Can Inspection Rights Be Waived? Some Observations on Delaware Law
As recent decisions from the Delaware courts remind us (e.g., Murfey v. WHC Ventures, LLC), Delaware entities often have the ability to negotiate the scope of investors’ right to inspect company books and records—and perhaps even to eliminate those rights. But few corporations, partnerships, or LLCs appear to do so. With the proliferation of books-and-records litigation in recent years, however, more Delaware entities should consider whether opportunities may be available to limit the potential burden of such litigation and whether it would be prudent to explore those opportunities.
Delaware courts have urged investors for decades to use the “tools at hand” to gather company information. Stockholders and stakeholders in other ventures have heeded that call. Books-and-records actions brought under Section 220 of the Delaware General Corporation Law (or its analogues in the partnership and LLC contexts, 6 Del C. § 17-305 and 6 Del C. § 18-305, respectively) have surged in recent years, from more than 60 in 2015 to nearly 150 in 2020, and have become a staple of the Chancery Court’s docket. Of course, these figures do not reflect the countless books-and-records requests that are resolved without litigation, which anecdotal evidence suggests have followed a similar pattern.
For companies, this can entail significant expense and distraction, often in exchange for little (or no) perceived benefit to the company or its stakeholders. But companies may have opportunities to mitigate these risks by placing limits on inspection rights in their governing documents or through separate contracts. Delaware law suggests that courts would enforce these limits.
One recent example from the alternative entity context is Murfey v. WHC Ventures, LLC. There, the Delaware Supreme Court held that a limited partnership faced with a demand for books and records could not require a showing that each such request was “necessary and essential” to the demanding party’s stated purpose, where the applicable partnership agreement provided for inspection rights and did not “expressly condition” those rights upon satisfying the “necessary and essential” standard.
The partnership might have been entitled to exercise discretion to “cull” information provided to the demanding party, however, had it “set forth . . . standards that pertain to such inspection requests.” And the Court recognized that further restrictions could be imposed on limited partners’ rights to inspect or access information where the partnership agreement provides a basis for the general partner to prevent that access—for example, through a provision that states that “Limited Partners will not be entitled to inspect or receive copies of” specified categories of information.
Just how far the Delaware courts will extend companies’ ability to limit inspection remains an open question. To some degree, the answer may depend on the type of entity at issue and the mechanism through which inspection rights are restricted.
As a general principle, parties may waive statutory rights under Delaware law, provided that the waiver is clearly and affirmatively expressed in the applicable document. And in the partnership and limited liability company context in particular, Delaware’s alternative entity statutes further provide that a party’s right to inspection “may be restricted” in the original governing documents or in subsequent amendments, and that nothing in the applicable inspection statute should be construed to limit the ability to impose such restrictions. Delaware courts have stressed the stated policy of those statutes to give maximum effect to the principle of freedom of contract and to the enforceability of governing instruments, including in circumstances where parties agreed to limit inspection rights or even to modify or eliminate fiduciary duties. Together, this should provide ample grounds to give effect to a waiver of (or at least a restriction upon) statutory inspection rights under the alternative entity statutes.
In the corporation context, Delaware courts have recognized waiver as to several rights set forth in the Delaware General Corporation Law, including stockholders’ appraisal rights under Section 262, rights to end a joint venture or seek liquidation under Section 273, or rights to seek a receivership under Section 291. Although we are not yet aware of a decision holding that stockholders validly waived inspection rights under Section 220, the Court of Chancery has recently suggested (without reaching the issue) that there may be strong considerations to support waiver of inspection rights in some circumstances—including “Delaware’s broad recognition of parties’ ability to waive other important rights, whether constitutional or statutory”—and that other recent Delaware precedent “implies that a stockholders’ agreement could waive statutory inspection rights if the waiver was sufficiently clear.” But the method may be key: though Delaware courts have refused past efforts to limit Section 220 rights through provisions in the corporation’s charter, as the same court noted (again, in dicta), “there are arguments for distinguishing between provisions that appear in those documents and waivers in private agreements.” How Delaware courts will receive those arguments remains to be seen.
As investors increasingly wield the “tools at hand” by pursuing books-and-records litigation, companies should likewise actively evaluate the possible tools at their disposal to reduce the burdens presented by these lawsuits. Among other things, this may include placing limits on investors’ statutory inspection rights, which may be appropriate to consider upon formation, in connection with amendments to governing documents, or in separate negotiations with investors. Options may vary according to the circumstances, and companies should discuss with their counsel the solutions best suited to their context and needs. Although we have seen some recent evidence that corporations and other entities are beginning to adopt these measures, we expect that evidence will continue to grow as more companies evaluate and adapt to these trends—and that the Delaware courts will soon be called upon to resolve the matter conclusively.