Corporate Governance

City of Westland Police v. Axcelis: The Erosion of the Credible Evidence Standard (One Hand Giveth, One Hand Taketh Away)

By J Robert Brown Jr.

The case made it easier for shareholders to meet the pleading requirements for some of the elements under Section 220 when seeking materials used by the board in refusing to accept resignations by defeated directors.  Yet there is no guarantee that in fact shareholders will succeed in obtaining the necessary information.  The case was very explicit in providing a basis for lower courts to continue to deny shareholders access to the necessary documents in these circumstances and, indeed, denied plaintiff the documents in this case.

What are the remaining roadblocks?  First, the Court emphasized over and over that this was a policy adopted by the board.  It left open the possibility that if adopted as a bylaw by shareholders (say under Rule 14a-8), the outcome might be different. 

Second, its not enough to show that the board refused to accept the letters of resignation.  The Court emphasized that this did not render inspections automatic.  Beyond a credible basis, shareholders needed to make additional showings.  Borrowing from Pershing Square, these included the requirement that:    

• that the information it seeks is necessary and essential to assessing whether a director is unsuitable to stand for reelection. Finally, access to board documents may be further limited by the need to protect confidential board communications. Thus, accepting that a desire to investigate the "suitability of a director" is a proper purpose does not necessarily expose corporations to greater risk of abuse.

In other words, even with a proper purpose and credible basis, access could still be denied if the documents requested were not "necessary and essential" or if they threatened to expose confidential board communications. 

Indeed, in Pershing Square, L.P. v. Ceridian Corp., 923 A.2d 810 (Del. Ch. 2007), the case used by the Supreme Court to develop the requisite standard, the Chancery Court refused to allow access to the requested document even though shareholders alleged a proper purpose.  The court viewed the harm of disclosure as outweighing any benefits.  As the court noted: 

• The potential harm to, and chilling effect on, the candid communications between high ranking executives and the board is significant. "If any stockholder can make public the preliminary discussions, opinions, and assessments of board members and other high-ranking employees, it will surely have a chilling effect on board deliberations" and on important relations and communications between directors and executives.

Given that most board proceedings are confidential, there is plenty of room for companies to deny inspection rights and raise as a primary defense the need to maintain secrecy.

Similarly, the requirement that the documents be necessary and essential provide ample room to deny inspection rights. 

In short, the Court was correct to overturn the analysis used by the Chancery Court.  But in its place is an approach that does not guarantee access to the materials that will enable shareholders to explore the actual reasons the board opted to refuse to accept the letters of resignation.  Indeed, the decision of the Court illustrates this in practice.  Although City of Westland Police met all of the requirements articulated by the Supreme Court, the Court nonetheless affirmed the Chancery Court's decision to deny inspection rights. 

Primary materials on this case are posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on August 27, 2010 (boomark / email).