Delaware Court of Chancery Confirms Directors’ Right to Access Company’s Privileged Information

Kramer Levin Naftalis & Frankel LLP

Can management of a Delaware corporation block members of the board of directors from gaining access to the company’s privileged information? The Delaware Court of Chancery recently addressed this question in the ongoing corporate battle involving WeWork and SoftBank in In re WeWork Litigation, C.A. No. 0258-AGB (Del. Ch. Aug. 21, 2020). In a case of first impression, Chancellor Bouchard held that directors of a Delaware corporation are presumptively entitled to the company’s privileged information as joint clients of the corporation, and management cannot ordinarily curtail that right. The decision provides important guidance for corporations and their counsel concerning the information rights of directors.

Background

The case arises from a series of proposed transactions in October 2019 between The We Company (WeWork) and SoftBank. The transactions included among other things corporate governance changes that would allow SoftBank to install management and appoint half of WeWork’s board of directors, in exchange for a $3 billion tender offer in which SoftBank would provide much-needed liquidity to WeWork. The tender offer was to be completed by SoftBank subject to certain closing conditions, which would expire on April 1, 2020. If fully consummated, the proposed transactions would result in SoftBank acquiring majority ownership and voting control of WeWork from its co-founder and former CEO, Adam Neumann. At the time of the proposal, WeWork's board established a “Special Committee” — consisting of two members “free of any material conflict of interest” — to evaluate the transactions. The Special Committee retained its own independent counsel and was also regularly advised by WeWork’s outside counsel. On April 1, SoftBank terminated the tender offer. Days later, on April 7, the Special Committee brought an action on behalf of WeWork against SoftBank for breach of contract and breach of fiduciary duty.

In response, SoftBank sent a letter to the WeWork board asserting that the Special Committee did not have authority to sue on behalf of WeWork because each of its members faces “material, disabling” conflicts because they stood to benefit personally from the tender offer through the sale of their WeWork shares to SoftBank. The Special Committee responded with its own letter to the WeWork board, maintaining that it did not have a disabling conflict preventing it from continuing the litigation and claiming that every other member of the board had a conflict of interest. The Special Committee contended that it was properly authorized to continue the litigation, citing the 2019 board resolutions that formed the Special Committee.

By this time, the WeWork board consisted of eight directors: four SoftBank designees (including WeWork’s CEO), two other directors and the two members of the Special Committee. On April 29, the board met and voted 6-2 (with the Special Committee members voting against) to engage an executive search firm to identify two new temporary members of the board (New Committee), whose purpose would be to investigate “the proper scope of the Special Committee’s authority and the pending litigation.” Two candidates were subsequently identified and appointed to the New Committee for a two-month term.

Once appointed, the New Committee engaged its own counsel and investigated the issues raised by SoftBank and the Special Committee. The day before it disbanded, the New Committee delivered its report to the WeWork board and “unanimously” found that the Special Committee did not have authority to initiate the lawsuit on behalf of WeWork and directed the company to discontinue the action. As instructed, on July 30, WeWork filed a motion seeking leave to voluntarily dismiss the action without prejudice under Court of Chancery Rule 41.

The Discovery Dispute

In opposing WeWork’s Rule 41 motion, the Special Committee sought discovery of the communications between the company’s management and its in-house counsel and outside counsel regarding the circumstances under which the New Committee was formed. That decision, according to the Special Committee, was made “secretly” by WeWork’s outside counsel and management through an “inherently tainted process” because the board and CEO were beholden to SoftBank. The Special Committee also sought deposition testimony from the two members of the New Committee and the company’s CEO, its chief legal officer and its outside counsel.

WeWork’s management rejected the Special Committee’s discovery requests, claiming that management’s communications with the company’s in-house and outside counsel were protected by the attorney-client privilege and work product doctrine. Management withheld the privileged information based on the argument that the Special Committee was and is adverse to the company. Thus, according to management, the Special Committee “could not have reasonably expected it would have access to advice from Company counsel, nor did it seek that advice.” They further claimed that sharing privileged communications with the Special Committee would create “a disincentive for Company management to communicate with its counsel.”

In response, the Special Committee argued that it was entitled to the privileged communications because under Delaware law the board has ultimate authority to manage the company, and a corporation cannot deny a director access to legal advice furnished during the director’s tenure. The Special Committee also argued that it was not “adverse” to the company and should instead be treated as a “joint client” when legal advice is rendered to the company.

The Court’s Decision

The Court of Chancery found that the Special Committee was entitled to the company’s privileged communications and the depositions sought. The starting point for Chancellor Bouchard’s analysis was the “fundamental principle” of Delaware law that directors of a corporation are generally entitled to share in legal advice the corporation receives. Because the board of directors — not management — is responsible for overseeing the affairs of a Delaware corporation, board members should be treated as a “joint client” when legal advice is rendered to the corporation through one of its directors or officers. In claiming the right to shield privileged company information from the entire board, in the Chancellor’s view, management “turns these bedrock principles of Delaware law on their head.”

Chancellor Bouchard relied heavily on the 2013 Delaware Court of Chancery opinion in Kalisman v. Friedman, 2013 WL 1668205 (Del. Ch. Apr. 17, 2013), in which the court found that a dissident director was entitled to privileged company information. The Chancellor noted important limitations on a director’s right of access:

  • Special Committee: A board can create a special committee that excludes certain directors, so long as that is done “openly and with the knowledge of” the excluded directors. A special committee is free to retain separate counsel, and its communications with counsel will, to the extent necessary for the committee’s work, remain privileged relative to the excluded directors. Accordingly, the WeWork Special Committee did not seek communications between the New Committee and its separate counsel.
  • Adversity: The board or committee may withhold privileged information where adversity exists between the director and the corporation “such that the director could no longer have a reasonable expectation that he was a client of the board’s counsel.” In withholding the privileged information, WeWork’s management asserted that the Special Committee was “adverse” to the company.

The court found that the “adversity” limitation identified in Kalisman was inapplicable because the WeWork board did not make the decision to withhold the privileged communications from the Special Committee. Rather, management made that decision. Moreover, management’s assertion that the Special Committee was adverse to the company was “far from clear.” The dispute was between the Special Committee and SoftBank, not between the Special Committee and the company. As to management’s fear that disclosing the privileged communications would chill free and open communication between management and its counsel, under Delaware law “these concerns must give way to the ultimate authority of the board of directors.”

Key Takeaways

The WeWork decision raises important considerations for corporate boards, management and corporate counsel. The discovery dispute highlights the significance of the joint client relationship between board members and company counsel and the need to navigate carefully these thorny and often hotly contested privilege issues.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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