The City of Cambridge Retirement System v. Universal Health Services, Inc.

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

THE CITY OF CAMBRIDGE )
RETIREMENT SYSTEM, )
)
Plaintiff, )
) C.A. No. 2017-0322-SG
v. )
)
)
UNIVERSAL HEALTH SERVICES, )
INC., )
)
Defendant. )

MEMORANDUM OPINION

Date Submitted: July 10, 2017
Date Decided: October 12, 2017

Stuart Grant, Michael J. Barry, Irene R. Lax, of GRANT & EISENHOFER P.A.,
Wilmington, Delaware; OF COUNSEL: Mark Lebovitch, David Wales, and David
MacIsaac, of BERNSTEIN LITOWITZ BERGER & GROSSMANN LLP, New
York, New York, Attorneys for Plaintiff.

Joseph C. Schoell, Ryan T. Costa, of DRINKER BIDDLE & REATH LLP,
Wilmington, Delaware; OF COUNSEL: Gary A. Orseck, Matthew M. Madden, and
Joshua S. Bolian, of ROBBINS, RUSSELL, ENGLERT, ORSECK, UNTEREINER
& SAUBER LLP, Washington, D.C., Attorneys for Defendant.

GLASSCOCK, Vice Chancellor
 This action concerns a demand for inspection of books and records, to

investigate corporate wrongdoing for purposes of potential derivative litigation.1

Defendant Universal Health Services (“UHS”) is the owner and operator of hundreds

of acute care hospitals, outpatient facilities, and behavioral health facilities across

thirty-seven states and several countries.2 Plaintiff The City of Cambridge

Retirement System (“Cambridge”) is a current and former stockholder of UHS.3

Currently before me is a question about the limitations of judicial discretion under

Section 220(c) of the Delaware General Corporation Law (“DGCL”). 4 That statute

conveys on this Court discretion to “prescribe any limitations or conditions” on the

inspection of corporate records by a demanding stockholder “as the Court may deem

just and proper.” Our Supreme Court has already interpreted this broad grant of

discretion as encompassing a requirement, for instance, that should subsequent

litigation rely on records so obtained, the venue of that litigation shall be this Court.5

Here, the Defendant requests a requirement that a complaint in any subsequent

litigation relying on corporate records produced in this litigation be deemed to

incorporate by reference all such records produced.6 In other words, the Defendant

1
8 Del. C. § 220 (“Section 220”); Verified Complaint Pursuant to 8 Del. C. § 220 to Compel
Inspection of Books and Records (the “Compl.” or “Complaint”) ¶ 4–5.
2
Compl. ¶ 14.
3
Id ¶ 13.
4
8 Del. C. § 220(c).
5
United Techs. Corp. v. Treppel, 109 A.3d 553, 559 (Del. 2014).
6
Id. ¶ 9; Def.’s Opening Br. on the Incorporation Condition 1 (stating that the incorporation-by-
reference provision issue is “likely dispositive”) (“Def.’s Opening Br.”).

1
(via its directors) wishes to be able to rely on all documents produced in this action

to support any hypothetical motion to dismiss an anticipated derivative complaint.7

This Memorandum Opinion examines that narrow issue. For the reasons that follow,

I find that the condition requested is within my discretion under the statute, and that

imposing the restriction here is just and proper under these circumstances.

I. BACKGROUND FACTS

A December 2016 article in an online publication, BuzzFeed,8 described

purported misconduct by UHS9 and led to the Plaintiff’s Section 220 demand10 and

several other actions.11 The Plaintiff alleges that UHS illegally committed patients

by “lur[ing] [them] into behavioral health facilities using advertisements for free

wellness examinations . . . [and] trick[ing] patients into implying they harbored

suicidal thoughts.”12 UHS then allegedly maximized the patients’ insurance

payments “until their insurance benefits ran out . . . even if there were no legitimate

mental health considerations” for the continued stay.13 The Plaintiff further

7
The allegations here, which I note are allegations only, and stoutly denied by the Defendant, are
that the company manipulated vulnerable people into unnecessary inpatient psychiatric treatment,
draining their insurance benefits thereby. If true, in addition to being morally despicable behavior
by the individuals responsible, this would represent the worst abuse of a Delaware corporate
franchise of which I am aware.
8
Compl. ¶ 18; Transmittal Aff. of Irene R. Lax in Support of Pl.’s Opening Br. Ex. 2.
9
Compl. ¶ 18.
10
Id. ¶¶ 5, 18, 20.
11
Pl.’s Opening Br. 14; Def.’s Opening Br. 3 (“Based on the story, a securities class action and a
derivative action were filed” along with three requests to inspect UHS’s books and records
(including Cambridge)).
12
Compl. ¶ 15.
13
Id.

