[co-author: Nitin Nainani]
Section 220 demands are a commonly used tool for stockholders to gain access to a company’s books and records. Although this provision of the Delaware General Corporation Law vests stockholders with a right of access thereto, it also places upon them the preliminary burden of demonstrating that their “primary purpose” for requesting such documents is “proper.” Just what is proper is a fact-intensive inquiry frequently subject to judicial review; the question gets only more complicated when a demand may be inspired by multiple purposes, with varying degrees of propriety. A decision by the Delaware Court of Chancery, recently affirmed by the Delaware Supreme Court, sheds light on how such competing purposes are balanced.
EpicentRx, Inc. v. Prothex Inc. was a single installment in a years-long mano a mano between two parties: biotechnology and pharmaceutical companies working to develop cancer treatments, that entered into a license agreement whereby Prothex gained the right to sell a particular molecule developed by EpicentRx, and EpicentRx acquired a substantial stake in Prothex. In the midst of a deteriorating relationship, EpicentRx sought to acquire Prothex’s assets, and then (as faltering negotiations continued) filed at least four lawsuits against the company and its directors. The second of these aimed to enforce a Section 220 demand that sought copious amounts of company information. The demand was purportedly designed to investigate mismanagement at Prothex, but—according to Prothex—was actually a negotiating cudgel intended to force a better deal.
In its rulings following trial, the Court of Chancery found that both sides were correct: That is, EpicentRx proffered its Section 220 demand for both the proper purpose of investigating mismanagement and the improper purpose of effecting Prothex’s capitulation. But a proper purpose, standing alone, was insufficient. Because the Court found that the improper purpose was the primary purpose, it denied EpicentRx’s Section 220 demand. The ruling highlights the dual nature of the burden faced by requesting stockholders—to show not just a proper purpose, but that the proper purpose is the primary purpose—and also its weight. No one fact was dispositive to the Court’s opinion; instead, its wide-ranging analysis impressed the importance of the context surrounding a Section 220 demand.
BOOKS-AND-RECORDS DEMANDS
Section 220 of the Delaware General Corporation Law vests stockholders of a company with the right to examine the company’s books and records, provided that (a) their demand conforms with certain requirements regarding form and manner, and (b) they express an appropriate purpose for their inspection. If requesting books and records other than stocklists, “the stockholder bears the burden of establishing that his primary purpose is proper.”1
Courts have discretion, based on a review of the facts, to decide whether the stockholder’s stated purpose is proper.2 To be deemed proper, the stockholder’s purpose must be “reasonably related to such person’s interest as a stockholder and . . . not adverse to the company.”3 Should a stockholder satisfy this standard, the burden shifts to the party resisting inspection to “prove that the stockholder’s avowed purpose is not [their] actual purpose and that [their] actual purpose for conducting the inspection is improper.”4 Importantly, a secondary improper purpose does not overcome this burden; to do so, the company must demonstrate that the stockholder’s “primary purpose is [ ] improper.”5 Doing so is “fact intensive and difficult to establish.”6
In most circumstances, investigating mismanagement qualifies as an appropriate purpose for a Section 220 demand.7 But when a requesting stockholder also transacts business with the company, and thus has an interest in obtaining information for its own financial benefit, courts will weigh “whether the stockholder-related purpose predominates over the ulterior purpose.”8 If the stockholder’s ulterior purpose is its primary motivation, the stockholder may be barred from relief; even if the ulterior purpose is plainly secondary to a legitimate purpose, however, courts can restrict relief under Section 220.9
BACKGROUND
EpicentRx is a biotechnology company focused on cancer treatments that was founded in 2002.10 Prothex, founded in 2008, is a clinical-stage pharmaceutical company that develops radiation treatments for cancer.11
