August 9, 2022

Books & Records: “Reliable Hearsay” May Satisfy Delaware’s Proper Purpose Requirement

In order to establish the existence of a proper purpose for a books & records demand under Section 220 of the DGCL, a stockholder must demonstrate a “credible basis” from which the Chancery Court may infer there is possible mismanagement that would warrant further investigation. Last month, in NVIDIA v. City of Westland Police & Fire Retirement System, (Del.; 7/22), the Delaware Supreme Court held that “reliable hearsay” evidence may support the Chancery Court’s conclusion that such a credible basis for investigation exists.  This excerpt from Francis Pileggi’s blog on the decision summarizes the key takeaway from the case:

Prior to this decision, it was not well-settled whether a stockholder could satisfy the “proper purpose” requirement under DGCL Section 220 with hearsay–instead of live testimony, for example. The Delaware Supreme Court ruled that: “The Court of Chancery did not err in holding that sufficiently reliably hearsay may be used to show proper purpose in a Section 220 litigation, but did err in allowing the stockholders in this case to rely on hearsay evidence because the stockholders’ actions deprived NVIDIA of the opportunity to test the stockholders’ stated purpose.”

The Supreme Court’s problem with the Chancery Court’s decision concerning the use of hearsay in this case was based on the stockholders’ refusal to provide testimony relating to their allegations.  The Court said that If stockholders are going to use reliable hearsay to establish a proper purpose, they “must communicate honestly and early with companies regarding their intent so as to allow companies to decide whether to depose the stockholders or to identify their own witnesses for trial.”

Justice Traynor issued an opinion concurring in the Court’s conclusion that the Chancery erred in allowing the stockholders to rely exclusively on hearsay in their books & records demand, but expressed “serious misgivings” about the majority’s statement that “hearsay is admissible in a Section 220 proceeding when that hearsay is sufficiently reliable.”

John Jenkins