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Imagine this situation: No lawsuit has been filed, yet plaintiffs’ lawyers are pawing through a company’s sensitive nonpublic documents, including special investigation committee records and internal audit reports, searching for any reason to sue the officers and directors. Although discovery fishing expeditions by securities plaintiffs have long been an issue after a lawsuit is commenced (and in fact were a motivating force in the adoption of the Private Securities Litigation Reform Act of 1995), the Delaware Court of Chancery has suggested that plaintiffs look into a company’s documents before even filing a suit. Grimes v. DSC Communications Corp., 724 A.2d 561 (Del. Ch. 1998); Scattered Corp. v. Chicago Stock Exchange, 701 A.2d 70, 78 (Del. 1997); Rales v. Blasband, 634 A.2d 927, 934-35 n.10 (Del. 1993). Delaware General Corporations Code � 220 provides the tools for a pre-litigation review of a company’s books and records. In a number of recent cases, plaintiffs have been expressly admonished for failing to take advantage of � 220 (books and records) inspections to obtain pre-filing ammunition for their complaints. In every derivative case dismissed this past year, including cases against Martha Stewart, Walt Disney Co., VeriSign Inc. and nVidia Corp., the Chancery Court explicitly told the plaintiffs that they should have bolstered their allegations with company documents obtained pursuant to � 220 and that their failure to do so contributed to dismissal. See Beam v. Martha Stewart, 2003 WL 22271421, at 13 (Del. Ch. 2003); In re the Walt Disney Co. Derivative Litigation, 825 A.2d 275, 279 (Del. Ch., 2003); Rattner v. Bidzos, 2003 WL 22284323, at 14 (Del. Ch. 2003); Guttman v. nVidia, 823 A.2d 492 (Del. Ch. 2003). In Walt Disney, after the Delaware Supreme Court reversed and remanded, the plaintiffs made a � 220 demand and used the information to amend their complaint. The Chancery Court then denied the defendants’ motion to dismiss the amended complaint. The Disney opinion lauded the plaintiffs’ use of � 220 to gather information to bolster their amended complaint. In Beam v. Martha Stewart, the Chancery Court referred to Disney as an example of how to gather information before filing a derivative case. General counsel need to be aware of the rising prominence of � 220 and be prepared to deal with demands for inspection. Section 220 allows forwide-ranging inspection Section 220 grants shareholders of Delaware corporations the right to inspect a corporation’s stock ledger, list of shareholders and “its other books and records.” Delaware courts have liberally interpreted “other books and records” to cover virtually every document generated, used or stored by a corporation. Along with such expected categories as bylaws, articles of incorporation and minutes of shareholder and board meetings, Delaware courts have allowed inspection deep into corporate records. The Chancery Court has permitted shareholders to inspect all reports and findings in connection with a restatement; orders and communications with the Securities and Exchange Commission (SEC) regarding an investigation; reports presented to the board and board committees, including those regarding internal and SEC investigations; internal and external audit reports; documents reviewed by special litigation committees; documents relating to premerger legal advice; all financial records (including loans and compensation information for employees making more than $50,000 annually); and all documents from transactions approved at the annual meeting. See e.g., Grimes v. DSC Communications Corp.; Everett v. Hollywood Park, No. 14556, 1996 Lexis 2 (Del. Ch. 1996); Skoglund v. Ormand Indus. Inc., 372 A.2d 204 (Del. 1976). Recently, in Freund v. Lucent, 2003 WL 139766 (Del. Ch. 2003), the Chancery Court allowed the plaintiff, who had filed a securities class action against Lucent Technologies Inc., but lost the lead plaintiff contest, to inspect all of Lucent’s communications with the SEC regarding an SEC investigation; all reports, findings and conclusions reached by Lucent regarding its restatement; transcripts from a whistleblowing case brought against Lucent; information on Lucent’s accounting compliance programs; board minutes; and descriptions of the responsibilities of Lucent’s audit committee. The Chancery Court explicitly rejected Lucent’s argument that the plaintiff, by virtue of his filing of a securities complaint, was making the � 220 demand for the improper purpose of avoiding the statutory discovery stay. The Chancery Court also rejected the argument that the � 220 inspection would undermine a current discovery stay in a pending Delaware derivative action against Lucent-even though the discovery requests in that action mirrored the � 220 demand. Shareholders may invoke � 220 at any time, regardless of the existence or status of litigation. Shareholders may also designate an agent, such as a plaintiffs’ attorney, to make the actual inspection of the books and records. A shareholder simply