In July 2018, EpicentRx and Prothex commenced a licensing agreement, pursuant to which EpicentRx acquired roughly 43% of Prothex’s outstanding stock and the right to appoint a member of Prothex’s board of directors.12 Factoring in the shares controlled by senior EpicentRx leaders in their individual capacity, this left EpicentRx with control over more than 47% of Prothex’s stock.13 The remaining shares were owned by Prothex’s only other stockholder, InterWest Partners LLC, a venture-capital firm and co-owner of EpicentRx.14 InterWest likewise had the right to appoint a member to Prothex’s board, which, until November 2020, consisted of Prothex’s CEO and a representative from each of EpicentRx and InterWest.15 As part of this arrangement, Prothex gained an exclusive, albeit limited, license to sell RRx-001—a molecule EpicentRx had cultivated that offered potential uses in chemotherapy and other cancer treatments.16
The licensing agreement, no doubt, was intended to foster greater cooperation between Prothex and EpicentRx. Instead, their relationship soon spiraled into mistrust. EpicentRx expressed alarm over Prothex’s communications with the FDA, concerned that Prothex did not sufficiently clarify the limits of its RRx-001 license.17 EpicentRx also alleged that Prothex did not provide notice before filing a patent application for using RRx-001 for radioprotection; if granted, EpicentRx said, Prothex’s patent would infringe on others held by EpicentRx.18 Given these concerns, in July 2020, EpicentRx, InterWest, and Prothex amended the licensing agreement to give EpicentRx greater control of decision-making and the development of RRx-001.19 Among other things, the amendment compelled Prothex to withdraw its pending patent application, and permitted EpicentRx to request that Prothex withdraw or amend future applications.20
But these changes did not resolve the entities’ ongoing issues, as Prothex and EpicentRx disagreed about payments that Prothex purportedly owed to EpicentRx.21 Then, on March 4, 2021, EpicentRx delivered a letter of intent to Prothex, outlining a proposal under which it would acquire Prothex’s RRx-001-related assets for $8 million.22 The proposal called for the licensing agreement to terminate, placing EpicentRx back in full control over RRx-001 technology.23 Prothex replied on March 15 with a written indication of interest, albeit a substantially higher proposed price: $50 million for the remaining 53% of the company.24 By now, Prothex’s board consisted of only two members: its own CEO and EpicentRx’s representative.25
EpicentRx did not respond to the counterproposal, and so two weeks later, on March 29, 2021, Prothex followed up. The next day, EpicentRx furnished Prothex with a books-and-records demand seeking 18 categories of corporate documents and communications.26 By way of purpose, EpicentRx stated that it was “investigating whether Prothex and [its founder] have demonstrated an ability to benefit shareholder interests by moving RRx-001 forward and completing clinical trials,” and cited what it claimed were breaches of the license agreement.27 The same day, EpicentRx delivered a letter rejecting Prothex’s counteroffer; the letter also accused Prothex’s officers of mismanaging the company and breaching both their fiduciary duties and the licensing agreement.28
Prothex responded to the books-and-records demand on April 6, 2021; it said the demand lacked a proper purpose and was overbroad, and refused to provide documents in response to the large majority of requests.29 A week later, it responded to the accusation of breach.30 EpicentRx reiterated its demand on April 20 and, on May 2, provided Prothex with an increased offer.31 The parties exchanged multiple term sheets over the course of several weeks, including one on May 26 that they ultimately executed and that was followed by the exchange of due diligence.32 But negotiations broke down, and EpicentRx shifted its approach to the courts.33 This included two complaints in California state court, filed on August 13 and 30, 2021. In the first action, EpicentRx charged Prothex’s leadership with breach of fiduciary duty related to the failed negotiations; intentional and negligent interference with prospective economic advantage; and business disparagement and trade libel.34 In the second, EpicentRx claimed that Prothex had breached the licensing agreement, such as through its communications with the FDA and its patent application, and therefore sought a declaratory judgment that Prothex had no rights to RRx-001.35
PROCEDURAL HISTORY
