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Delaware Supreme Court Rules Shareholders Can Pierce Corporation’s Attorney-Client Privilege for Good Cause

2/27/15

By: Michael Wolak, III

The attorney-client privilege is a fixture in American jurisprudence and the oldest recognized privilege.  The privilege, however, is not absolute.  The Delaware Supreme Court recently adopted an exception to the attorney-client privilege that gives shareholders the pre-litigation right to inspect privileged and otherwise inaccessible internal investigation documents upon a showing of “good cause.”  Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, 95 A.3d 1264 (Del. 2014).  Wal-Mart is a cautionary reminder of how fragile the privilege is where shareholders, purporting to act derivatively on behalf of the corporation, seek internal documents to corroborate their claim that directors or officers breached their fiduciary duties to the corporation.

Wal-Mart involved a demand by IBEW (a Wal-Mart stockholder) under Delaware law to inspect Wal-Mart’s records concerning an alleged bribery scandal involving Wal-Mart’s Mexican subsidiary.  IBEW’s stated purpose for its demand was to investigate the possibility of mismanagement and breaches of fiduciary duty by Wal-Mart executives in connection with the bribery allegations, and to determine whether pre-suit demand on the Wal-Mart board would be futile as part of a derivative lawsuit on behalf of the corporation.  In response to Wal-Mart’s production, which withheld certain documents based on the attorney-client privilege and/or work product doctrine, IBEW filed a lawsuit pursuant to Section 220 of the Delaware Code to enforce its inspection rights as a shareholder.  IBEW claimed that Wal-Mart’s production was deficient and that privileged documents were necessary to determine whether the company’s directors and officers had knowledge of the bribery allegations and breached their fiduciary duties.

The Court of Chancery held that IBEW was entitled to documents protected by the attorney-client privilege and ordered Wal-Mart to produce its internal investigation documents concerning the bribery allegations, including officer-level documents that were never provided to Wal-Mart’s board or to any executive committee.  In ordering production of privileged documents, the Court of Chancery invoked the “Garner Doctrine,” which was articulated in a 1970 decision of the Fifth Circuit Court of Appeals that recognized a fiduciary duty exception to the attorney-client privilege.  Garner v. Wolfinbarger, 430 F.2d 1093, 1103-04 (5th Cir. 1970).  Garner held that shareholders suing derivatively to redress alleged breaches of fiduciary duties by officers and directors can pierce the corporation’s attorney-client privilege upon a showing of “good cause.”  The Garner court listed several factors that should be considered when evaluating whether the plaintiff has shown “good cause,” including:

• The number of shareholders and stock percentage they represent;
• The bona fides of the shareholders;
• The nature of the shareholders’ claim and whether it is “obviously colorable;”
• The apparent necessity of the information and its availability from other sources;
• Whether the alleged misconduct is criminal in nature; and
• The extent to which the communications are identified, or whether the shareholders are “blindly fishing.”

The Delaware Supreme Court affirmed the Chancery Court’s invocation of the Garner doctrine, finding that IBEW showed “good cause” to invade the privilege because, among other factors, the information sought by IBEW concerned the board’s handling of the bribery allegations, including whether a cover-up took place, and was “necessary and essential” to IBEW’s proper purposes.

The Wal-Mart decision is critical for many reasons.  First, the Delaware Supreme Court directly endorsed Garner for the first time, holding that the doctrine “should be applied in plenary stockholder/corporation proceedings” and Section 220 actions.  Prior to Wal-Mart, the Delaware high court had only tacitly endorsed the doctrine in dicta on two prior occasions.  Second, the Wal-Mart Court made clear that the Garner doctrine’s fiduciary exception to the attorney-client privilege is “narrow, exacting, and intended to be very difficult to satisfy,” and does not apply to work product.  The Court’s directive helps achieve a proper balance between the competing interests at play – the encouragement of full and frank communication between attorneys and their clients, on the one hand, and the protection of the interests of stockholders, the corporation, and of the public, on the other hand.

Despite the grudgingly narrow standard emphasized by the Court, it remains to be seen what impact Wal-Mart will have in the area of derivative and D&O claims and whether other states will follow Delaware and endorse the Garner doctrine.  Garner has rarely been followed by courts.  For example, California rejects the Garner doctrine and precludes shareholders from discovering privileged information and documents despite good cause.  Holes v. Superior Court, 157 Cal. App. 3d 1199 (1984).  Wal-Mart, however, may trigger an increase – in Delaware and in other jurisdictions – in shareholder derivative actions and shareholder demands to inspect corporate records concerning purported corporate mismanagement and/or breaches of fiduciary duty.  An increase in such claims could lead other jurisdictions to endorse the Garner doctrine, especially because corporate decisions from Delaware courts often influence the corporation law adopted by other jurisdictions.

As we await the judicial impact of Wal-Mart, there are cautionary takeaways that need no waiting.  As shareholders continue to scrutinize the actions and inaction of directors and officers concerning compliance issues, corporate decision-makers (including corporate counsel) should not assume that internal investigation materials related to possible corporate misconduct or other wrongdoing are protected from disclosure in pre-suit discovery.  Corporate counsel must be cognizant of the fact that a court may order the disclosure of privileged investigation materials and communications to shareholders seeking to substantiate their claim of breach of fiduciary duty.  With that risk of disclosure in mind, and to avoid allegations or proof that the board was deprived of its ability to take effective remedial action to protect the company’s interests, corporations should implement internal control measures designed to ensure that internal investigations are handled with proper oversight by high level officers and directors, and that all material information concerning possible corporate violations or misconduct is shared with the board.