2
describes investigations by several federal agencies for improper billing and other

claims.14 The Plaintiff seeks to determine “whether the board of directors of [UHS]

. . . violated its duties by approving and/or endorsing” the alleged illegal activities

and to “investigate the independence and disinterest of the Board . . . [to] determin[e]

whether pre-suit demand is necessary.”15

A. The Plaintiff’s Section 220 Demand

The Plaintiff sent a demand letter and confidentiality agreement to the

Defendant on March 9, 2017.16 The Defendant responded on March 17, 2017

(“March 17 Letter”)17 with a competing confidentiality agreement and again on April

3, 2017 (“April 3 Letter”) by stating that the Plaintiff lacked a “credible basis to

suspect wrongdoing” or “any other proper purpose” for the inspection.18 The

Defendant contested the scope of the Plaintiff’s demand as overbroad but offered to

produce certain documents if the Plaintiff would agree to the Defendant’s

confidentiality agreement.19 The Defendant’s confidentiality agreement included an

incorporation-by-reference provision (the “Incorporation Condition”) which stated:

[T]he Stockholder agrees that the complaint in any derivative lawsuit
that it files relating to, involving or in connection with the Inspection
Demand or any Confidential Inspection Material, shall be deemed to
incorporate by reference the entirety of the books and records of

14
Id. ¶¶ 3, 16.
15
Id. ¶ 4.
16
Id. ¶¶ 5–6.
17
Id. ¶ 6.
18
Id. ¶ 7.
19
Id. ¶¶ 7–8.

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 which inspection is permitted.20

The Plaintiff refused to agree to the Incorporation Condition and the Defendant

refused to produce any documents.21 The Defendant points out that the other two

stockholders with Section 220 demands have agreed to an Incorporation Condition.22

The Plaintiff seeks to compel inspection of the Defendant’s books and records

without agreeing to the Incorporation Condition.23

The Plaintiff filed its Complaint to compel inspection of books and records

pursuant to Section 220 and a motion to expedite on April 26, 2017. On a May 8,

2017 teleconference, I agreed to resolve the Incorporation Condition issue on

opening and answering briefs.24 Other issues in the matter were resolved by the

parties, and I consider the matter submitted as of July 10, 2017.

II. STANDARD OF REVIEW

Section 220 of the DGCL allows stockholders of a Delaware corporation to

inspect the books and records of a corporation for any proper purpose.25 Section 220

inspections are a “qualified”26 right used to “maintain a proper balance between the

rights of shareholders to obtain information based on credible allegations of

20
Id. ¶ 23.
21
Id. ¶ 10.
22
Pl.’s Opening Br. 14; Def.’s Opening Br. 3–4.
23
Compl. ¶¶ 28–32.
24
May 8, 2017 Telephonic Scheduling Conference on Pl.’s Mot. to Expedite Tr. 6:1–4.
25
8 Del. C. § 220.
26
United Techs., 109 A.3d at 559.

4
corporation mismanagement and the rights of directors to manage the business of

the corporation without undue interference from stockholders.”27 The Court of

Chancery possesses “broad power”28 to impose “other conditions as the Court deems

appropriate”29 on those inspections through consideration of “case-specific

factors.”30 Section 220 actions should be “streamlined, summary proceedings that

do not get bogged down in collateral issues”31 and that “help[] balance [corporate]

rights against those of the [stockholder]”32 while remaining cognizant of the costs of

these inspections to stockholders33 and corporations.34

III. ANALYSIS

The Court of Chancery may impose “conditions as the Court deems

appropriate,”35 which may vary36 but include confidentiality orders,37 subsequent