Between the two California lawsuits, on August 24, 2021, EpicentRx filed a third: a complaint in the Delaware Court of Chancery seeking resolution within 60 days of its books-and-records demands.36 One week later, through a letter, EpicentRx reiterated its desire for the court to consider its motion at the earliest opportunity.37 Over the next two months, however, when the Court and defendant’s counsel sought to finalize a trial date for January 2022, EpicentRx failed to respond; Prothex thus filed a motion to dismiss for failure to prosecute.38 Denying the motion, the Court scheduled trial for May 24, 2022.39
Meanwhile, a week prior to its motion to dismiss, Prothex filed a certificate of dissolution. But the certificate did not comply with the formalities of Delaware law, and falsely stated that dissolution had been approved by both Prothex’s board and its stockholders.40 Nor did Prothex disclose the filing to EpicentRx or the Court; in fact, Prothex’s own Delaware counsel were unaware of the dissolution until EpicentRx discovered the filing in March 2022.41 With seeming perplexity, the Court noted in its ultimate ruling that “to this day, no one is challenging the filing of the certificate of dissolution as a void act, even though both parties . . . concede it was not authorized in accordance with the DGCL.”42 In any event, at a pre-trial conference held on May 20, 2022, the Court declared that EpicentRx’s initial demand was “facially overbroad” given the company’s ability to influence Prothex’s board proceedings, and in light of discovery that had already taken place.43 Shortly before trial, therefore, EpicentRx filed a revised demand with the Court.44
The trial took place on May 24, 2022, and featured testimony from EpicentRx’s controller and Prothex’s founder and CEO. Of note, EpicentRx’s controller testified that the company believed investigating a company’s mismanagement was the province of its stockholders, not board members.45 Moreover, Prothex’s CEO linked EpicentRx’s books-and-records demand to the acquisition, testifying that EpicentRx already possessed “many, many, many of the books and records that they were demanding.”46 Trial was followed by post-trial briefing and argument. Although the Court asked the parties to attempt to resolve their disputes over the outstanding books-and-records demand, the parties notified the Court in December 2022 that they remained unable to reach a resolution.47 The records that Prothex refused to provide, the Court noted, primarily pertained to (a) communications within the company or with InterWest, and (b) EpicentRx’s acquisition attempts or Prothex’s discussions with the FDA and United States Patent and Trademark Office.48
With post-trial proceedings complete and as the case remained under advisement, EpicentRx filed yet another lawsuit—its fourth—against Prothex.49 Filed in Delaware Chancery Court on January 27, 2023, the latest lawsuit asserted claims for breach of fiduciary duty, conversion, defamation, and trade libel, and requested a judicial wind-up of Prothex and the appointment of a receiver.50
THE COURT’S RULING AND JUSTIFICATION
The Court issued a ruling from the bench on March 24, 2023. The Court started with the underlying purpose of Section 220. Whereas EpicentRx insisted its only purpose was to investigate mismanagement, Prothex maintained that EpicentRx was really acting to intimidate and pressure Prothex into relinquishing its rights to RRx-001.51 Under the latter view, EpicentRx put its interests as a license holder above its obligations as a shareholder; this tension advanced interests adverse to Prothex, and so EpicentRx’s motivations for the inspection could not be proper under the applicable standards.52 The Court found Prothex’s framing convincing, viewing EpicentRx’s demand as part of a broader, concerted attempt to force Prothex to accept unfavorable terms.53
The Court also scrutinized the context surrounding EpicentRx’s relative power and its decision-making. Specifically, the Court pointed out that EpicentRx could not be considered a “typical contractual party.”54 As an equity holder and participant on Prothex’s board, EpicentRx would have had influence on and visibility into the corporation’s management.55 Despite board members’ obligations to stay “informed and attentive to the affairs of the corporation,” however, the Court noted that EpicentRx’s representative neither requested documents in his capacity as a director nor investigated management issues while serving on the board.56 Nor did EpicentRx respond to either the Court’s or Prothex’s attempts to schedule a timely trial date, despite having initiated the action and moved for a timely process.57 To the Court, this was another example of EpicentRx’s inaction and reflected a lack of urgency, undermining the company’s claims that its real purpose was to address mismanagement.58
