The Chancery Court held that a stockholder must show that there is a proper purpose with a credible basis in order to succeed in a Section 220 action to inspect the books and records of a corporation.
In Southeastern Pennsylvania Transportation Authority v. AbbVie Inc. and James Rizzolo v. AbbVie Inc., the plaintiffs, Southeastern Pennsylvania Transportation Authority (“SEPTA”) and James Rizzolo (“Rizzolo”), as shareholders of defendant AbbVie Inc. (“AbbVie”), made individual written demands on AbbVie for inspection of certain books and records pursuant to Section 220 of the Delaware General Corporation Law (“DGCL”). The plaintiffs sought to obtain records to demonstrate that AbbVie’s directors breached their fiduciary duties. AbbVie rejected the demands for failure to state a proper purpose and each plaintiff then filed a Section 220 Complaint. As the actions stemmed from the same event, the Court utilized a single Memorandum Opinion to deliver its decisions.
Under Section 220 of the DGCL, the plaintiffs are required to demonstrate a credible basis that actionable corporate wrongdoing on the part of the directors occurred. The alleged corporate wrongdoing related to its proposed takeover of Shire plc, a public limited company registered in the island of Jersey, a Crown Dependency of the United Kingdom (“Shire”). As part of AbbVie’s efforts to reach an agreement with Shire, AbbVie agreed to pay a substantial break fee to Shire under certain conditions.
AbbVie’s reasons for the transaction with Shire included, among other things, the favorable tax treatment of income resulting from AbbVie’s plan to change its country of residence to Jersey following consummation of the transaction (i.e., a corporate inversion). AbbVie’s board of directors were informed of and considered the risk that U.S. tax law regarding corporate inversions, or its then-current interpretation, could change prior to AbbVie’s realization of the sufficient tax benefits generated by the corporate inversion. Prior to the merger being consummated, the U.S. Treasury Department issued regulatory guidance eliminating the potential advantages of the corporate inversion. Accordingly, AbbVie withdrew from the transaction and triggered payment to Shire of a $1.635 billion break fee.
Section 220 of the DGCL entitles a stockholder to inspect the books and records of a corporation only if the stockholder initially shows, by a preponderance of the evidence, that there is a proper purpose, defined as “a purpose reasonably related to such person’s interest as a stockholder.” Here, both SEPTA and Rizzolo filed a Section 220 action to investigate AbbVie’s directors and officers for potential breaches of fiduciary duties, mismanagement, wrongdoing, and waste. SEPTA also set forth a purpose of investigating demand futility, and Rizzolo set forth a purpose of investigating aiding and abetting by J.P. Morgan, a third party advisor to AbbVie in connection with the transaction.
With regard to both plaintiffs’ claims of investigating potential corporate wrongdoing by AbbVie’s directors, the Court explained that merely stating a proper purpose in a conclusory manner is insufficient. Instead, a plaintiff must further “state a reason for the purpose, i.e., what it will do with the information or an end to which the investigation will lead.” The Court detailed a number of acceptable reasons, but noted that neither SEPTA nor Rizzolo expressly stated a reason in its demand letter. The Court, however, inferred from the plaintiffs’ oral arguments that the reason they were seeking information was to support a potential derivative action, a valid reason to justify a proper purpose of investigating corporate wrongdoing. The Court then noted that AbbVie’s Certificate of Incorporation included an exculpatory provision which “exculpate[d] AbbVie directors from liability for breach of the duty of care pursuant to Section 102(b)(7) of the DGCL,” but not from breach of the duty of loyalty. The Court stated that “if a stockholder seeks inspection solely to evaluate whether to bring derivative litigation, the corporate wrongdoing which he seeks to investigate must necessarily be justiciable.” Thus, the Court determined that the plaintiffs stated a proper purpose only in regard to the non-exculpated potential breach of the directors’ duty of loyalty.
The Court noted that, beyond stating a proper purpose of investigating AbbVie’s directors for non-exculpated corporate wrongdoing in the form of a breach of their duty of loyalty, the plaintiffs must further demonstrate ‘a credible basis’ for the Court to infer that wrongdoing, waste, or mismanagement occurred. The plaintiffs argued that wrongdoing occurred as the directors knew that there was a risk that the U.S. interpretation of the tax laws could change and yet they failed to negotiate a contingency to avoid triggering the break fee upon the occurrence of such an event. The plaintiffs further alleged that (i) the break fee itself was enormous and (ii) the directors claimed there were other reasons to pursue the merger, yet they changed their recommendation and triggered the break fee anyway. The Court noted that a 3% termination fee does not indicate bad faith. Further, the Court determined that the directors clearly reviewed and weighed the risks of a change in the interpretation of the tax laws and factored it into their ultimate decision to pursue the transaction with Shire. Though the directors took a risk and failed, the Court concluded that there was no credible basis to infer a lack of good faith. The Court also stated that the directors did not commit corporate waste by agreeing to, and ultimately paying, the break fee. The break fee was a necessary provision to induce Shire into agreeing to the transaction which, if successful, would have created significant value for the stockholders. Thus, the Court determined that there was no credible basis to infer waste. The Court also considered whether a credible basis existed to infer mismanagement. The Court stated that a failed transaction in itself is not a credible basis for mismanagement when a material change in circumstances leads to the failed transaction. Here, the loss of the tax benefits resulting from the change in interpretation of U.S. tax laws was such a material change.
As the Court found no credible basis to investigate corporate wrongdoing, SEPTA’s additional purpose to investigate demand futility was found moot as it would only have been a proper purpose if SEPTA established a credible basis to investigate corporate wrongdoing. Lastly, the Court also determined that Rizzolo’s additional purpose to investigate aiding and abetting by J.P. Morgan was an improper purpose as the Court had already found no credible basis to infer non-exculpated wrongdoing by AbbVie’s directors. The Court noted that even if it had found such credible basis, an aiding-and-abetting claim would need to be pursued by AbbVie itself, not as a derivative action. Thus, all demands for inspection of the books and records pursuant to Section 220 of the DGCL were denied.