For Shareholder Inspection Demands, A Purpose Isn’t “Proper” When the Issue Has Already Been Decided

As we have previously discussed in prior posts, shareholder demands to inspect confidential corporate information are being made with increased frequency, and are forcing more and more companies to grapple with their legal obligations to respond.  Earlier this month in Fuchs Family Trust v. Parker Drilling, the Delaware Court of Chancery issued further guidance, and explained why in certain cases, companies need not provide any information at all.

Generally speaking, Delaware General Corporations Law Section 220 provides shareholders with a limited right to inspect confidential corporate records if they can establish a “proper purpose” for the inspection and explain why each category of documents sought is “necessary and essential” to fulfill the stated purpose.  As courts have long recognized, seeking to initiate litigation against company insiders constitutes a proper purpose under the law.  In Fuchs, however, the Chancery Court recognized a limit to that usual rule.

The Fuchs plaintiff was a shareholder in Parker Drilling Company (“Parker”), and sought to inspect records regarding the Company’s FCPA violations for the purposes of (1) investigating wrongdoing, and (2) making a litigation demand on the Board or filing derivative litigation.  Parker had disclosed the FCPA violations nearly six years before plaintiff’s request, and by the time of the request had already reached settlements with both the DOJ and SEC in that regard.  Parker had also convened a Special Litigation Committee to investigate the violations, which concluded that it would not be in the Company’s business interests to pursue claims against the offending employees, and had successfully moved to dismiss a shareholder derivative suit on grounds that demand on Parker’s Board would not have been futile.

In short, at the time the Fuchs plaintiff made its inspection demand, the question of whether there had been “corporate wrongdoing” had been answered, and the “potential litigation” concluded.  Thus, the Court of Chancery held, plaintiff’s purpose for the demand was no longer “proper”—indeed, even if the inspection showed that Parker employees had violated the FCPA, litigation on those violations had already been dismissed, and therefore “collateral estoppel would bar Fuchs from pursuing further derivative litigation.”

For companies facing shareholder inspection requests, the important take-away from this case is that each shareholder inspection demand requires careful evaluation under governing law.  Particularly when faced with a thicket of competing litigation, litigation demands and other shareholder action, as Parker was, a thoughtful, informed response can help avoid further unwarranted litigation and expense.