In this appellate opinion, the Delaware Supreme Court reviewed a challenge to a final judgment of the Court of Chancery requiring NVIDIA Corporation (the Company) to produce books and records under Section 220 of the Delaware General Corporation Law. The Supreme Court ultimately affirmed multiple aspects of the judgment entered by the Court of Chancery, but found that the Court of Chancery erred by allowing the plaintiff-stockholders to establish their proper purpose using hearsay evidence that was not sufficiently reliable. Accordingly, the case was reversed in part and remanded for further proceedings.
In February 2019, certain of the Company’s stockholders (the Stockholders) sought to inspect particular categories of the Company’s books and records to (i) investigate possible wrongdoing and mismanagement at the Company, (ii) assess the ability of the board to consider a demand for action, (iii) determine whether the Company’s board members were fit to serve on the board, and (iv) take the appropriate action in response to the investigation. In response[LG1] , the Company produced some documents, and the Stockholders followed up with an additional request, to which the Company objected.
In February 2020, the Stockholders filed suit in the Court of Chancery, seeking inspection of the Company’s records. In particular, the Stockholders alleged that Company executives and directors made knowingly false and misleading statements about the Company’s internal controls, prospects, and earnings, while at the same time selling $147 million of the Company’s stock “at artificially inflated prices.”
During the proceedings in the Court of Chancery, the Company made a number of arguments against the Stockholders’ request for books and records, including the typical arguments that the Stockholders had not established a proper purpose and questioning whether the Stockholders had established a credible basis for inspection with respect to wrongdoing. The Court of Chancery rejected the Company’s arguments and ordered the Company to produce two categories of documents—certain communications with the CEO and certain specific sets of emails. In addition, the Court of Chancery held that it was permissible for the Stockholders to establish their proper purpose under Section 220 based on hearsay evidence—in particular, information contained in the Stockholders’ demands and interrogatory responses.
Importantly, prior to the trial, the Stockholders told the Company that they had not determined which witnesses they were going to call at trial to testify regarding the purpose of the demand. The Company also did not identify any trial witnesses and reserved the right to depose and cross-examine any witnesses identified by the Stockholders. The Stockholders later told the Company that they would use affidavits instead of live testimony at trial. The Company expressed that it would need to see the affidavits and then have the opportunity to depose any affiant in advance of trial. The Stockholders eventually chose not to call any witnesses to testify regarding their purpose, instead relying on the purpose expressed in the demands and interrogatories.
Issues on Appeal
On appeal, the Company asserted multiple challenges to the Court of Chancery’s judgment, including that (i) the Stockholders’ demand for certain documents was overbroad and violated Section 220’s form and manner requirements, (ii) the Stockholders’ reliance on impermissible hearsay evidence to establish a proper purpose did not meet the burden of proof required by Section 220, (iii) the Stockholders did not show a credible basis from which the court could infer wrongdoing or mismanagement, and (iv) the Court of Chancery’s order of production was not essential and sufficient to the Stockholders’ stated purpose.
Central to the Delaware Supreme Court’s opinion is the analysis regarding the Company’s second challenge to the Court of Chancery’s holding, allowing the Stockholders to rely upon hearsay evidence to establish a proper purpose. Ultimately, the Delaware Supreme Court found that this holding was erroneous. The Court of Chancery based this conclusion on the concept that “requiring Section 220 plaintiffs to establish a proper purpose without hearsay, absent a stipulation to proceed on a paper record, would amount to a requirement that all Section 220 plaintiffs testify live at trial, resulting in ‘inefficiency in the process.’”
In support of its arguments on this issue, the Company argued that the Delaware Rules of Evidence apply in all cases and that requiring live testimony from Section 220 plaintiffs would not result in any significant delay, and that is not a reason to set aside the rules of evidence. In response, the Stockholders argued that Delaware case law allows for the use of hearsay in Section 220 proceedings, as long as the hearsay is sufficiently reliable. The Stockholders maintained that the demands upon which they relied were submitted under penalty of perjury and were therefore sufficiently reliable.
While the parties agreed that the statements in the demands on which the Stockholders relied were hearsay, they disputed whether there is, or should be, an exception that would permit the Stockholders to rely on hearsay evidence in a books and records action to establish a proper purpose.
The parties’ arguments on this point focused on a line of cases from the past 18 years from the Court of Chancery that relied upon the Delaware Supreme Court’s ruling in Thomas & Betts Corp. v. Leviton Manufacturing, Co., Inc. The Supreme Court explained that in Thomas & Betts it already had created an exception in the Section 220 context allowing the use of sufficiently reliable hearsay in books and records actions.
The Company argued that the Court of Chancery cases relying on Thomas & Betts should not be extended to apply to the proper purpose requirement. The Supreme Court noted that Thomas & Betts’ holding is not limited to the credible basis context and the Court refused to reconsider that case when neither party had asked it to do so.
The Company separately argued that even in light of Thomas & Betts’ holding regarding sufficiently reliable hearsay in support of a proper purpose, the Stockholders’ evidence should be excluded because (i) the Company was not able to test the Stockholders’ claimed purpose through cross-examination (due to the Stockholders’ tactics regarding witnesses) and (ii) the evidence was unreliable. Specifically, the Stockholders never identified any witnesses by the deadline in the scheduling order and never produced any affidavits for the Company’s review, despite promising to do so.
The Supreme Court emphasized that the hearsay exception is particularly beneficial to plaintiffs in Section 220 actions but cautioned against abusing this benefit. Highlighting the Stockholders’ plan that deprived the Company of the ability to test the Stockholders’ stated purpose by not cooperating with the Company with respect to the identification of trial witnesses or affiants, the Supreme Court warned that “[t]his type of behavior creates the potential for gamesmanship, which should be discouraged. If stockholders are going to introduce sufficiently 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.”
Therefore, the Supreme Court reversed the Court of Chancery’s holding that the Stockholders could rely on the contents of their demands and interrogatory responses to show a proper purpose. Sufficiently reliable evidence may still be used for this purpose, but here, the Stockholders deprived the Company of the ability to test that purpose through depositions.
This opinion reflects the Delaware Supreme Court’s scrutiny of hearsay evidence in Section 220 actions, requiring that such evidence be sufficiently reliable. Moreover, both the Court of Chancery and the Supreme Court emphasized the need for transparency in the identification of trial witnesses in this context to allow defendants to determine whether to depose the stockholders or call them as witnesses at trial. Both courts clearly disfavored the gamesmanship that the Stockholders employed here.
NVIDIA Corp. v. City of Westland Police & Fire Ret. Sys., 282 A.3d 1 (Del. 2022), as revised (July 25, 2022)