Stockholders Can Hire Lawyers to Monitor Investments for Potential Litigation: Delaware Court of Chancery Gives Corporate Books to Law Firm Retained by Institutional Investor

By Jay McMillan

As I reported in November 2017, the Delaware Court of Chancery, in Wilkinson v. A. Schulman, Inc., C.A. No. 2017-0138-JTL, 2017 Del. Ch. LEXIS 798 (Del. Ch. Nov. 13, 2017), ruled that stockholder plaintiffs in books-and-records actions under Section 220 of the Delaware General Corporation Law are required to have “substantive involvement” in the litigation. In Wilkinson, Vice Chancellor J. Travis Laster rejected a demand for corporate books and records based on his finding that the purpose for inspection stated in the plaintiff’s demand was not his true purpose. Jack Wilkinson, an individual investor, responded to a law firm’s press release announcing an investigation of potential wrongdoing at A. Schulman, Inc. Wilkinson’s purpose, as revealed in discovery, was to investigate a corporate loss following a merger. His lawyers served a books-and-records demand on A. Schulman in his name, stating that his purpose was to investigate excessive compensation paid to the corporation’s chief executive officer upon his retirement. Wilkinson and his attorneys subsequently filed a books-and-records action in the Delaware Court of Chancery. The Court dismissed the action, finding that “Wilkinson simply lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel” and that he “did not take any steps to confirm the accuracy of the allegations in the complaint.”

Last month, in Inter-Local Pension Fund GCC/IBT v. Calgon Carbon Corp., C.A. No. 2017-0910-MTZ, 2018 Del. Ch. LEXIS 587 (Del. Ch. Jan. 25, 2018), Vice Chancellor Morgan T. Zurn distinguished Wilkinson, finding that the Calgon plaintiff, an institutional investor referred to as the Fund, could rely on its outside counsel (prominent class-action plaintiffs’ firm Robbins Geller Rudman & Dowd LLP) to “monitor” the Fund’s investments, identify potential legal issues, draft books-and-records demands, and prosecute subsequent litigation. Although the Fund’s representative testified that Robbins Geller determined the requests in the books-and-records demand, and that the Fund did not independently confirm the allegations, the Court ruled in the Fund’s favor, finding that it was not necessary for the plaintiff to “originally conceive of” the purposes for the demand.

The Court in Calgon held that:

“Stockholders are entitled to hire counsel to review and monitor their portfolios for potential mismanagement or wrongdoing. They are also entitled to rely on that counsel to raise concerns, to advise them on how to remedy those concerns, and to pursue appropriate remedies.”

The Court accepted the Fund’s argument that the action was not “lawyer-driven” like that in Wilkinson. The Court distinguished the prior case because in Wilkinson the plaintiff admittedly had a purpose that was different from the purpose stated by his lawyers in his demand. In Calgon, the Court found that the Fund’s purpose “aligns with” the purpose stated in the demand and that Robbins Geller had not “usurped the process for a different purpose” like the lawyers did in Wilkinson. The Court concluded “[t]o hold otherwise would largely leave Section 220 open only to sophisticated stockholders with the financial or legal training necessary to independently spot relevant corporate governance and similar issues.”

While Wilkinson suggested that stockholder plaintiffs must be self-motivated and substantively involved in books-and-records actions (although not necessarily in plenary litigation), Calgon allows investors to hire attorneys to monitor their investment portfolios, identify potential litigation, draft books-and-records demands, and prosecute subsequent litigation with limited involvement by the investor. In Calgon, the Fund argued that Robbins Geller served the same function as in-house counsel would in monitoring the Fund’s investments, and that the litigation was not “lawyer-driven” because the Fund had an established relationship with Robbins Geller. In Wilkinson, the case involved a “serial plaintiff” who had been involved in several cases that were settled for little consideration other than attorneys’ fees.

Wilkinson and Calgon taken together suggest that stockholder plaintiffs’ law firms should work closely with their clients in bringing books-and-records actions, and should communicate effectively with their clients to determine the clients’ true purposes and expectations. Plaintiffs in books-and-records actions risk dismissal where discovery can reveal a disconnect, as in Wilkinson, between the client’s purposes and those of his or her attorneys.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP.  He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery.  For more information on the firm, visit hfk.law.

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