needs to provide his agent with a written document delegating the right of inspection to the agent. A demand to inspect books and records under � 220 need only identify the records to be inspected; state the purpose for which inspection is requested; be under oath; and be delivered to the corporation’s principal place of business or its Delaware registered office. Any shareholder may make such a request-regardless of the extent of his holdings. Once a � 220 demand is made, the company has five business days to respond in one of three ways: It can grant demand (the business-judgment rule protects decisions to grant demand); it can refuse demand; or it can let five business days pass without responding-constructively refusing demand. Any other action, including an inquiry to seek further information or clarification from the shareholder has been found equivalent to refusing demand. With such a short time to respond, it is crucial that directors, officers and inside counsel understand their options and the mechanics in advance. If a company grants demand, it may provide the documents for inspection by the shareholder or his agent at its offices. A company should consider trying to reach an agreement limiting the scope of the inspection. The company should be wary of granting unqualified access to records-as it is the equivalent of opening the company to unlimited discovery. Officers, directors and inside counsel should also remember that a shareholder may use anything found in a limited search as a basis for making a second � 220 demand. There are no limits on the number of � 220 demands a shareholder may make. Following either an affirmative refusal or a constructive refusal, a shareholder may (and, if fishing for complaint ammunition, will) file a motion with the Chancery Court seeking an order to compel inspection. The court may act on such motions “summarily” and set a hearing within a week. Shareholders often concurrently file a complaint alleging that the corporation refused inspection and an application for an ex parte order shortening the 20-day period allowed for answering and fixing a hearing date. The court generally grants the ex parte order. In some cases, the hearing is set within two or three days, but in most cases it will be close to a week. Defending against � 220 inspections Defending against the motion to compel is often the first opportunity for a corporation to oppose a � 220 demand substantively. The shareholder has the bur- den to prove, by a preponderance of the evidence, that the inspection is sought for a proper purpose. At this point, the court construes demands narrowly and limits inspection to those records deemed sufficient to satisfy the articulated purpose. (However, since doubts are generally resolved in favor of the shareholder, a company is best served by drawing clear lines around the scope of the inspection.) A corporation may raise the following defenses and objections (listed in order of efficacy): The shareholder has failed to articulate a proper purpose reasonably related to his interest as a shareholder; demand is made for a purpose adverse to the corporation; demand is insufficient (i.e., too vague or imprecise to allow the corporation or the court to gauge its propriety); the records sought are beyond the necessary scope to meet the purpose of the demand; and the demand is technically deficient. Delaware courts have demonstrated willingness to allow shareholders to cure the last three categories of defects during the hearing, making the first two defenses the most effective. If the corporation is planning to refuse demand, affirmative refusal, rather than simply letting five business days elapse, may provide some benefits. (Affirmative refusal on the fifth business day will capture all the time benefits of ignoring the demand.) First, it will allow the corporation to make a preliminary record showing that demand was refused for a reason (other than neglect). Second, it offers the court a preview of any defenses the company intends to raise. Third, it may give the court pause in granting an ex parte request to expedite the hearing or at least provide a basis for allowing time for briefing. Fourth, it might lead a legitimate shareholder to engage in further discussion with the corporation regarding his or her reasons for inspection. Finally, it allows for an attempt to navigate a more limited production. While � 220 is not a new law, the Delaware courts are currently taking an incredibly activist role in bolstering its importance and impact on companies facing securities and derivative cases. Advance awareness of the issues and the ability to respond promptly are crucial. Sara B. Brody is a partner, and Jonathan B. Gaskin is an associate, in the San Francisco office of Clifford Chance. Christopher A. Garcia, an associate in that office, and Teodora Manolova, a 2003 summer associate in that office, contributed to this article. The firm represented the defendants in the nVidia case mentioned in the article.

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