Why it matters: On April 30, 2015, the Delaware Chancery Court ruled that two shareholder pension funds seeking access to bona fide privileged attorney-client communications in a Section 220 “books and records” action were permitted to do so pursuant to the “fiduciary exception” to the privilege, which permits shareholder plaintiffs to “pierce” the corporation’s attorney-client privilege upon a sufficient showing of good cause. The fiduciary exception, which originated in nineteenth-century English law and was first recognized in the United States by the Fifth Circuit in 1970, appears to be gaining traction in the Delaware courts starting with the Delaware Supreme Court adopting and extending it to Section 220 actions in 2014.
Detailed discussion: The case of In re Lululemon Athletica Inc. involves separate shareholder actions (later consolidated) brought in the Delaware Chancery Court by two pension funds (Funds) against sports apparel retailer Lululemon Athletica, Inc. (Lululemon) under Section 220 of the Delaware General Corporation Law (Section 220), which governs a shareholder’s rights with respect to inspection of corporate books and records. On April 30, 2015, the Chancery Court held that the Funds were entitled to access privileged attorney-client communications pursuant to the “fiduciary exception” to the privilege, which permits shareholder plaintiffs to obtain documents protected by the attorney-client privilege upon a sufficient showing of “good cause.” The Chancery Court was relying on the Delaware Supreme Court’s July 2014 opinion in Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW (Wal-Mart II), where the Court adopted the exception and extended it to Section 220 actions for the first time. The Delaware Supreme Court was in turn relying on the 1970 Fifth Circuit case of Garner v. Wolfinberger (Garner), which was the first U.S. court to recognize the exception that had its origins in nineteenth-century English law. More on this later.
Through the Section 220 actions, the Funds were seeking to inspect Lululemon’s books and records in connection with certain stock trades made in June 2013 by Dennis Wilson (Wilson), Lululemon’s founder and ex-chairman of the board. Of particular interest to the Funds was the trade that occurred on June 7, 2013. The facts show that Lululemon’s then-CEO Christine Day (Day) informed Wilson and Lululemon’s board separately of her plans to resign on June 5 and June 7, respectively. On June 7, Wilson’s broker executed a trade on behalf of Wilson of 607,545 shares at a per-share sale price over the established $81.25 floor. On June 10, 2013, Lululemon publicly announced Day’s resignation, and the per-share price for Lululemon stock dropped by 22%. Two days later, on June 12, The Wall Street Journal emailed Lululemon seeking information about Wilson’s “incredibly well-timed” June 7 trade. There ensued an email chain (WSJ email chain) among Wilson, Swinton, Lululemon’s attorney, and Wilson’s personal attorney to formulate a coordinated response. Some of the emails in the WSJ email chain were authored either by Wilson’s personal attorney or by Lululemon’s outside counsel. In addition, on July 2, 2013, Erin Nicholas, Lululemon’s secretary and one of its in-house counsel, responded to an email from a board member seeking information about Wilson’s trades (Nicholas email).
On April 2, 2014, Vice Chancellor Donald F. Parsons issued an oral ruling finding that the Funds “had a proper purpose under Section 220 to seek books and records regarding Wilson’s June 7, 2013 trades because there was a credible basis to infer wrongdoing by Wilson and Lululemon . . . and possible mismanagement by the Company in connection with their oversight as to the questionable trading.” Vice Chancellor Parsons ordered Lululemon to produce all “documents” concerning Wilson’s June 7 trade and inquiries by any board member regarding Wilson’s trades during June 2013. On April 18, 2014, Lululemon produced 195 pages of documents, and on April 19, it produced a “privilege log” including the WSJ email chain and the Nicholas email.
On June 12, 2014, the Funds filed a motion contending that the WSJ email chain and the Nicholas email were improperly designated as privileged or the privilege had been waived. The following month, on July 23, 2014, the Delaware Supreme Court decided Wal-Mart II, and on August 26, the Funds filed a reply brief relying extensively on Wal-Mart II to argue that, even if the WSJ email chain and the Nicholas email were found to be privileged, the Funds could still gain access under the fiduciary exception. On November 24, 2014, Lululemon filed a “sur-reply” letter that addressed Wal-Mart II’s adverse implications.
In his April 30, 2015, opinion, Vice Chancellor Parsons began by establishing that the WSJ email chain and the Nicholas email were properly designated as attorney-client privileged, and that the privilege had not been waived with respect to either document. Notwithstanding this, however, he found that the “Plaintiffs have shown good cause to access those documents under the fiduciary exception as articulated in Garner and Wal-Mart [II].”
Vice Chancellor Parsons began his analysis of the applicable law by stating that “[i]n Wal-Mart II, the Delaware Supreme Court for the first time applied the Garner [fiduciary] exception in a Section 220 action.” In Garner, the Fifth Circuit established a “good cause” standard and factors for determining when a fiduciary exception applies to allow a shareholder access to corporate documents protected by the attorney-client privilege. Relying on the Garner opinion and extending it to Section 220 actions, the Delaware Supreme Court in Wal-Mart II identified the following as the relevant factors that would demonstrate “good cause” so as to justify the fiduciary exception: (1) the number of shareholders and the percentage of stock they represent, (2) the “bona fides” of the shareholders, (3) the nature of the shareholders’ claim and whether it is obviously “colorable,” (4) the apparent “necessity or desirability” of the shareholders having the information and whether it is available from other sources, (5) whether, if the shareholders are alleging wrongful action by the corporation, the action they are alleging is criminal, illegal (but not criminal) or of doubtful legality, (6) whether the communication is of advice concerning the litigation itself, (7) the extent to which the information is identified versus whether the shareholders are “blindly fishing,” and (8) the risk of revelation of trade secrets or other confidential information, independent from the shareholders’ claim. Noting that the plaintiff bears the burden of proof to demonstrate good cause, Vice Chancellor Parsons quoted from Wal-Mart II that the fiduciary exception is “narrow, exacting, and intended to be very difficult to satisfy.”
After applying the Garner and Wal-Mart II analyses to the facts of the Lululemon case before him, Vice Chancellor Parsons found that the Funds had successfully met their burden of proof for each of the factors—albeit some more strongly than others—and “on balance” had demonstrated good cause to access the Nicholas email and the WSJ email chain. Thus, notwithstanding his finding that they were legitimately covered by an unwaived attorney-client privilege, Vice Chancellor Parsons held that “Plaintiffs are entitled to review the Nicholas email and the WSJ email chain under Garner’s fiduciary exception to privilege.”
A cautionary tale for in-house and outside counsel everywhere…
See here to read the Delaware Chancery Court opinion in In re Lululemon Athletica, Inc. (220 Litigation), C.A. No. 9039-VCP (4/30/15).
See here to read the Delaware Supreme Court opinion in Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, 95 A.3d 1264 (Del. 2014).
For more on this topic, see Garner v. Wolfinberger, 450 F.2d 1093 (5th Cir. 1970).