Timing, too, was critical to the Court’s ruling. The Court expressly traced the chronology of litigation, starting with the breakdown of the parties’ relationship. At this juncture, the Court noted, EpicentRx became “more focused on regaining control over the RRx-001 molecule,” given its distrust of Prothex; the Court saw this reflected in EpicentRx’s March 4, 2021, proposal to acquire all of Prothex’s assets related to RRx-001.59 Likewise, the Court saw the fact that EpicentRx did not reply to Prothex’s counteroffer, but instead levied both its books-and-records demand and its warning that Prothex was in breach of the licensing agreement, as “no coincidence.”60 To the Court, this demonstrated that EpicentRx sought to escalate the situation in hopes of pressuring Prothex into capitulation.61
Also relevant to the Court’s analysis was the extent of EpicentRx’s litigation: three lawsuits in August 2021 alone, including the books-and-records demand and its California state-court bookends. In the Court’s eyes, this weakened EpicentRx’s pretense of probing mismanagement. EpicentRx’s claims in California state court related “directly to its interests as a license holder or potential acquirer,” the Court found, not to its interests as a major shareholder: “EpicentRx initially demanded to inspect books and records here to pressure Prothex to accept its acquisition offer at low price and has launched this action as part of a multi-pronged litigation strategy to cancel the license agreement or otherwise extract the rights that Prothex currently has to RRx-001 for itself.”62 And though EpicentRx tried to distinguish its demand from the California litigations, the Court contemplated that, should the out-of-state filings be taken at their word, the records demand would in fact be redundant, for “the fact that EpicentRx is pursuing derivate claims against a Prothex officer for breach of fiduciary duty and a series of unnamed Does on these topics shows that EpicentRx has satisfied itself that it had sufficient information to assert those claims without obtaining books and records.”63 Similarly, the Court observed that EpicentRx could obtain relevant documents through discovery in the California litigation.64 These details thus reinforced the Court’s conclusion that EpicentRx’s “stated purposes are not its primary purpose and that its primary purpose is not a proper purpose.”65 Still, the Court did note that EpicentRx had other secondary purposes that were proper—“including the investigation of mismanagement by [Prothex’s CEO].”66
Following trial, the Court also scrutinized the parties’ respective requests that attorney fees be borne by the other, each accusing the other of bad faith. The Court swiftly denied EpicentRx’s application, as its “primary purpose [was] not proper and [ ] some of its litigation conduct was egregious.”67 The Court acknowledged that Prothex had “a better case” for fee shifting and awarded those fees incurred as part of its motion to dismiss for failure to prosecute, finding that EpicentRx “acted in bad faith when it failed to advance its summary books and records case despite seeking expedition.”68 But beyond that, the Court noted, “it’s complicated.”69 The Court declined Prothex’s request for its full fees, pointing to Prothex’s apparent subterfuge in connection with its defective certificate of dissolution.70 For the Court, this issue and the company’s handling amounted to “bad faith” and an “unnecessary sideshow.”71
Appeal and Affirmance
EpicentRx appealed the decision of the Court of Chancery to the Delaware Supreme Court. Briefing was followed by oral argument on November 29, 2023.72 Two weeks later, on December 14, the Supreme Court issued a one-sentence order affirming the ruling “on the basis of and for the reasons assigned by the Court of Chancery in its Telephonic Bench Rulings on Section 220 Trial dated March 24, 2023.”73
TAKEAWAYS
Although the Delaware General Corporate Law colors access to a company’s books and records as a stockholder’s right, the decision in EpicentRx, Inc. v. Prothex Inc. serves as a reminder that the right is not unbounded. Instead, it remains a stockholder’s burden to demonstrate both that its request is buttressed by a proper purpose, and that such purpose is the primary purpose; an improper primary purpose can be fatal to a request, even if attended by a proper secondary purpose.
