Delaware Supreme Court, en Banc, hews to inspection standard

The Delaware Supreme Court has reaffirmed that the standard for shareholder inspection of books and records (rather than inspection of the stock ledger or list of stockholders) under DGCL § 220(b) is whether the shareholder has produced some evidence to suggest a credible basis from which the court can infer that waste or mismanagement may have occurred. In Seinfeld v. Verizon Communications, Inc., (listen to oral argument) Seinfeld sought limited inspection to investigate mismanagement and waste in connection with the compensation of three executives. Seinfeld admitted he had no factual basis for his claim. He urged the court to permit inspection based upon “suspicions, reasonable beliefs, and logic arising from public disclosure”.

After oral argument, before Holland, Berger, and Ridgely, JJ., the panel referred the case to the court en Banc. Presumably this referral was pursuant to Internal Operating Procedure VII that permits en Banc consideration when there is a reasonable likelihood that a prior decision may be modified or overruled. The court asked for supplemental briefs on whether the inspection standard should be whether “the stockholder has a rational basis for the stated purpose and no other purpose that would militate against inspection”. The court also invited the parties to suggest another standard that reduced the current standard. After supplemental briefing, the court en Banc affirmed its existing standard.

Justice Holland, for a unanimous court, held that the existing standard appropriately balances the interests of stockholders in stemming mismanagement and the interests of directors in managing the business of the corporation. He noted that Delaware courts have rejected Seinfeld’s proposed standard. As an empirical matter, Justice Holland observed that Seinfeld’s litigation was only the second since the adoption of the current standard in 1996 and 1997 in which no credible basis at all was found in contrast to at least 15 cases in which at least some inspection was ordered. At bottom, Justice Holland grounded the retention of the rule in the finding that it “maximizes stockholder value by limiting the range of permitted stockholder inspections to those that might have merit”.

Starting with Grimes v. Donald in 1996, a § 220 books and records request is always referred to as “one of the ‘tools at hand’” that plaintiffs should use to assemble evidence to survive a motion to dismiss. Plaintiffs who do not make use of this avenue are typically chastised for not doing so. Since Grimes, books and records litigation has increased and some inspection has been ordered in nearly all instances. However, it is clear that at least some Justices were of the view that the current standard is too restrictive. This view was substantial enough to warrant referring the case to the court en Banc and ordering supplemental briefing after oral argument. It’s unclear to me why some members of the court viewed the current standard as too strict, given that litigation has increased and is nearly always successful. The opinion is also interesting in that it suggests that the standard might be changed if empirical studies show that the current rule is suboptimal in terms of shareholder returns. That is, the opinion suggests that the rule is entirely economically based rather than anchored in a theoretical understanding of the appropriate balance between managers and shareholders.