Section 220 Books and Records Demand Denied by Court of Chancery

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In the recent decision of Hoeller v. Tempur Sealy Int’l Inc., C.A. No. 2018-0336-JRS (Del. Ch. Feb. 12, 2019), the Court of Chancery adjudicated a books and records dispute brought pursuant to Section 220 of the Delaware General Corporation Law (“DGCL”).  In a very careful and thoughtful memorandum opinion, Vice Chancellor Slights denied plaintiff’s books and records demand, finding that a proper purpose had not been stated.

Plaintiff’s demand letter alleged that misconduct or wrongdoing occurred in light of defendant’s loss of a major client, Mattress Firm, a long-term customer relationship accounting for a substantial percentage of defendant’s sales.  On the day that the company disclosed to investors that it had issued formal termination notices for all brands supplied to Mattress Firm, the company’s stock fell significantly.

Prior to the filing of the books and records suit, the company produced a subset of documents to plaintiff under a confidentiality agreement, which according to the company demonstrated that no wrongdoing existed in connection with the termination of the contract with Mattress Firm.  Plaintiff, unsatisfied with the production, moved forward with the books and records suit before the Court of Chancery.

Plaintiff alleged three theories of wrongdoing on the part of defendant’s management: (i) “allowing or causing the Company to breach its contracts with [Mattress Firm]”; (ii) “allowing or causing the Company to ruin its relationship with its most important customer”; and (iii) “allowing or causing the Company to make false and misleading statements to the investing public related to the fact that the Company’s relationship with its key client, Mattress Firm, had soured, and was at significant risk of termination.”

Vice Chancellor Slights declined to find that a credible basis to infer wrongdoing was established that would otherwise entitle plaintiff to inspect company books and records. This in spite of the fact that “[a]s the lowest standard of proof known in our law, credible basis requires that the plaintiff demonstrate only some evidence of wrongdoing, not that wrongdoing actually occurred.” Slip op. at 20 (internal quotations omitted).

The Court noted that Plaintiff’s theory of mismanagement was that “a customer of Mattress Firm’s significance ‘doesn’t, at the drop of a hat, just leave. Something smells. There is smoke. I suspect there’s fire.'”  However, the Court found that plaintiff had not met his burden, finding it and other allegations “too thin a reed upon which to rest a ‘credible basis’ finding of wrongdoing.”  Slip op. at 3.

Key Takeaway: Although the credible basis to infer wrongdoing standard presents a very low burden in Section 220 disputes, this case nonetheless demonstrates that a plaintiff cannot meet this standard merely through conjecture or speculation.  Rather, at minimum some evidence of wrongdoing must be presented in order to support such a standard.

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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. Attorney Advertising.

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