Ask a MoFo: What are inspection rights under Delaware law?

The following article is part of our "Ask a MoFo" series, where we address some of the frequently asked questions our MoFo startup team is asked during the course of business. These questions span the entirety of the startup lifecycle – from questions relating to incorporation, to tips for a successful exit. We encourage you to submit questions you would like to see answered as part of this series to ECVCevents@mofo.com.

In a corporation, stockholders are typically not involved in the management of the business (unless otherwise negotiated). The corporation’s board of directors and executive officers bear that responsibility. As a result, stockholders may not have relevant information concerning the corporation’s activities.

To address this information imbalance, Section 220 of the Delaware General Corporation Law (DGCL) grants stockholders certain statutory rights to access corporate information. Specifically, a stockholder has a qualified right to inspect and make copies of the corporation’s stock ledger, stockholder list, and other books and records, upon written demand under oath. The right of inspection may be exercised by any stockholder of the corporation, regardless of the number of shares owned or the duration of ownership.

The “proper purpose” requirement

To mitigate potential abuse of the inspection right, a stockholder must assert a “proper purpose” when demanding to inspect the corporation’s records. A “proper purpose” is a purpose that is reasonably related to the stockholder’s interests as a stockholder. This purpose may not be adverse to the interests of the corporation and may not be a “mere fishing expedition.” Some examples that Delaware courts have held to be “proper” include: (i) investigating allegedly improper transactions or mismanagement, (ii) clarifying unexplained discrepancies in financial statements regarding assets, (iii) ascertaining the value of stock, and (iv) in some circumstances, aiding litigation the stockholder has instituted.

Scope of the inspection

The DGCL allows a stockholder to inspect (i) the corporations’ stock ledger, (ii) the list of other stockholders of the corporation, and (iii) the corporation’s other books and records. While the stock ledger and list of stockholders are relatively specific items, the catchall phrase “other books and records” has been interpreted in certain cases to allow for inspection of a wide range of documents, including those related to the corporation’s organization, business, and financial condition, such as meeting minutes and board-level materials, officer emails, and audited financial statements, to name a few, if they are “essential and sufficient” to the accomplishment of the stated purpose.

Can a stockholder waive information rights?

Although a corporation’s certificate of incorporation and bylaws may not limit stockholders’ information rights, a corporation may be able to negotiate waivers of such rights through separate stockholder agreements.

Delaware courts have not conclusively ruled on the issue, but there is evidence to suggest that these waivers of statutory information rights may be enforceable. In a recent case, for example, the Delaware Court of Chancery suggested that there are policy considerations to support the waiver of information rights, including “Delaware’s broad recognition of parties’ ability to waive other important rights, whether constitutional or statutory[.]” In the same case, the Delaware Court of Chancery advised that although attempts to limit statutory information rights in a corporation’s governance documents have been rejected in the past, the distinctions between “provisions that appear in those [corporate governance] documents and waivers in private agreements” may be enough to validate waivers in private contracts between the corporation and its stockholders.

Conclusion

Stockholder inspection rights are a core matter of internal corporate affairs. Because stockholders are generally not privy to the day-to-day management and affairs of the corporation, Delaware codified a right to access information in Section 220 of the DGCL. Recently, there has been an increase in books-and-records demands. These demands can be expensive and disruptive to the business and are often a sign of litigation or other hostile action to follow.

While a Delaware corporation may not eliminate or limit the inspection right in its charter or bylaws, there is a growing trend for parties to agree to waive such rights through separate stockholder agreements. As a sign of the market moving in this direction, the NVCA form of Investors’ Rights Agreements includes a provision for a waiver of statutory inspection rights.

Officers and directors should promptly consult legal counsel in order to determine legal options if any such demand letter is received as there is limited time to respond and the corporation will want to explore its options such as requiring the inquiring stockholder to sign a confidentiality agreement, disputing whether all of the statutory requirements for a proper demand have been met, and/or attempting to enforce any waivers included in the inquiring stockholder’s agreements.