Court of Chancery Sides with Papa John’s Founder on Books and Records Inspection Demand
By Scott Waxman and Will Grossenbacher
John Schnatter’s falling-out with Papa John’s, the company he founded in the back of his father’s bar in Louisville, Kentucky, has been highly publicized since the dispute began in late 2017. Now, the Delaware Court of Chancery has waded into the fray. In John Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), the Court ruled in favor of Schnatter, granting his demand to inspect four categories of the Company’s books and records, subject to certain limitations and exclusions.
The beginning of the dispute between John Schnatter (“Schnatter”) and Papa John’s International, Inc. (“Papa John’s” or the “Company”) can be traced, at least in part, to a November 1, 2017 earnings call. At that time, Papa John’s was the official pizza sponsor of the NFL. During the earnings call, Schnatter, who at that time served as the Company’s CEO, Chairman, public spokesperson, and largest stockholder, blamed the Company’s recent decline in sales on what he deemed the NFL’s “poor leadership” regarding the national anthem protests by NFL players. Schnatter’s comments were widely criticized, and, roughly two months after the earnings call, Schnatter resigned as CEO of Papa John’s on December 31, 2017.
Despite Schnatter’s resignation as CEO at the end of 2017, the Company’s troubles continued in 2018. On February 27, 2018, the NFL terminated its relationship with Papa John’s. The Company’s stock price also continued to decline. Then, on July 11, an article published by Forbes recounted Schnatter’s use of the “N-word” during a conference call in May. Later that day, Schnatter resigned as Chairman at the request of the board of directors of the Company (the “Board”). However, he refused to resign as a director when the Board later requested that he do so.
On July 15, 2018, the Board formed a special committee (the “Special Committee”) that consisted of all of the directors except Schnatter. That same day, the Special Committee voted to terminate the agreement under which Schnatter provided services to the Company as its founder and spokesperson. On July 18, 2018, Schnatter delivered a demand under 8 Del. C. § 220(d) to inspect certain categories of the Company’s books and records, which the Company mostly rejected in its response.
In siding with Schnatter, the Court held that purpose for Schnatter’s demand was reasonably-related to his position as a director of the Company and that the scope of Schnatter’s demand, as limited by the Court, was sufficiently narrow to effectuate that purpose. Under Section 220(d), a director of a corporation has the right to examine the books and records of the corporation “for a purpose reasonably related to the director’s position as a director.” As such, the Company, in disputing this right bore “the burden of proving by a preponderance of the evidence that Schnatter’s purpose” failed to pass this reasonably-related standard.
Although Schnatter presented different variations of his purpose at trial, the Court found that “the stated purpose for his Demand boils down to a single purpose: to investigate mismanagement of the Company by other members of the Board.” In order to dispute the relation between this purpose and Schnatter’s position as a director of the Company, the Company argued that Schnatter’s demand related not to his role as director, but to his “individual status as John Schnatter—founder and stockholder and former Chairman of the Company.” Although, as the Company argued, the demand generally concerned documents personally related to Schnatter, the Court held that the “personal element. . . does not negate that these concerns are legitimate corporate concerns, particularly given that Schnatter’s image and standing has been inextricably intertwined with the Company’s public persona for decades.”
On August 30, 2018, Schnatter filed a second action against the members of the Special Committee alleging breach of fiduciary duties. As such, the Company argued that Schnatter’s subsequently filed fiduciary action against the Company negated the purpose of his inspection demand. In rejecting the Company’s argument, the Court clarified that when the demand is filed by an individual in his role as a director, and the fiduciary action is filed in his role as stockholder, the subsequent action does not negate the demand because of the distinct roles and duties of directors and stockholders under Delaware law.
Delaware courts have previously ruled that a stockholder who files an inspection demand under Section 220 and then subsequently files a plenary action alleging breach of fiduciary duties generally undercuts his initial demand. The reasoning behind this rule is that by filing the plenary action, the stockholder concedes that the books and records covered by the demand are not necessary to his claim of investigating mismanagement because otherwise, he would have filed an action without having conducted a reasonable inquiry, as required by Rule 11, Del R. Civ. Pro. In holding that Schnatter’s fiduciary action did not negate the purpose of his demand, the Court first recognized that no existing authority supported the Company’s position that Schnatter’s stockholder fiduciary action negated the purpose of his director demand. Additionally, the Court looked to the fact that Schnatter has broader rights (and correspondingly broader duties) to inspect the books and records of the company as a director than he does as a stockholder, along the fact that he cannot subsequently bring a derivative action on behalf of the Company as a director. As such, the documents he inspects under the demand cannot be used in his stockholder’s fiduciary action.
Having determined that Schnatter’s purpose in bringing the demand was proper, and notwithstanding his subsequent fiduciary action, the Court turned to the scope of materials Schnatter sought to inspect. Although Schnatter initially demanded to inspect 17 categories of documents, by the time the case reached the Court of Chancery, the parties had resolved outstanding issues with 13 of the 17 categories. The four remaining requests related to director communications regarding the events between the October 31 earnings call and the July 15 formation of the Special Committee, including communications “referring or relating” to Schnatter. Since the Court deemed that all communications “referring or relating” to Schnatter “are not sufficiently related to Schnatter’s purpose of investigating mismanagement,” the Court limited the records “only to the extent such communications reflect and consideration of changing Schnatter’s relations with the Company. Additionally, to the extent that the individuals identified in the demand used personal accounts and devices to communicate about this changing relationship, the Court also ordered that those communications be provided to the Company.
In the Memorandum Opinion, the Court reserved the right to further review any requests for communication between the Special Committee and its outside counsel, subject to confirmation from the parties as to whether this issue had been resolved. In the Final Order, the Court ruled that Schnatter was not entitled to review communication between the Special Committee and its outside counsel, specifically with respect to the two-day period between the time when counsel was contacted regarding the formation of the Special Committee and when the Special Committee was officially formed. (Schnatter did not request documents relating to the time after the Board formed the Special Committee.) The Court reasoned that since outside counsel was only engaged for the purposes of advising the Special Committee, Schnatter had no reasonable expectation that the Special Committee’s counsel would represent him, either individually or as a director, and therefore had no right to review those communications. Other than the conditions and exceptions as previously noted, the Court otherwise found the scope of the materials requested to comport with Schnatter’s purpose, and as such, granted his inspection demand.
