June 21, 2024
In our inaugural installment of Securities Litigation 101, we discussed the ins and outs of shareholder derivative actions—lawsuits in which shareholders act on behalf the company to sue its directors for fiduciary breaches that caused harm to the company. Today, we will explore a powerful tool that shareholders can use to determine whether to file a derivative lawsuit: a books and records demand.
These procedures, often referred to as Section 220 demands for the section of the Delaware General Corporation Law (DGCL) that gives shareholders the right to inspect records of Delaware corporations, are also available outside the First State. By seeking internal board materials, shareholders can determine whether a company’s board of directors acted properly from a fiduciary standpoint or, conversely, can lay the groundwork for potential derivative litigation.
Submitting a books and records demand is straightforward and follows relatively the same process under each state’s corporate laws. If the shareholder has a “proper purpose”—defined as one “reasonably related to such person’s interest as a stockholder”—counsel prepares a letter explaining the concerns and basis for the document requests. A proper purpose for making a demand may include valuing the shareholder’s interest in the corporation or investigating possible wrongdoing, such as breaches of fiduciary duty by directors or officers that could include corporate waste, self-dealing, failure to oversee the business, allowing the business to engage in illegal activity, or insider trading. Along with the letter, the shareholder provides proof of their ownership of the stock during the relevant period and a power of attorney authorizing counsel to make the demand on their behalf.
Once a shareholder clears these hurdles, they are typically able to obtain access to board documents (such as board meeting agendas, minutes, and presentations), policies and procedures, and annual directors’ and officers’ questionnaires. The scope of the board materials to be produced is defined by the evolving caselaw in the particular state where the company is incorporated.
Annual directors’ and officers’ questionnaires are particularly helpful in identifying any intertwined relationships between the executives running the company and the directors charged with its oversight. Certain interdependencies may mean board members lack independence, thus making it “futile” to demand that the board bring claims against the company in a derivative action and allowing the shareholder to sue the board on the company’s behalf to protect the company from further harm—and in turn, protect the shareholder’s interest in the company. Derivative litigation does not return money directly to shareholders but rather may seek a monetary remedy for the company itself and/or seek to force companies to address inadequacies in corporate governance oversight, workplace policies, or other shortcomings that can harm shareholder value over the long term.
If the corporation does not comply with the books and records demand, the shareholder may enforce their right to make the demand by filing an action asking the court to compel the company to comply with the demand. These cases, typically summary proceedings, are litigated at an unusually fast pace, with litigators asking for a bench trial as soon as two to three months after filing a complaint. More like an evidentiary hearing than a full-blown trial, books-and-records trials normally last one day or less, with no opening or closing statements.
Cohen Milstein has significant experience issuing books and records demands on behalf of its institutional investor clients to uncover evidence of wrongdoing or mismanagement that would otherwise go unseen. By taking this preliminary step, shareholders can better assess how best to act as responsible stewards of the companies they own before bringing litigation.