White and Williams LLP

On January 15, 2019, the Delaware Court of Chancery ruled that Papa John’s International, Inc. must allow its director John Schnatter access to materials responsive to his demand pursuant to the books and records inspection statute, 8 Del. C. § 220, subject to certain restrictions on use of the materials.[1] Schnatter is Papa John’s founder, its largest stockholder and a director on its board. Until recently, he served as the company’s Chairman of the Board, CEO and spokesman. He resigned as Chairman and CEO following much publicized reports of his commentary on the NFL’s handling of player protests and his use of a racially charged term during a company training session. His spokesman role was terminated following recommendations by a special committee comprised of his fellow board members.

Schnatter contends that his resignations were forced and his company agreements were terminated as part of a coup orchestrated by others in management to scapegoat him for the company’s poor financial performance. Schnatter filed a derivative lawsuit in Delaware accusing the board and a company officer of breaching their fiduciary duties in a variety of ways related to their handling of the public backlash following his NFL comments and racially charged statement. At the same time, he sought the right to inspect seventeen categories of documents as a company director pursuant to Section 220. He reached an agreement with the company regarding inspection of all but four categories of documents. The Chancery Court’s January 15th decision addressed his right to inspect the disputed categories of documents. Although the decision relies upon established precedent, it provides guidance on a plethora of issues commonly arising in books and records inspection disputes, such as:

  • Section 220 provides the right to inspect books and records for stockholders and directors, but these rights are not equal. Stockholders and directors must both have a proper purpose for their inspection demands. However, stockholders have the added burden of demonstrating that the records sought are necessary and essential for the stated purpose. On the other hand, once a director demonstrates a proper purpose, his or her access to company records is essentially unfettered. The company has the burden of proving the director’s purpose is improper.
  • An investigation of mismanagement will naturally involve the personal interests of a director who has had a long relationship with a company. This tangential impact on personal interest will not automatically render improper that the director’s demand to inspect records for the mismanagement investigation.
  • Pursuit of a derivative lawsuit is generally considered a concession by a stockholder that inspection of books and records is not necessary or essential to pursue his or her claims. There is not a similar concession automatically attributed to a director who pursues a derivative lawsuit as a stockholder while simultaneously seeking inspection of books and records as a director. Rather, the generally unfettered access to company books and records for a director without obligation to demonstrate that they are necessary or essential to the claim, coupled with the director’s fiduciary obligations not to misuse the materials, safeguards the director’s ability to inspect books and records even though he or she is pursuing a derivative lawsuit as a stockholder.
  • Public policy dictates that a director’s access to company books and records necessarily is broad so that the director can properly exercise his or her fiduciary duties and police whether fellow management is doing the same. And, although the director need not show the records are necessary or essential, he or she must still direct the court to those books and records related to the director’s proper purpose. Vague descriptions of categories of records will not suffice.
  • Inspection of records from personal accounts and devices of company management may be allowed where there is more than mere suspicion that company business was transacted with the personal accounts or devices. In this regard, lack of company email accounts for directors or absence of a policy expressing that information on a personal account or device is personal and unrestricted from access by the company can elevate the request for inspection above mere suspicion.
  • Production of nonpublic materials to a stockholder is conditioned upon a reasonable confidentiality agreement. Directors need not enter a confidentiality agreement to access materials under Section 220. This distinction emanates from the director’s fiduciary obligation to protect the nonpublic information. Although a director may be barred from sharing information with other parties, the information can be shared with the director’s lawyers – particularly where it is agreed that the information will not be used in a derivative lawsuit pursued in the director’s interest as a stockholder.

In conclusion, this decision served up a review of Section 220 inspection demands with all of the toppings. While the general principles discussed in the decision are a useful guide, analysis of Section 220 inspection demands are fact-intensive and contextual. It is therefore imperative that careful consideration be given when making or responding to an inspection demand after consultation with counsel familiar with these nuances.

[1]Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15,2019).

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