Chancery Court Finds That Stockholders May Rely on Allegations Forming the Basis of Other Lawsuits to Demand Inspection of Books And Records Pursuant to Section 220 of the DGCL

By: David Forney and Sean Boyle

In Deborah Pettry, et al. v. Gilead Sciences, Inc., C.A. No. 2020-0132-KSJM (Del. Ch. Nov. 24, 2020), the Court of Chancery found that plaintiffs may rely on allegations forming the basis of other lawsuits to meet the credible basis standard for demands to inspect books and records under Section 220 of the DGCL. Further, the Court granted plaintiffs leave to move for attorneys’ fees and expenses as a result of Gilead Sciences, Inc.’s (“Gilead”) “overly aggressive defense” at the Section 220 phase, pointing to Gilead’s pre-litigation and litigation-related conduct as a potential basis for awarding fees.

These consolidated Section 220 actions arose in connection with Gilead’s development and commercialization of its HIV treatments, specifically its TDF and TAF-based drugs. Gilead first gained Food and Drug Administration (“FDA”) approval for TDF in 2001, and developed various TDF-based treatments from 2001 to 2012. Despite its commercial success, TDF poses significant health risks for a patient’s bones and kidney. Prior to FDA approval for TDF in 2001, Gilead had developed another substantially lower dosage and toxicity HIV treatment, TAF, which Gilead themselves recognized as being safer than TDF in its 2001 10-K. Despite this, Gilead stopped the development of TAF-based drugs in 2004 and did not renew development efforts until 2010. Gilead did not submit a drug application for TAF-based drugs until November 2014 and eventually got FDA approval for a TAF-based treatment in November 2015.

Gilead’s development and commercialization of its HIV treatments has received significant criticism and has been the subject of a number of legal actions, including: (i) an antitrust class-action lawsuit (the “Staley Action”) alleging that Gilead and other drug manufacturers engaged in anticompetitive conduct in connection with Gilead’s TDF-based drugs designed to delay generic versions of TDF; (ii) at least 250 tort actions accusing Gilead of deliberately withholding its safer TAF-based drugs from the market to lengthen the sales window of its TDF-based drugs; (iii) a lawsuit filed by the United States government accusing Gilead of infringing on CDC developed patents held by the U.S. government for the delivery of the TDF treatment; and (iv) investigations and civil litigation for violations of the False Claims Act.

The plaintiffs, Deborah Pettry, Gail Friedt, Richard C. Collins, Hollywood Police Officers’ Retirement System, and Anthony Ramirez each made a written demand on Gilead to inspect and copy certain books and records of the Company pursuant to Section 220, seeking to investigate possible wrongdoing in connection with Gilead’s development and commercialization of its HIV drugs. Gilead declined to provide any documentation in response to the damages, arguing that each plaintiff’s demand was unfounded and deficient.

For a successful inspection demand under Section 220, a plaintiff must establish by a preponderance of the evidence that: (i) the plaintiff is a stockholder; (ii) has complied with the statutory requirements for making a demand; and (iii) has a proper purpose for conducting the inspection. The plaintiff must then establish that each type of book and record requested is “essential and sufficient” to the plaintiff’s stated purpose.

Gilead argued that the plaintiffs lacked proper purposes and failed to justify the scope of their inspections, and further argued that the plaintiffs lacked “standing” because they could not defeat defenses to anticipated derivative claims that would follow a Section 220 action. The Court addressed Gilead’s “standing” arguments in context of the plaintiffs’ proper purposes for making their inspection demands.

In addressing the proper purpose issue, the Court stated that a purpose is “proper” under Section 220 where it is “reasonably related” to the plaintiff’s interest as a stockholder. Further, a plaintiff must present evidence to demonstrate a “credible basis” from which a court can infer the occurrence of mismanagement or wrongdoing. Gilead presented two defenses on this issue: (i) that the plaintiffs demonstrated no credible basis to suspect wrongdoing; and (ii) that the plaintiffs’ stated purposes were not their own, but they instead were acting as a Manchurian candidate for a law firm.

In addressing whether the plaintiffs established a credible basis, the Court stated that such a standard imposes “the lowest possible burden” on plaintiffs and that they need only establish by a preponderance of the evidence that there is a credible basis to suspect a “possibility” of wrongdoing. Despite Gilead’s argument that plaintiffs cannot rely on unsubstantiated allegations in other lawsuits to establish a credible basis, the Court held that, because the standard requires the allegations only be credible, not substantiated, courts may consider the allegations collectively, including on-going lawsuits, investigations, circumstantial evidence, and even hearsay statements indicative of potential wrongdoing. Accordingly, the Court found that (i) the Staley Action served as a credible basis for the plaintiffs to investigate anticompetitive activity, (ii) the allegations in the 15,000 tort claims served as a credible basis for the plaintiffs to investigate mass torts regarding Gilead’s delay in introducing safer HIV treatments, (iii) the United States Department of Justice (“DOJ”) claims of “deliberate” and “wanton” infringement of government owned patents in the litigation between Gilead and the United States government served as a credible basis for the investigation of patent infringement, and (iv) the investigation by the DOJ, in combination with civil litigation for the violation of anti-kickback provisions of the False Claims Act, served as a credible basis for the investigation of False Claims Act violations.

In addressing the question of whether the plaintiffs’ stated purposes were their own, the Court acknowledged that Gilead established that the lawyers were heavily involved in the demand process and litigation, but that they were investigating wrongdoing and Gilead failed to establish that any of the plaintiffs’ lawyers’ involvement “undermined any [p]laintiff’s purpose.”

The Court quickly did away with Gilead’s arguments that the plaintiffs lacked “standing” to investigate the alleged wrongdoings because: (i) the plaintiffs did not own shares at the time of the alleged wrongdoing; (ii) any derivative claims that could be pursued would be time-barred; and (iii) any derivative claims pursued would be blocked by exculpatory language in Gilead’s charter. The Court stated that the only requirement for standing to pursue a Section 220 action is that the plaintiff be a stockholder. The Court further stated that a defense to a future derivative claim impacts a stockholder’s ability to invoke Section 220 only where the stockholder indicates that the only purpose of the Section 220 action is to subsequently pursue a derivative claim.  The Court also stated that Gilead’s arguments speak to the Plaintiff’s standing to bring a derivative suite, not a Section 220 action.

Gilead’s final argument was that plaintiffs’ inspections should be limited to formal board materials, but this failed as well. The Court quickly did away with this argument by noting that inspection need not be limited to formal board materials when the wrongdoing appears to be wide-spread. The Court held that plaintiffs were entitled to inspect agreements between Gilead and its competitors at issue in the antitrust litigation, Gilead’s policies and procedures concerning compliance with antitrust regulations and patent law, certain emails sent to senior management members prior to their bi-monthly Leadership Team Meetings, communications between Gilead and the government, and directors’ and officers’ questionnaires for each Board member on the basis that these documents were “necessary and essential” to the plaintiffs’ purposes and were unlikely to be available from another source.

Lastly, the Court granted the plaintiffs leave to move for attorneys’ fees and expense on the basis of bad faith conduct in frustrating the plaintiffs’ efforts to pursue their 220 action. In granting this, the Court noted it can consider both litigation-related conduct and pre-litigation conduct, and indicated that Gilead’s conduct in both of these phases served as the basis for its belief that fee shifting may be appropriate in this case. The Court criticized Gilead’s overly aggressive litigation strategies of “blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of [p]laintiffs’ statutory rights” and Gilead’s pre-litigation decision to refuse to provide plaintiffs any documentation despite the “ample evidence of a credible basis” and the clear responsiveness of certain categories of requested books and records.

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