Section 220’s Privacy Problem

-- By RoReynolds - 08 Mar 2022

Intro

Modern technology has created a perhaps untenable environment in boardrooms. It is virtually impossible to truly delete anything that has been typed, emailed, texted, etc. Delaware corporate law, and particularly the development of Section 220 claims, has created an enormous privacy issue for directors, as now courts can order electronic records to be produced during litigation. Without an expectation of privacy, or even a possibility of such, directors will not be free to openly voice their opinions, thus hamstringing their roles in the boardroom.

Smith v. Van Gorkom

In 1985, in Smith v. Van Gorkom, a major case in Delaware corporate law, the Delaware Supreme Court found that directors could be held personally liable if they act on an uniformed basis. Given the magnitude of the transaction, directors had the obligation to ask questions and to make themselves informed. By not doing so, they violated their duty of care by being uninformed, and could not hide behind the business judgment rule.

This holding was rather controversial because it created incentives to avoid serving on boards. Indeed, before Van Gorkom, there were virtually no cases of director liability for breach of duty of care because, from a shareholder's perspective, one would not want their directors to be liable for the full cost of a misstep. If they were, directors would never do anything risky, and thus nothing profitable. Shareholders could always diversify their risk, perhaps through holding a diverse portfolio. What they did not want was their directors acting like their surgeons.

Section 220

The improved processes and transparency on boards as a result of the case have created a privacy problem however. Plaintiffs' lawyers now can file Section 220 claims to obtain corporate records and documents for a "proper purpose," typically a breach of fiduciary duty claim. These Section 220 claims are not limited to books and records, as a recent Delaware Supreme Court decision held that electronic records and communications could be fair game. While records produced as part of Section 220 claims are generally kept non-public, ultimately only confidential information such as trade secrets will be kept under seal.

Corporations now face the issue that anything typed cannot be destroyed. Historically, when notes were taken during a board meeting, they could always be shredded or otherwise destroyed. Yet today, due to modern technology, even if a director deletes something they have typed, or versions up a document, that original can likely still be found and recovered. Corporations and their directors must now contend with the increased liability for directors that results from the fact that any electronic record from notes to text messages could be revealed.

The Privacy Problem

The privacy issue is significant enough that major law firms have published guidance on their websites for directors. Yet, even these firms have not been able to produce any sort of elegant solution to protecting directors' privacy. Instead, the guidance boils down to advising against sending emails and text messages discussing material matters, and scheduling calls and meetings for substantive matters. Perhaps most poignant, one article on Skadden's website suggests the following: A good rule of thumb, before texting or emailing, is to ask, "Would you want to read this in a newspaper?"

Directors today would do well to remember Melvin Gross v. Biogen Inc., which limited the plaintiff to inspecting "board-level materials" on the grounds that "[t]hese documents and communications will enable Plaintiff to assess the extent to which Board members were made aware of the alleged wrongdoing and to evaluate how the Board members responded to the investigation." In essence, Section 220 claims are subject to some restraints and will not guarantee access to corporate records, emails, and texts if the formal board-level materials exists, are available, and would satisfy a plaintiff's "proper purpose" demand. So, if directors can refrain from conducting business over email, text, and other informal channels, their electronic communications will not be subject to inspection.

More realistic solutions that companies can implement include having a designated notetaker in meetings who complies with a particular format to ensure favorable documentation of why certain board decisions were approved. Alternatively, boards can revert to only allowing handwritten meeting notes. More broadly, companies can create their own narratives by purposefully designing email trails that explain their thought process. For instance, if a company wants to work with a particular investor but has a previous relationship with the individual that could cause the transaction to be questioned, compliance professionals could preemptively form an email thread that explains the rationale of the decision and why that investor provided the best outcome for shareholders. Thus, if the transaction were questioned, the Section 220 claims would end up benefitting the potential defendant.

"Just don't do it" is of course easier said than done in today's hyper-connected world. Business is conducted through texts and emails, imprudent as it may be. And, while directors may sacrifice practicality for the sake of privacy and avoid emails discussing sensitive matters, they will be hard pressed to avoid keyboards altogether. Even if someone were to delete an improper comment, sentence, or entire document typed on a laptop for example, those words will still be recoverable and thus theoretically subject to a Section 220 claim. For those directors set on keeping their phones and laptops, they should transition to dedicated devices for personal versus work use.

As noted by David Katz, in order for a board to function properly and fulfill its role, directors must be able to express their thoughts and opinions freely without fear that they will be made public. If they cannot (and indeed they cannot for Section 220 provides the legal hook with which to access materials computers prevent from being completely private), then either boards will cease to function effectively, people will be less likely to serve as directors, or those who do will be subject to increased liability.

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