Stockholders who seek to inspect the books and records of a Delaware corporation to investigate mismanagement merely have to demonstrate a “credible suspicion” that officers or directors have breached their fiduciary duties. That low standard means that in most instances either companies themselves or courts respond to narrowly tailored requests by producing, or ordering produced, necessary and specific information to enable a stockholder to investigate alleged wrongdoing. Recently, the scope of permissible inspection has extended to emails, leading some commentators to become concerned that the courts have tilted the playing field too much in favor of stockholders. As the recent case of Hoeller v. Tempur Sealy International, C.A. No. 2018-0336-JRS, demonstrates, however, the Delaware courts will not permit a stockholder any inspection if he cannot demonstrate a credible suspicion of cognizable wrongdoing, and the mere allegation that a company unexpectedly lost a major customer does not suffice to raise a credible suspicion of fiduciary wrongdoing.

The Hoeller complaint arose from the January 2017 termination of agreements whereby Tempur Sealy International Inc. supplied mattresses to Mattress Firm. The latter was Tempur Sealy's largest customer, accounting for 20 percent of its sales. Mattress Firm terminated the relationship after a European entity acquired it in August 2016. That entity's assets included a mattress supply chain. This weakened Mattress Firm's dependence on Tempur Sealy. Nonetheless, Tempur Sealy's CEO told the market “he was optimistic about the strength of Tempur Sealy's continuing relationship with Mattress Firm.” Within three months of those statements, Mattress Sealy terminated the relationship. Litigation between the parties ensued, including a securities class action in which a pension fund contended that Tempur Sealy had failed to disclose the material risk that Mattress Firm would terminate its contracts with Tempur Sealy based on the leverage Mattress Firm acquired once it had a vertically integrated parent to supply product. Hoeller sought books and records related to alleged fiduciary wrongdoing arising out of the termination of the contracts with Mattress Firm and the allegations in the ensuing litigation. The company supplied a limited set of documents designed to show that there was no wrongdoing, including that the company believed as of late January 2017 that its relationship with Mattress Firm would continue. The plaintiff did not agree and filed this action on May 10, 2018. The court's decision issued following a trial on a paper record.

Critical to the court's denial of the plaintiff's inspection claim was its finding that Hoeller failed to provide evidence to support bad-faith conduct in the company's negotiations with Mattress Firm. The court distinguished Elow v. Express Scripts Holding, (Del. Ch. May 31, 2017), a case where the defendant allegedly had refused to negotiate in good faith after having been placed on notice of breaches in a contractual relationship and having been given an opportunity to cure. In Express Scripts, unlike in Hoeller, the defendant had admitted that its relationship with its contractual counter-party was deteriorating “even as its fiduciaries represented to the market that the relationship was strong.” In contrast, in Hoeller, the court found “no hint that the company negotiated in bad faith or failed to cure after being placed on notice that it was in breach of the agreements.” Likewise, the court found that plaintiff offered no evidence that the company's CEO knew his statements were false when made concerning his opinion that the Tempur Sealy-Mattress Firm relationship would continue. The court held that “Delaware law 'requires more than a divergence between forward-looking statements and subsequent results' to infer mismanagement or wrongdoing.”

The Hoeller decision reflects the Delaware courts' concern to maintain a proper balance between the rights of stockholders to obtain books and records based upon credible allegations of wrongdoing and the rights of managers of Delaware corporations to conduct the company's  business and affairs without undue stockholder interference. From a policy standpoint, the court well-explained the flaws in Hoeller's complaint: “The credible basis standard would be turned on its head if a stockholder was afforded inspection rights every time a company in which he owned stock lost a major customer or was sued for breach of contract. Customers, even major customers, come and go in business. The mere fact of departure says nothing of corporate wrongdoing.” As long as managers do not negotiate in bad faith or misrepresent to the market their beliefs about the nature of a relationship with a major customer, the mere fact that that relationship goes sour does not present a credible case of fiduciary wrongdoing.

Lewis H. Lazarus ([email protected]) is a partner at Morris James in Wilmington and chair of the corporate and commercial litigation group. His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.