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From Securities Regulation Daily, January 17, 2019

Papa John’s must allow ousted founder to inspect company documents

By Rebecca Kahn, J.D.

Court finds that Schnatter did not want documents for personal reasons. Documents can include emails and text messages, but must deal with changing Schnatter’s relationship with the company.

In a post-trial decision, the Delaware chancery court ordered Papa John’s to allow its founder and former chairman to inspect certain corporate documents (including emails and texts from personal accounts and devices) in order to investigate alleged corporate mismanagement and fiduciary breach. The court found that the company failed to prove by a preponderance of the evidence that the founder had a personal or otherwise improper purpose for seeking the documents. He therefore is entitled to inspect these documents subject to certain restrictions (Schnatter v. Papa John’s International, Inc., January 15, 2019, Bouchard, C.).

Background. In November 2017, John Schnatter, the founder of Papa John’s International, Inc., (the "company") criticized the National Football League’s handling of the dispute between NFL players and owners over national anthem protests during a company earnings call. Some in the media portrayed Schnatter’s comments about the NFL as racial in nature. In July 2018, Forbes reported that Schnatter used a racial slur during an internal diversity training exercise at the company ("Forbes Article"). That same day, the company’s board asked Schnatter to resign as chairman, which he did. Over the next few days, the board also asked Schnatter to resign as a director of the company, which he declined to do. The board then established a special committee to investigate all of the company’s relationships with Schnatter. Within three hours of its formation, the special committee decided to terminate the company’s agreements with Schnatter.

Demand for access. In the wake of these events, Schnatter made a demand under 8 Del. C. Section 220 in his capacity as a director of the company to inspect 17 categories of documents. Perplexed about why the company made no effort to defend him as the founder and long standing public face of the company from what he believes was unfair treatment by the media, and why the company instead seemed intent on abruptly cutting ties with him without investigating the matter, Schnatter questioned whether his fellow directors had fulfilled their fiduciary obligations.

Actions filed. After the company had largely rejected his demand to access corporate records, Schnatter filed this action. Schnatter filed a second action against the board members who serve on the special committee, asserting claims for breach of fiduciary duty. A one-day trial was held on October 1, 2018.

Document categories. The parties have resolved their disputes concerning all but four categories of documents sought in the demand: certain communications among officers, directors, and counsel referencing Schnatter from October 31, 2017 through the special committee’s formation at a July 15, 2018 board meeting.

No improper purpose shown. The court found that the company failed to prove by a preponderance of the evidence that Schnatter’s purpose for seeking the documents was "personal" or otherwise improper. The company bore the burden of proving by a preponderance of the evidence that Schnatter’s purpose was not "reasonably related" to his position as a director. The court found that the purpose for Schnatter’s demand was to investigate mismanagement of the company by other board members, a well-established proper purpose for a Section 220 books and records inspection.

Objections. The company argued that Schnatter’s demand sought mostly documents about himself; that his complaint conceded that he sought to inspect documents because of the "unexplained and heavy-handed way" the company treated him since the Forbes Article was published; and that Schnatter had conceded at trial that he wanted to "get hold of documents he feels will clear him and his reputation."

Overlapping interests. The court acknowledged that Schnatter’s interests as a director and as an individual often overlap because of the unique public role he has played at the company. He is the founder and largest stockholder, and over the course of his thirty-four-year career with the company, he held virtually every position and ultimately became the public face of the company in print and television marketing. Given his unique role, Schnatter’s concerns that the company made no effort to defend him in response to the controversies arising from his NFL comments and the Forbes Article, and that the company instead appeared intent on abruptly severing ties with him were "relevant concerns that any director would have about the company’s management and oversight," the court wrote.

Additionally, based on Schnatter’s conduct at trial, the court found that his demand arose from a genuine desire to investigate whether the other board members had fulfilled their fiduciary obligations in handling the controversies during the period leading up to the July 15 meeting. Therefore, the company failed to prove that Schnatter’s purpose for the demand was not reasonably related to his position as a director.

Access to documents: shareholder vs. director. The company further contended that Schnatter was seeking documents "to further his current fiduciary suit or to pursue another fiduciary suit." But the company failed to meet its burden to prove that Schnatter’s purpose for seeking the documents is improper based on the assertion of his narrow claim in his fiduciary action, the court decided. A stockholder seeking to inspect such books and records must prove that the documents sought are "necessary and essential" to satisfy a proper purpose. By contrast, a director with a proper purpose "is entitled to virtually unfettered access to the books and records of the corporation," and it is the corporation’s burden to prove that the director’s purpose is not reasonably related to the director’s position as a director.

Importantly, the court wrote, standing to bring a derivative claim has not been extended to a director under Delaware law. Thus, any documents Schnatter obtains in response to his demand may not be used to pursue a derivative claim unilaterally. Schnatter had represented he will not use any documents produced in response to the demand to assert a claim as a stockholder without first obtaining the company’s consent to do so.

Given the significant differences in law between inspection demands made by stockholders and those made by directors, the fact that a director lacks standing to assert derivative claims in that capacity, and the fact that Schnatter agreed not to use any documents produced in response to the demand to file a claim as a stockholder without the company’s consent, the court saw no basis to deny Schnatter access to the documents. The company failed to prove that the alleged acts of mismanagement Schnatter sought to investigate through his demand necessarily concern the same conduct at issue in his fiduciary action.

Scope of production limited. Schnatter limited the potential custodians to the other directors, Ritchie, and the company’s general counsel during the October 31, 2017 to July 15, 2018 time frame. The court found these restrictions reasonable. Each request covers a limited period of less than nine months that began with the earnings call, when the concerns to which Schnatter testified began to arise, and ended with the formation of the Special Committee.

Subject-matter restriction. However, the court limited the production only to the extent such communications reflect any consideration of changing Schnatter’s relationship with the company, which would include assessments of his behavior or performance in his various roles at the company during the specified time period. The court also allowed production of emails and text messages from personal accounts and devices, subject to these subject-matter limitations.

Schnatter is obliged as a fiduciary to protect the company’s information, and confirmed during his trial testimony that he would abide by the board’s confidentiality policy with respect to any documents provided to him in this action. However, the court required the parties to specify that Schnatter would not use the documents produced in response to the demand to assert a claim as a stockholder without first obtaining the company’s consent to do so.

The case is No. 2018-0542-AGB.

Attorneys: Peter B. Ladig (Bayard, PA) for John Schnatter. Blake Rohrbacher (Richards, Layton & Finger, P.A.) for Papa John's International, Inc.

Companies: Papa John's International, Inc.

MainStory: TopStory DirectorsOfficers FiduciaryDuties DelawareNews

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