Inroads into the Chimera of Demand Refusal in Delaware: Louisiana Municipal Police v. Morgan Stanley (Part 3)

We are discussing Louisiana Municipal Police v. Morgan Stanley, an inspection rights case.  In deciding cases, VC Laster often brings to his opinions reasoning that reflect his longstanding experience with practice in Delaware.  In this case, it seems as if he wants to send a message to counsel that "demand refusal" cases in his court will be treated differently.  On this issue, it is worth quoting the opinion at length:

• The question of whether a corporation should sue its directors and senior officers puts directors in a difficult position where they are subject to potentially subtle influences and pressures.  Basic notions of accountability require that stockholders be able to use Section 220 to evaluate whether the demand-refusal decision was made in good faith, after a reasonable investigation, “or whether the Board had some different, ulterior motivation.” Axcelis, 1 A.3d at 291.  It is only if the directors refuse the litigation demand, as typically happens, that the subsequent litigation paths diverge.  By contrast, a decision to refuse a litigation demand is reviewed under the business judgment rule, which forces a plaintiff to overcome the rule’s powerful presumptions before a court will examine the merits of the directors’ decision. See Levine v. Smith, 591 A.2d 194, 212 (Del. 1991). The highly deferential standard for reviewing a demand-refusal decision makes it critical that an accountability mechanism exist in the form of a limited right to information under Section 220.

Demand refusal letters, in his court, will have to have some real substance.  As he states:

• Morgan Stanley cannot rely on the Demand Refusal Letter to foreclose LAMPERS’s right to use Section 220. The letter describes the Board’s process, but it does not provide any substantive insight into the Board’s decision. In form, the Demand Refusal Letter is longer than the peremptory refusal found insufficient in Grimes II. In substance, the two letters are identical. A board cannot defeat the use of Section 220 that the Delaware Supreme Court contemplated in Grimes I, Scattered, and Spiegel by sending a self-serving letter describing process sans content. Such an approach would render nugatory the right to use Section 220 to investigate demand refusal.

This doesn't mean that, ultimately, shareholders will have an easy time challenging the demand refusal decision.

• LAMPERS recognizes that the deference afforded to the Board’s decision means it faces long odds in showing that the refusal was wrongful. Whether the Board in fact acted wrongfully is not currently at issue. Rather, the question is whether LAMPERS’s purpose for inspection is proper. It is.

But companies will now know that the demand refusal process will be subject to shareholder inspection.  With that in mind, it is likely to become more rigorous.  There may even be an instance when the committee decides to authorize the action.  This is the right approach and right outcome.