Client Alert

Chancery Allows Limited Discovery in Books and Records Action to Test Stockholder’s Purpose

04 Aug 2020

On July 24, 2020, the Court of Chancery in Delaware rejected defendant Centene Corporation’s broad document requests and third-party subpoenas issued as part of a stockholder action to inspect books and records, but allowed Centene to inquire into the stockholder’s stated purpose and source of funding. The decision provides an example of the outer limits of the amount and type of discovery that the court may allow to inquire into a stockholder’s purpose for making a books and records demand.

On May 27, 2020, Laura Wood, a stockholder of Centene Corporation (“Centene”), filed a complaint in the Delaware Court of Chancery (the “Chancery Court”) seeking access to Centene’s books and records. Centene, a Missouri-based healthcare company, provides comprehensive healthcare services to correctional facilities, detention centers, and government agencies in seventeen states. Centene operates as Centurion Detention Health Services (“Centurion”) through separate wholly owned subsidiaries in each state. 

Stockholder seeks to investigate lack of oversight

In January 2020, prisoners incarcerated at the Mississippi State Penitentiary (“Parchman”) filed a civil rights lawsuit against the head of the Mississippi Department of Corrections and the warden of the state penitentiary alleging constitutional violations relating to the inhumane conditions in Parchman (the “Mississippi lawsuit”). The Mississippi lawsuit is reportedly funded by Shawn Carter, the artist popularly known as Jay-Z, and his entertainment company Roc Nation, to challenge the conditions in Mississippi prisons, including the allegedly “non-functioning” Centurion healthcare system at Parchman.

Alleging that Centene’s board of directors may have breached their fiduciary duties by failing to monitor and remediate Centurion’s mismanagement, Wood filed a demand under Delaware General Corporate Law § 220 (the “§ 220 Demand”) seeking access to Centene’s books and records relating to Centurion’s operations and Centene’s oversight of those operations. Wood stated that her intent was to investigate potential wrongdoing, communicate with other stockholders about these concerns, and, if necessary, take further action to prevent additional damage to the company.

Chancery allows limited discovery

Centene alleged that Wood’s demand is a straw man, publicly solicited by Bernstein Liebhard and represented by Quinn Emanuel, to advance Roc Nation’s interests in the Mississippi lawsuit. Centene based its allegation on the fact that Wood’s counsel at Quinn Emanuel also represents Roc Nation and appearedin the Mississippi lawsuit. Centene argued that Wood’s purpose is improper because she is pursuing the interests of her lawyers and Roc Nation, rather than her own, and that the § 220 Demand was an effort to obtain documents to support the Mississippi lawsuit and “engage in a media campaign against” Centene.

Centene served document requests and interrogatories on Wood, and issued third-party subpoenas to Roc Nation and Quinn Emanuel, seeking communications relating to the Mississippi lawsuit, the § 220 Demand, and Wood’s sources of funding. Wood moved to quash the subpoenas arguing that Centene had not yet deposed Wood and had no evidence of an improper purpose. Rejecting Wood’s argument that Centene’s discovery requests were a “fishing expedition,” Vice Chancellor Paul A. Fioravanti held that this was not a typical books and records case, and allowed a sub-set of Centene’s requests related to Wood’s sources of funding and her solicitation as a plaintiff for the § 220 Demand.

Sincere and proper purpose

Section 220 of the Delaware General Corporation Law authorizes a stockholder to inspect a corporation’s books and records for any proper purpose.[1]  A proper purpose is any purpose “reasonably related to such person’s interest as a stockholder.”[2] If the stockholder’s purpose is proper, “secondary motivations for seeking inspection, even if improper, will not be examined by the court.”[3] Once a stockholder has identified a proper purpose, the burden shifts to the corporation to prove that the stockholder’s avowed purpose is not her actual purpose and that her actual purpose for conducting the investigation is improper.[4]

Defendant corporations face an uphill battle to prove that a stockholder’s demand is based on false pretenses. Earlier this year, Vice Chancellor Fioravanti remarked that “discovery into determining whether a stockholder has a proper purpose or whether the purpose is entirely lawyer driven should begin by asking questions of the Section 220 plaintiffs regarding the purpose of his or her demand at deposition rather than propounding broad discovery on the plaintiffs’ attorneys, either directly or through subpoena.”[5]

Depositions have proven to be a sufficient test of a plaintiff’s purpose in some actions brought under § 220. In 2017, Vice Chancellor Laster denied access to books and records where the stockholder admitted at deposition that the demand was lawyer-driven, that his involvement was minor and non-substantive, and that the purpose stated in the demand was not his own.[6] In contrast, Vice Chancellor McCormick recently found a stockholder “to be sincere in his pursuit of books and records” when he “admitted that his counsel helped articulate his demand purposes, but demonstrated a clear understanding of the facts and goals relevant to each purpose.”[7]

In this instance, the court afforded Centene “marginally greater latitude” to seek documents relating to Wood’s solicitation as a plaintiff because of Quinn Emanuel’s simultaneous involvement in the § 220 Demand and the Mississippi lawsuit. There is precedent to compel production of lawyers’ communications to solicit plaintiffs for books and records actions considering the relevance of these communications to plaintiff’s stated purpose.[8]

Discovery remains the exception rather than the norm in summary proceedings under § 220. The vice chancellor’s order quashing third-party subpoenas and broader document requests reflects the Court’s discretion under Chancery Court Rule 26(b)(1) to balance the tension between the parties’ general right to liberal discovery and the summary nature of a books and records action. Without strong indications of a pretextual demand and an ulterior, improper purpose, defendant corporations must continue to rely on direct questions at deposition to test the sincerity of a stockholder’s purpose.

Key Takeaways

  • Corporations can challenge a stockholder’s purpose as improper in § 220 proceedings if there is reason to believe that the demand is pretextual, or that there is an ulterior motive unrelated to the movant’s status as a stockholder.
  • Corporations must rely on depositions to test the sincerity of the stockholder’s purpose, but the court may allow limited document discovery if there is reason to believe that the demand is driven by the stockholder’s lawyers or funded by a third party.

[1] 8 Del. Code § 220.

[2] 8 Del. C. § 220(b).

[3] Sutherland v. Dardanelle Timber Co.,No. Civ. A. 671-N, 2006 WL 1451531, at *8 (Del. Ch. May 16, 2006).

[4] See Woods v. Sahara Enters., Inc., C.A. No. 2020-0153-JTL, 2020 WL 4200131 (Del. Ch. July 22, 2020).

[5] Tr. of Oral Argument at 67, Randolph v. GrubHub, Inc.,C.A. No. 2020-0066-PAF (Del. Ch. May 28, 2020).

[6] Wilkinson v. A. Schulman, Inc., No. 2017-0138-VCL, 2017 WL 5289553 (Del. Ch. Nov. 13, 2017).

[7] Kosinski v. GGP Inc., 214 A.3d 944, 951 (Del. Ch. 2019).

[8] See Meltzer, et al. v. CNET Networks, Inc.,C.A. No. 3023-CC, 2007 WL 2593065 (Del. Ch. Sept. 6, 2007).

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