Opinion ID: 2556088
Heading Depth: 3
Heading Rank: 1

Heading: Cases Where Section 220 Inspection Allowed, Despite An Earlier-Filed Derivative Action

Text: In In re Walt Disney Co. Derivative Litigation, [26] the stockholder-plaintiffs filed a derivative action in the Court of Chancery, claiming that the Disney directors had breached their fiduciary duties by approving an employment contract with Disney's president, which contained a very large severance package, and thereafter, by approving a non-fault termination of the president under that contract. [27] The Court of Chancery dismissed the stockholder-plaintiffs' derivative complaint with prejudice for failure to make a pre-suit demand upon the Disney board. [28] On appeal, this Court affirmed, but held that the derivative complaint should have been dismissed without prejudice. [29] This Court further suggested that the plaintiffs use 8 Del. C. § 220 as a tool to develop facts sufficient to replead demand futility in an amended derivative complaint. [30] Following that suggestion, the stockholder-plaintiffs prosecuted a Section 220 action in the Court of Chancery seeking inspection of Disney's books and records. [31] Armed with additional information, the plaintiffs thereafter filed an amended complaint in their (earlier-dismissed) derivative action. This time, that complaint survived a renewed Rule 23.1 motion to dismiss. The Court of Chancery held that pre-suit demand was excused, because the amended complaint adequately pled demand futility, based on particularized facts uncovered through the Section 220 inspection, which showed a lack of board oversight so egregious that it called into question whether the directors had exercised their fiduciary duties in good faith. [32]
The McKesson HBOC litigation is a second example. There, stockholder-plaintiffs of McKesson HBOC filed a derivative action in the Court of Chancery against certain directors of McKesson HBOC and its subsidiary, HBOC. [33] The complaint alleged breaches of fiduciary duty based on accounting irregularities arising out of a previous merger between McKesson Corporation and HBO & Company. [34] Despite having twice amended their derivative complaint, the stockholder-plaintiffs were again found to have failed to plead particularized facts establishing demand excusal. [35] Dismissing their complaint without prejudice, the Court of Chancery advised plaintiffs to use Section 220 as a tool to obtain facts necessary to plead demand futility adequately before filing a further amended derivative complaint. [36] One plaintiff (Saito) followed that advice and filed a Section 220 action demanding inspection of corporate books and records. A claimed purpose for Saito's demand was to gather information [relating to potential breaches of fiduciary duties] . . . in order to supplement [his earlier dismissed] complaint . . . in accordance with the [Court of Chancery's earlier] opinion. [37] The Court of Chancery found that purpose to be proper under Section 220, and granted Saito inspection relief. [38] Using facts gleaned from his Section 220 inspection, Saito then filed an amended complaint in the plenary derivative action, which survived a Rule 12(b)(6) motion to dismiss for failure to make a pre-suit demand under Rule 23.1. [39]
A third example is Melzer v. CNET Networks , which factually is similar to this case. [40] Unlike Disney and McKesson HBOC, where the plenary derivative actions were first-filed in the Delaware Court of Chancery, the plaintiffs in Melzer (like King here) first filed a plenary derivative action in the California Federal Court. [41] The Melzer plaintiffs alleged that the board of CNET Networks (CNET) had breached their fiduciary duty, and violated federal securities law, by granting backdated stock options to former and current directors. [42] CNET moved to dismiss the derivative complaint under FRCP 23.1 for failure to make a pre-suit demand on the board. [43] The California Federal Court granted the motion to dismiss, holding that the complaint failed to plead particularized facts that, if true, would show that a majority of the directors had a conflicting financial interest. [44] That dismissal was granted with leave to amend, however, and the California Federal Court suggested (as it did in this case) that the plaintiffs file a Section 220 books and records action in Delaware. [45] The plaintiffs, like King here, did that. Granting the plaintiffs relief in their Section 220 action, the Court of Chancery found that the plaintiffs had a proper purpose for demanding inspection, because the California Federal Court had granted them leave to amend and refile their derivative complaint. [46] Thus, the plaintiffs were found to have a proper purpose for bringing a Section 220 action to inspect CNET's books and records, namely, to investigate facts needed adequately to plead demand futility in their to-be-amended California federal derivative complaint. [47] These examples illustrate that what the California Federal Court suggested to King in this caseand what King did herewas fully consistent with Delaware case precedent. The defendants, however, point to other cases where Delaware courts refused to allow a post-filed Section 220 action to go forward. Those cases, however, are inapposite for the reasons next discussed.