City of Westland Police v. Axcelis: The Erosion of the Credible Evidence Standard (The Implications of the Lower Court's Reasoning)

Invoking inspection rights under Section 220 in Delaware involves a two step process.  First, plaintiffs must assert a proper purpose for inspecting the records.  In general, a proper purpose requires some evidence of wrongdoing.  Second, even with a proper purpose, there must be credible evidence supporting the purpose.  In other words, its not enough to state a proper purpose; shareholders must present some evidence of the alleged misbehavior. 

Locked into this framework, plaintiff alleged as a proper purpose that the board had an entrenchment motive in refusing to accept the letters of resignation.  While entrenchment amounted to a proper purpose, the case, according to the Vice Chancellor, foundered on the credible basis standard.  Plaintiff had failed to produce affirmative evidence indicating that the board had acted with an entrenchment motive.  In reaching the conclusion, the court explained away evidence produced by plaintiff suggesting that the board had not accurately stated the reasons for refusing to accept the resignation letters.

To the Chancery Court, the only real evidence produced by plaintiff was the decision to reject the letters of resignation.  The court dismissed the contention summarily.  "If mere acting in accordance with the terms of a Pfizer-style policy is to be found credible evidence of wrongdoing, then its death knell has been rung.”  City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc., 2009 Del. Ch. LEXIS 173 (Del. Ch. Sept. 28, 2009). 

Had the decision been allowed to stand, shareholders would have been effectively denied all opportunity to explore the basis for a board's decision in this area.  Finding affirmative evidence of entrenchment would have been all but impossible.  Thus, boards would know that the process used or the actual reasoning employed would never be subject to disclosure.  This decision all but calle for federal preemption, with the SEC imposing disclosure obligations designed to provide shareholders with material information denied to them by the Delaware courts.

Although affirming the lower court, the Supreme Court really reversed.  We will explore how the Court did so and the implications in the next post. 

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