Ellis E. Herington, Pepper Hamilton

Shareholder inspection of books and records pursuant to Section 220 of the Delaware General Corporation Law is a routine procedure for Delaware practitioners, and represents an important tool for shareholders when it comes to their involvement in corporate governance. As is well known, a Section 220 plaintiff must prove that he has a proper purpose for the inspection in order for the court to allow it. Recently, in High River Limited Partnership v. Occidental Petroleum, No. 2019-0403-JRS (Del. Ch. Nov. 14, 2019), the Delaware Court of Chancery considered the shareholder plaintiffs' two proffered purposes—investigation of corporate mismanagement and communication with other shareholders in furtherance of a potential proxy contest—and found that neither presented a basis for the requested inspection. The court's opinion provides useful guidance to all practitioners who assist shareholders with Section 220 inspections, and is of particular note to those who represent investors involved in proxy contests for its analysis of the plaintiffs' novel argument.

Background of the Case

The plaintiffs in the case, High River Limited Partnership, Icahn Partners Master Fund LP and Icahn Partners LP (all affiliates of the prominent activist investor Carl Icahn), began buying stock in the defendant, Occidental Petroleum Corp., after Occidental's May 2, offer to buy Anadarko Petroleum Corp. At the time of trial, the plaintiffs had come to own around 26 million shares in Occidental, valued at more than $1 billion. Shortly after making its offer to Anadarko, on May 9, Occidental entered into a merger agreement with Anadarko, and Occidental funded substantial portions of the $55 billion purchase price through preferred stock sales to Berkshire Hathaway, Inc. and a presale of certain Anadarko assets to Total S.A.

On May 21, the plaintiffs sent a Section 220 demand to Occidental, requesting inspection of a broad swath of Occidental documents relating to the Anadarko merger, the Berkshire Hathaway financing, the Anadarko asset presale to Total, and other elements of the transaction and the Occidental board's decision-making process. The plaintiffs also sought documents "concerning whether the board intended to comply with the stockholder proposal, adopted at Occidental's annual meeting, that seeks to lower the threshold to call a special meeting from 25% stockholder approval to 15%." A week later, Occidental replied that it was "considering" the plaintiffs' demand. Two days after that, on May 30, the plaintiffs filed their Section 220 complaint.

While the Section 220 action was ongoing, on June 26, the plaintiffs and other Icahn affiliates filed preliminary proxy materials. They intended to solicit written consents for a variety of actions, including electing four directors nominated by Icahn affiliates, revising certain Occidental bylaws, and changing various aspects of Occidental's consent solicitation process. Occidental contested all of the Icahn affiliates' proposals.

Section 220 Standards Generally

As the court explained, a shareholder plaintiff must have a proper purpose for the requested inspection for the court to order it. While a variety of purposes have been deemed proper, in many Section 220 actions, the proper purpose asserted for the inspection is investigation of corporate mismanagement or wrongdoing. When the plaintiff claims this as his or her proper purpose, the plaintiff is required to "demonstrate a credible basis to suspect that mismanagement or wrongdoing has occurred before the corporation will be compelled to allow inspection." This is the lowest burden of proof under Delaware law, but it nevertheless requires the plaintiff to put forth some evidence supporting his or her allegations of mismanagement or wrongdoing.

The court found that the plaintiffs failed to carry that burden at trial and, as a result, did not successfully demonstrate that there was a credible basis to believe that the Occidental directors had engaged in mismanagement or wrongdoing in connection with the Anadarko merger or the other related transactions. Rather, the court found that any allegations the plaintiffs had made to that effect amounted to "nothing more than disagreements with how Occidental's directors exercised their business judgment."

Section 220 and Proxy Contests

The plaintiffs also proffered a second purpose for their inspection: to utilize the information sought in the prosecution of their proxy contest. The plaintiffs advanced a novel proper purpose argument, asking the court "to recognize a new rule entitling stockholders to inspect documents under Section 220 if they can show a credible basis that the information sought would be material in the prosecution of a proxy contest." The court noted that while shareholders who had been allowed to inspect books and records after demonstrating credible bases for suspecting wrongdoing had been permitted to use the information acquired in subsequent proxy contests, no case had previously held that waging a proxy contest was itself a proper purpose.

The closest case the plaintiffs cited in support of this proxy contest standard was then-Master Abigail LeGrow's report in High River Limited Partnership v. Forest Laboratories, No. 7663-ML (Del. Ch. July 27, 2012). In Forest Laboratories, the plaintiffs sought documents in connection with an imminent proxy contest, arguing that they needed the requested documents to ascertain whether the directors had implemented corporate governance reforms that they had agreed to during an earlier proxy contest. The court in that case ordered the company to permit the plaintiffs' inspection, finding that "a stockholder states a proper purpose by demonstrating that they are engaged or are imminently about to be engaged in a proxy contest," but that the plaintiffs were only entitled to those documents that were "essential and sufficient" to the stated purpose of mounting the proxy contest. The plaintiffs in Occidental also cited to Tactron v. KDI, (Del. Ch. Jan. 10, 1985), which permitted inspection of documents "that would provide logistical assistance in mounting a proxy contest."

The court in Occidental found these cases distinguishable, primarily on the ground that the plaintiffs did not seek documents needed to mount a proxy contest, but rather sought documents that they believed would confirm their critical view of the Occidental board's substantive decision-making process regarding the Anadarko transactions. As the court phrased it, "Plaintiffs hope to use these documents to show Occidental's stockholders that the Board botched multiple decisions in connection with the Anadarko merger not just to conduct, but to win, a proxy contest." Ultimately, because the broad set of documents requested by the plaintiffs was not "necessary and essential" to conduct the proxy contest, the court found that the plaintiffs failed to demonstrate a proper purpose and denied their inspection request.

Practical Considerations

The court's opinion delves into an area of Section 220 law that is relatively unexplored at this stage—indeed, the court observed the lack of clarity in this area, but explained that the Occidental case was "not the vehicle to provide that clarity." Thus, some questions remain about the potential for shareholders to successfully demonstrate a proper purpose by showing that the documents will be used in furtherance of a proxy contest. It seems clear that the court will require more from a shareholder plaintiff than simply pleading that that shareholder is or will be involved in a proxy contest; that fact alone will not suffice to show a proper purpose.

But what shareholder plaintiffs must show beyond that basic pleading, and the breadth of documents they may be able to obtain through a Section 220 action, seems less clear. The court's couching of its holding in Section 220's limiting principle—that the documents sought must be "necessary and essential" to the proxy fight—in line with the holding in Forest Laboratories may leave shareholder plaintiffs some room to maneuver. Practitioners in this field should consider whether proxy contest-related Section 220 demands are sufficiently tailored to fit this paradigm. They should also consider the contours of the distinctions laid out in Occidental between those documents sought to "conduct" the proxy fight and those sought to "win" it. Overall, the area seems ripe for further exploration, should the appropriate vehicle for clarification arise.

Ellis E. Herington ([email protected]) is an associate in the trial and dispute resolution practice group of Pepper Hamilton, resident in the Wilmington office.