Delaware Chancery Court Disfavors “Sue First, Ask Questions Later” Approach to a Books and Records Demand

White and Williams LLP

White and Williams LLP

Section 220 of the Delaware General Corporation Law entitles a stockholder of a corporation to inspect a corporation’s books and records. Section 220 requests are subject to specific technical requirements, one of which is that the inspection must be for a proper purpose. The investigation of suspected mismanagement and wrongdoing by corporate fiduciaries is generally considered to be a proper purpose for an inspection. The inspection may not, however, be a substitute for discovery in pending litigation.

With these principles in mind, the Delaware Chancery Court in CHC Investments, LLC v. FirstSun Capital Bancorp[1] dismissed a lawsuit seeking to compel a corporation’s response to an inspection request because the stated purpose was to investigate the stockholder’s claims in litigation already pending against the corporation and its management. The court explained that the “sue first, ask questions later” approach is problematic because of the inherent conflict between the representations required of a stockholder to support an inspection request, as opposed to the representations made upon commencement of litigation against the corporation and its management. An inspection request must be supported by an averment under oath that the stockholder does not possess information necessary to commence a lawsuit against the corporation or its management. That is, the purpose for the inspection is proper because the stockholder cannot sufficiently evaluate whether a lawsuit may be pursued in good faith without the requested information. By commencing the lawsuit, the stockholder concedes possession of the information necessary to do so; thereby discrediting that the stockholder has a proper purpose for the request.

Although there is not a bright-line rule prohibiting stockholders from using Section 220 to investigate pending claims, the court held that it will enforce those inspection requests in special circumstances only. One such circumstance identified by the court is when a stockholder must pursue the lawsuit during the pendency of an inspection request to avoid the expiration of a claim limitation period. This does not mean that a stockholder can file a lawsuit and then pursue an inspection request whenever a claim is about to expire. Rather, the stockholder must demonstrate that the timing concern resulted from the corporation’s mishandling of the inspection request.

Another example provided by the court arises when a lawsuit is dismissed without prejudice, with leave for the stockholder to refile after further investigating the potential claims. In that instance, the stockholder will be permitted to pursue an inspection request to investigate the previously-filed claims so as to better plead an amended complaint. By granting leave to amend, the court alleviates the inherent conflict in the “sue first, ask questions later” approach because the stockholder can genuinely represent that the inspection is necessary to properly support the amended complaint.

In conclusion, Section 220 provides a powerful tool for stockholders to investigate corporate mismanagement and wrongdoing. This statutory investigation right does not, however, substitute for discovery in a lawsuit against the corporation or its management. Properly pursuing and responding to Section 220 inspection requests can be complex, and parties should confer with counsel familiar with the nuances of this area of the law before committing to a position.

[1] C.A. No. 2018-0610-KSJM (Del. Ch. Jan. 24, 2019).

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