Slow Down and Think Twice About Filing a Derivative Claim Before Trying to Inspect Books and Records

The latest case in a string of Delaware Court opinions raises – again – an interesting question regarding a derivative plaintiff’s abilitySlow Down Before Filing a Derivative Action - Books and Records Inspection to inspect a corporation’s books and records after he/she files a derivative complaint.

In a November 30, 2011 opinion – Central Laborers Pension Fund v. News Corporation, C.A. No. 6287-VCN – the Delaware Court of Chancery addressed the rights of a shareholder seeking to inspect the books and records of a corporation.  Although not expressly stated in the opinion, the shareholder appears to have demanded to inspect the corporation’s books and records before filing any legal claim with the court.  The shareholder’s demand to inspect was presumably refused, which was followed by the shareholder filing a derivative claim against the corporation (First Case).  Importantly, after the shareholder filed the derivative claim (First Case), the shareholder then filed a second action (Second Case) seeking to enforce its right to inspect the corporation’s books and records.  In response to the Second Case (the books and records action), the corporation filed a motion to dismiss on the grounds that the shareholder could not establish a proper purpose, which is requirement to conduct a books and recods inspection.  See this article for more information about a proper purpose. 

The shareholder responded to the motion to dismiss and argued one of the “proper purposes” for making an inspection demand was to “investigate potential breaches of fiduciary duty in connection with the [challenged transaction] …”  After analyzing the issues, the court opined that the shareholder’s act of filing a derivative complaint was an acknowledgment – a Rule 11 reference – that the shareholder believed sufficient information existed (without conducting an inspection) to support the substantive allegations in the derivative case.  Thus, the court found it was inconsistent for the shareholder to argue it needed to inspect books and records to “investigate potential breaches of fiduciary duty…”  The court concluded, “[i]n short, the stockholder plaintiff who files a Section 220 action immediately after its derivative action is acting inconsistently.”  Id.p. 3.   The Court continued:  “Section 220 [the inspection statute] was not adopted as a substitute for litigation discovery; instead, in this context, it serves to enable potential derivative plaintiffs to obtain the necessary information in advance of filing their derivative action.” Id. p. 4 (emphasis added).  After acknowledging that “special circumstances” may exist in a different case, the Court dismissed the shareholder’s inspection case.  

A footnote in the opinion highlights an important point that is reflected on a number posts throughout this blog, which is: by first conducting a books and records inspection a shareholder-plaintiff may be able to uncover particularized facts that would establish demand excusal in a subsequent derivative suit.  See footnote 5 (citing King v. Verifone Holdings, Inc., 12 A.3d 1140, 1146-47 (Del.2011).  The opinion provides additional support for those making an argument that a litigant cannot use a books and records inspection as a substituted for formal discovery. 

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About Matthew McKinney

Attorney focused on civil and commercial litigation.
This entry was posted in Business Owner, Director, Intra-corporate dispute, Litigation, Shareholder and tagged , , , , , , , , , , , , , , . Bookmark the permalink.

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