March 11, 2015 Practice Points

DE Supreme Court Applies Fiduciary Exception to Privilege

A recent decision is likely to have a significant impact on the application of the corporate attorney-client privilege.

By Hope A. Comisky and Jessica K. Davis

On July 23, 2014, the Supreme Court of Delaware ruled that Wal-Mart, Inc. stockholders may invade the corporation’s attorney-client privilege to prove fiduciary breaches by those in control. In doing so, the Delaware Supreme Court formally recognized the fiduciary exception to the attorney-client privilege rooted in a 1970 federal appellate court decision. Given that many publicly traded corporations are incorporated in Delaware, this decision is likely to have a significant impact on the application of the corporate attorney-client privilege.

The case arose in the context of a books-and-records request under Title 8, Section 220 of the Delaware General Corporation Law (DGCL). Indiana Electrical Workers Pension Trust Fund (IBEW), a Wal-Mart stockholder, served a demand for inspection of broad categories of documents relating to reports that a Wal-Mart subsidiary, Wal-Mart de Mexico, S.A. de C.V. (WalMex), had made payments to Mexican officials in exchange for favors, such as zoning changes and rapid processing of licenses and permits, in violation of Mexican and U.S. laws.

To support the request, IBEW relied on DGCL Section 220, which allows stockholders to demand to inspect the books and records of a corporation to investigate possible breaches of fiduciary duty. Wal-Mart refused to turn over certain documents, claiming that they were protected by the attorney-client privilege.

Affirming the Chancery Court’s decision, the Supreme Court concluded that IBEW was entitled to documents responsive to the demand that otherwise may have been protected by the attorney-client privilege. In reaching its conclusion, the Delaware Supreme Court relied on an exception to the attorney-client privilege first recognized in 1970 by the U.S. Court of Appeals for the Fifth Circuit in Garner v. Wolfinbarger. There, the court of appeals held that stockholders of a corporation were permitted to invade the corporation’s attorney-client privilege “in order to prove fiduciary breaches by those in control of the corporation upon a showing of good cause.”

In Garner, the stockholders of First American Life Insurance Company of Alabama (FAL) sued FAL and various officers and directors, alleging both that they were damaged by fraud in the sale and were entitled to recover their purchase price, and also that FAL itself was damaged by the alleged fraud in the purchase and sale of securities. The plaintiffs sought certain documents and testimonial evidence through discovery to establish their claims, some of which the defendants refused to provide as protected by the attorney-client privilege. While recognizing that corporate management must have the tools and protections to allow it to manage, the Garner court reminded the parties that “management does not manage for itself,” rather, “the beneficiaries of its action are the stockholders.” Accordingly, the Garner court refused to allow the corporation to use the attorney-client privilege to shield certain information from stockholders in this context. It concluded,

The corporation is not barred from asserting [the attorney-client privilege] merely because those demanding information enjoy the status of stockholders. But where the corporation is in suit against its stockholders on charges of acting inimically to stockholder interests, protection of those interests as well as those of the corporation and of the public require that the availability of the privilege be subject to the right of the stockholders to show cause why it should not be invoked in the particular instance.

The Delaware Supreme Court not only adopted the Garner doctrine expressly for the first time in connection with IBEW’s demand of Wal-Mart and WalMex, but also ruled that this doctrine applies in the context of plenary stockholder/corporation proceedings, and specifically in section 220 actions. It cautioned, however, that a court must make the following two findings before applying Garner in the context of a section 220 action: first, whether the documents sought “necessary and essential” to the stockholders’ purpose under section 220, and second, whether the stockholders making the demand have demonstrated “good cause.” Only if the documents are deemed “necessary and essential” may the court then apply the Garner doctrine to determine whether the stockholders have demonstrated “good cause.” In making that determination, the court may consider several factors, including whether the plaintiffs have demonstrated a colorable claim and whether the information is available through other means. The Supreme Court affirmed the Chancery Court’s ruling that the plaintiffs clearly established a colorable claim based, in part, on Wal-Mart’s public statements, and that the plaintiffs could not prove their allegations without the privileged materials.

 

— Hope A. Comisky and Jessica K. Davis, Pepper Hamilton LLP, Philadelphia, PA


Copyright © 2015, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).