The EpicentRx decision also demonstrates the factual nature of such an inquiry, and the importance of the surrounding context. The Court of Chancery looked to everything from the scope of the 18 original requests, to the timeline of the dispute, to the diligence with which EpicentRx pursued its demand, to the fact of EpicentRx having a seat on Prothex’s board, to the ability of EpicentRx to obtain the requested materials through other means. To EpicentRx, this was all “circumstantial.” But to the Court, the circumstances were enough.
1 Bizzari v. Suburban Waste Servs., Inc., 2016 WL 4540292, at *5 (Del. Ch. Aug. 30, 2016).
2 Helmsman Mgmt. Servs., Inc. v. A & S Consultants, Inc., 525 A.2d 160, 164 (Del. Ch. 1987).
3 Bizzari, 2016 WL 4540292, at *5 (quotation mark omitted).
4 Rivest v. Hauppauge Digit., Inc., 2022 WL 203202, at *6 (Del. Ch. Jan. 24, 2022).
5 Pershing Square, L.P. v. Ceridian Corp., 923 A.2d 810, 817 (Del. Ch. 2007) (emphasis added).
6 Id.
7 Melzer v. CNET Networks, Inc., 934 A.2d 912, 917 (Del. Ch. 2007).
8 Helmsman Mgmt. Servs., 525 A.2d at 167.
9 Id. at 166–67. (citing CM & M Grp. v. Carroll, 453 A.2d 788 (Del. 1982)).
10 March 24, 2023 Telephonic Bench Rulings on Section 220 Trial (“Bench Rulings”) at 4:11–14; May 24, 2022, Section 220 Trial (“Trial Tr.”) at 107:5–7.
11 Bench Rulings at 4:2–6.
12 Id. at 4:16–21.
13 Id. at 4:22–5:6.
14 Id. at 5:7–15.
15 Id. at 5:9–19.
16 Id. at 6:5–15.
17 Id. at 6:16–7:5.
18 Id. at 7:6–12.
19 Id. at 7:13–16.
20 Id. at 7:21–8:1.
21 Id. at 28:23–29:9.
22 Id. at 8:2–4.
23 Id. at 8:10–13.
24 Id. at 8:23–9:3.
25 Id. at 8:19–22. InterWest’s representative, its managing director Arnold Oronsky, had died in November 2020. Id. at 5:12–13.
26 Bench Rulings at 9:7–10.
27 In full: “EpicentRx is investigating whether Prothex and [its founder] have demonstrated an ability to benefit shareholder interests by moving RRx-001 forward and completing clinical trials. EpicentRx intends to look into whether Prothex has run (or is close to running) out of funding and has demonstrated an ability to generate further fundraising interest in its extremely valuable asset. To date, Prothex has not paid significant debts it owes under the License Agreement and has failed to honor various obligations, including regular reporting. These breaches may result in the termination of the License Agreement and Prothex surrendering all rights to RRx-001, to the great detriment of its shareholders.” Id. at 9:11–10:1.
28 Id. at 10:2–10.
29 Id. at 10:18–11:10.
30 Id. at 10:16–17.
31 Id. at 11:11–21.
32 Id. at 11:21–12:6.
33 Id. at 12:7–8.
34 Id. at 12:8–22. See EpicentRx, Inc. v. Bianco, No. 37-2021-00039267 (Cal. Super. Ct.). The action was removed to federal court on November 15, 2021. See EpicentRx, Inc. v. Bianco, No. 3:21-cv-01950 (S.D. Cal.). The court granted summary judgment to the defendants on January 4, 2024. EpicentRx, Inc. v. Bianco, 2024 WL 56995, at *18 (S.D. Cal. Jan. 4, 2024). EpicentRx has appealed to the Ninth Circuit; briefing has not yet begun as of April 3, 2024. See EpicentRx, Inc. v. Bianco, No. 24-627 (9th Cir.).
