose a proper purpose? The proper-purpose requirement may not be met if the real reason the stockholder wants the books and records is not a proper purpose, even though a secondary reason for the demand may be a proper purpose.
- Is the demand tailored to ensure that the requested documents advance the stockholder’s proper purpose for making the demand? Overbroad requests may not be allowed, and this is a central ground on which courts limit inspection demands.
- If a stockholder’s stated purpose for making the inspection demand is to investigate corporate wrongdoing, can the stockholder show a credible basis to infer such wrongdoing? Suspicions of wrongdoing are insufficient. If the demand seeks to justify a wide investigation of corporate misconduct on the basis of a small amount of evidence or evidence consisting of a single incident, that may not be enough. The assertion that one incident is the “tip of the iceberg” may not justify a wider records inspection.
- Is the demand improperly being used as a form of discovery while a motion to dismiss a derivative action is pending?
- Does the stockholder already have the requested documents, or at least documents that are sufficient to satisfy its asserted purpose?
- Is the corporation being asked to produce the books and records of corporate subsidiaries? This is allowed only if “[t]he corporation has actual possession and control of such records of such subsidiary” or “[t]he corporation could obtain such records through the exercise of control over such subsidiary,” the inspection would not violate an agreement between the corporation (or subsidiary) and a third party, and the subsidiary does not have the right to deny the corporation access to the records.
- Are the documents privileged, work product, or confidential? Such documents, however, are not necessarily exempt from production. Work product documents may need to be produced if the stockholder makes a sufficient showing of need. Even attorney-client privileged documents may be subject to inspection if there is “good cause” to allow the inspection. An appropriate confidentiality order may nonetheless be required before confidential documents are produced to a stockholder.
Although these questions, as embodied in the Delaware caselaw, may enable the corporation to resist or limit an inspection demand, the corporation must also carefully consider whether and how to object to the demand. If, for example, producing documents may satisfy stockholder curiosity and avoid a derivative action, then the corporation must assess whether producing the requested books and records, though burdensome, is in the corporation’s interests. It is therefore critical that a corporation both to know the law and apply it thoughtfully after it receives a stockholder inspection demand.