CHANCERY COURT APPLIES INTERNAL AFFAIRS DOCTRINE TO DECLARATORY ACTION FOR INSPECTION RIGHTS SOUGHT UNDER CALIFORNIA LAW

By: Annette E. Becker and Claire Suni

In Juul Labs, Inc. v. Daniel Grove, C.A. No. 2020-0005-JTL (Del. Ch. August 13, 2020), defendant and e-cigarette maker Juul Labs, Inc. (“Juul”) is a privately held Delaware corporation with its principal place of business in California. The Delaware Court of Chancery (the “Court”) granted in part Juul’s motion for declaratory judgment, which sought confirmation that a stockholder seeking inspection rights was limited to rights and remedies under the Delaware General Corporation Law (“DGCL”), and could not apply California law, among other things. The Court held that inspection rights are a matter of internal affairs under the internal affairs doctrine articulated by the Supreme Court, and thus Delaware law applies.

Defendant Daniel Grove (“Grove”) was a stockholder and former employee of Juul. Grove had previously executed a grant agreement and exercise agreement in connection with his Juul stock options, as well as an investor agreement. The agreements provided certain waivers of inspection rights and Delaware forum selection clauses. When Grove later demanded to inspect Juul’s books and records, he did so under a California statute that provides inspection rights for any stockholder of a corporation with its principal executive offices in California, regardless of state of incorporation of such corporation. Grove further indicated that he might sue Juul in California state court to enforce these rights. In response, Juul filed a motion for declaratory judgment in Delaware seeking a declaration that (i) Delaware law (not California law) governs Grove’s request for inspection rights, (ii) Grove had waived his inspection rights under the stock option agreements, (iii) Juul was not obligated to honor Grove’s inspection request as he can only make an inspection request under Section 220 of the DGCL, and (iv) Grove was enjoined from pursuing inspection rights under California law. The parties filed cross motions for judgment on the pleadings.

In reviewing Juul’s motion, the Court stated that “no issue of material fact” may exist in order to enter a judgment on the pleadings. First, the Court found that the grant agreement and exercise agreement did not constitute contractual waivers of Grove’s statutory inspection rights in California. Under Delaware law, there can be no waiver of statutory rights unless the waiver is clearly and affirmatively expressed. The waiver provisions in the grant agreement and exercise agreement were substantively identical, and only addressed inspection rights under Section 220 of the DGCL. They did not reach other information rights, such as those under California law, and thus did not constitute valid waivers of Grove’s rights under California law.

The Court further found that Grove was not bound by the inspection rights waiver provision in the investor agreement. The language in the applicable waiver section applied only to “Holders” as defined in the investor agreement. Grove did not fall within the definition of a Holder, in part because his name was omitted from an exhibit that listed all Holders. As such, the Court determined the waiver provisions in the investor agreement were inapplicable to Grove.

The Court then found that Grove could not pursue inspection rights under California law because the constitutional principles outlined in the internal affairs doctrine, as applied by the Supreme Court of the United States and the Delaware Supreme Court, require that only Delaware law would apply. The internal affairs doctrine articulates the concept that the state of incorporation has authority to regulate a corporation’s internal affairs. Internal affairs are defined as “matters peculiar to the relationship among or between the corporation and its current officers, directors and shareholders.” Further, Delaware Supreme Court precedent has ruled inspection rights to be a core matter of internal corporate affairs. After a lengthy discussion of the California inspection regime and associated constitutional principles, the Court found that Grove could not seek a books and records inspection under California law on this basis.

The Court further found that, under Juul’s certificate of incorporation, any action to enforce Grove’s inspection rights must be brought in the (Delaware) Court. The Court’s decision did not address whether a stockholder can waive inspection rights under Delaware law, because Grove had not yet demanded access to Juul’s books and records under Delaware law.

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