Delaware Court of Chancery: "Internal affairs doctrine" bars stockholder from using California Corporations Code to inspect books and records of a Delaware corporation – four takeaways

On August 13, 2020, the Delaware Court of Chancery (Vice Chancellor Travis Laster) issued an opinion in JUUL Labs, Inc. v. Grove,^[1] holding that, because of the “internal affairs doctrine,” a stockholder could not use Section 1601 of the California Corporations Code^[2] to inspect the books and records of a Delaware corporation.

The case arose when Mr. Grove, a former employee of JUUL, was awarded and later exercised stock options.  As part of the grant and exercise of the options, Grove entered into agreements which purported to limit his inspection rights.  Notwithstanding those agreements, on December 27, 2019, Grove demanded to inspect JUUL’s books and records under Section 1601. Ten days later, the company filed suit in the Court of Chancery seeking a declaratory judgment that Delaware law governs Grove’s inspection rights if any existed and that Grove waived his rights to inspection.  The company also sought an order enjoining Grove from pursuing inspection in the California courts.  The next day, Grove filed suit in California state court.

In ruling on cross motions for judgment on the pleadings, Vice Chancellor Laster first rejected the company’s argument that Grove waived his right to inspection under Section 1601 of the California Corporations Code, because the operative grant and the exercise agreements only spoke to Section 220 of the Delaware General Corporation Law^[3] and were not sufficiently broad to encompass Section 1601.  However, the court found that the investor agreements were broad enough to encompass a waiver of Section 1601.  Nonetheless, not only was there a question as to whether Grove was bound by the investor agreements as he may not have received them (despite his representation that he had), he was not covered by the investor agreements because he was not within the definition of a “Holder” in those agreements and did not appear on the exhibit to those agreements as a holder.

Turning to the critical question involving the internal affairs doctrine, the court quoted the United States Supreme Court, which explained that:

The internal affairs doctrine is a conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation’s internal affairs – matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders – because otherwise a corporation could be faced with conflicting demands.^[4]

In interpreting the doctrine, the Court of Chancery held that “[s]tockholder inspection rights are a core matter of internal corporate affairs.”  Noting that “[a]n important public policy served by the internal affairs doctrine is to ensure the uniform treatment of directors, officers, and stockholders across jurisdictions,” the court found that, while superficially similar, “Section 1601 [and related information rights provisions] … balance the relative interests of stockholders and the corporation differently than Section 220.”  After recognizing that states in addition to California provide inspection rights for books and records of foreign corporations, the court reasoned that “a Delaware corporation could be subjected to different provisions and standards in jurisdictions around the country.”  As a result, the court held that under United States Supreme Court and Delaware Supreme Court precedent, “stockholder inspection rights are a matter of internal affairs [and because] Grove’s rights as a stockholder are governed by Delaware law, [he] cannot seek an inspection under Section 1601.”

Applying the Delaware forum selection provision contained in JUUL’s Certificate of Incorporation, the court held that Grove must pursue his case in Delaware.  Notably, the Court of Chancery did not decide the question of whether a stockholder could waive the right to inspect books and records under Section 220.  After a moderately detailed recitation of case law regarding waiver of constitutional and statutory rights, the court determined that because the issue was not briefed and “Grove has not attempted to demand books and records under Delaware law,” the court would “not address this issue.”

Four takeaways

• JUUL demonstrates the power of the internal affairs doctrine and its implications as to the enforceability of other jurisdiction’s laws on Delaware corporations.
• JUUL also shows the importance of Delaware forum selection provisions.
• The facts of JUUL further demonstrate the importance of good corporate record keeping and procedures related to options grants and investor agreements.
• While JUUL does not answer the question of whether a stockholder can waive his rights to inspect books and records under Section 220, it does summarize the competing arguments and policy considerations, and the ultimate resolution of whether a corporation can modify or eliminate mandatory rights expressly set forth in the Delaware General Corporation Law by putting the restriction or elimination in a separate agreement operating independently and outside the charter or bylaws will be of tremendous importance to corporate practitioners.

Find out more about the implications of this decision by contacting either of the authors.