35 Bench Rulings at 13:3–8. See EpicentRx, Inc. v. Prothex Inc., No. 37-2021-00038754 (Cal. Super. Ct.). Prothex filed a motion to compel arbitration based on an arbitration clause. Dkts. 59–63. The court substantially granted the motion on June 7, although it noted that it retained jurisdiction over the cause of action for declaratory judgment. Dkt. 101. Following a AAA arbitration, on January 17, 2024, the panel found that Prothex had breached the license agreement, and ordered it to pay $1.2 million to EpicentRx; on February 9, EpicentRx’s filed a motion before the Superior Court to confirm the award. Dkts. 159–62.
36 Bench Rulings at 13:16–20.
37 Id. at 13:21–23.
38 Id. at 13:24–14:15.
39 Id. at 14:15–18.
40 Id. at 15:3–9.
41 Id. at 14:19–15:9, 45:17–46:7.
42 Id. at 15:9–13; see also September 15, 2023, Telephonic Bench Rulings on Plaintiff’s Motion for Partial Summary Judgment and Defendants’ Motion to Dismiss (“Receiver Bench Rulings”) at 11:9–18 (“The Court has raised the issue multiple times. No effort has been made to correct the certificate. [Prothex’s CEO] does not deny that she filed the certificate of dissolution without having obtained the statutory authority under the DGCL. . . . Filing false statements with the Delaware Secretary of State constitutes perjury.”).
43 Bench Rulings at 15:22–16:3.
44 Id. at 16:6–8.
45 Trial Tr. at 15:6–12.
46 Id. at 119:11–12.
47 Bench Rulings at 17:22–18:10.
48 Id. at 19:1–6.
49 EpicentRx, Inc. v. Tempel, No. 2023-0090 (Del. Ch.).
50 See Receiver Bench Rulings at 6:21–7:12. The case was largely resolved at summary judgment, with the Court issuing its ruling from the bench on September 15, 2023. The Court granted the request for a receiver, stating that “At a base level, I am not willing to allow a CEO to wind up a Delaware corporation when that same CEO has admitted that she filed a certificate of dissolution that was not properly authorized by the DGCL, and who has failed to correct her improper conduct for 22 months, even after it was brought to her attention and the attention of the company.” Id. at 12:4–11. The Court dismissed the claim for trade libel, and either stayed or deferred the remaining claims given the appointment of the receiver and the related California litigation. Id. at 16:6–20:12.
51 Bench Rulings at 22:9–11, 23:9–17.
52 Id. at 23:15–17.
53 Id. at 26:15–22.
54 Id. at 27:18.
55 Id. at 27:16–20.
56 Id. at 29:23–24, 30:23–31:1.
57 Id. at 34:2–7.
58 Id. at 33:23–34:2.
59 Id. at 32:6–15.
60 Id. at 32:21.
61 Id. at 32:21–33:1. Even when asked about the chronology during oral argument during the subsequent appeal, EpicentRx admitted that “[t]he chronology is what it is. I can’t justify it, I can’t explain it.” Nov. 29, 2023, Oral Argument (“Del. Sup. Ct. Oral Argument”) at 16:58–17:24, available at https://vimeo.com/889539118. Instead, EpicentRx cast the timeline of events as a “a circumstantial piece of evidence.” Id.
62 Bench Rulings at 26:16–22, 32:1–3.
63 Id. at 33:10–16.
64 Id. at 33:16–18.
65 Id. at 33:20–22.
66 Id. at 45:10–12.
67 Id. at 43:1–9.
68 Id. at 37:2–7, 43:10–11.
69 Id. at 43:10–11.
70 Id. at 45:16–46:18.
71 Id. at 46:15.
72 See Del. Sup. Ct. Oral Argument. A substantial portion of the argument focused on the appropriate standard of review: de novo or clearly erroneous.
73 EpicentRx, Inc. v. Prothex, Inc., 2023 WL 8642075, at *1 (Del. Dec. 14, 2023).
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