27
Seinfeld v. Verizon Commc'ns, Inc., 909 A.2d 117, 122 (Del. 2006).
28
United Techs., 109 A.3d 553, 554 (Del. 2014).
29
8 Del. C. § 220(c).
30
United Techs., 109 A.3d at 559 (including the investment the corporation made in defending
prior litigation, producing documents for the current § 220 action and the potential for excessive
costs in further litigation).
31
United Techs., 109 A.3d at 561.
32
Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 798 (Del. Ch. 2016).
33
See United Techs., 109 A.3d at 559.
34
See Yahoo!, 132 A. 3d at 798.
35
8 Del. C. § 220(c).
36
See United Techs., 109 A.3d at 562 (“[W]e recognize that the circumstances in which books and
records are sought are diverse, and the Court of Chancery should therefore exercise its traditional
care in evaluating the factors relevant to the specific application before it in determining on remand
whether to impose the requested use restriction.”).
37
See, e.g., Disney v. Walt Disney Co., 857 A.2d 444, 448 (Del. Ch. 2004) (“[I]t is often the case
that the Court of Chancery will condition its judgment in Section 220 cases on the entry of a
reasonable confidentiality order ‘to prevent the dissemination of confidential business
information to ‘curiosity seekers.’’’).

5
forum restrictions,38 and incorporation-by-reference conditions.39 Imposition of the

latter condition has the result that all documents so produced are deemed

incorporated in a subsequent complaint, and thus fair game for citation and reliance

in a motion to dismiss. Imposition of such a condition has been found appropriate

in previous cases in this Court under Section 220,40 on the ground that it

appropriately permits a defendant to respond to “cherry-pick[ed] documents” that

are taken “out of context,” by pointing the Court to other documents already

produced for assistance in determining the reasonableness of inferences drawn in

any follow-on complaint.41 In this way, “the Incorporation Condition resembles an

approach that Delaware decisions have taken when ruling on motions to dismiss after

plaintiffs have taken expedited discovery in support of preliminary injunction

applications.”42

A requested Incorporation Condition in connection with Section 220,

therefore, to the extent found proper, is directed to the salutary ends of judicial and

litigants’ economy. It provides a remedy for the unreasonable anti-contextual use of

38
United Techs., 109 A.3d at 558.
39
See, e.g., Elow v. Express Scripts Holding Co., 2017 WL 2352151, at *1 (Del. Ch. May 31,
2017).
40
Yahoo! Inc., 132 A.3d at 797 (permitting “a court to review the actual document to ensure that
the plaintiff has not misrepresented its contents and that any inference the plaintiff seeks to have
drawn is a reasonable one.”); Reiter on Behalf of Capital One Fin. Corp. v. Fairbank, 2016 WL
6081823, at *5 (Del. Ch. Oct. 18, 2016).
41
Yahoo! Inc., 132 A.3d at 797.
42
Id. at 798.

6
a limited subset of the documents produced, in support of a complaint untenable

when examined under the full universe of documents obtained. In explaining its

current judicial pharmacology, this Court has noted the efficacy of an incorporation

requirement; it provides the Court an alternative to relying solely on the “strong

medicine”43 of Rule 11 where a plaintiff “takes a document out of context” and

“insists on an unreasonable inference that the court could not draw if it considered

related documents.”44 An Incorporation Condition, in that case, allows the Court the

context to address the merits of the situation under the milder and more broadly

applicable regimen of the motion to dismiss.45 Well-pled claims remain

unperturbed.46 The fundamental pleading standards for Rule 12(b)(6)47 and Rule

23.148 motions also remain unchanged and the plaintiff continues as the master of

her complaint.49

The Court of Chancery clearly has discretion to require an Incorporation

Condition in a Section 220 demand, as described above.50 The question before me

43
Id. at 799.
44
Id. at 798.
45
See id. at 799. (“The more common case will involve a plaintiff's counsel seeking to draw an
unreasonable inference by citing a document in isolation, not in bad faith but perhaps over-
zealously in the belief that the document reveals more than it does.”).
46
See id.
47
Id. at 798 (“The Incorporation Condition does not change the pleading standard that governs
a motion to dismiss.”) (emphasis in original).
48
Id. at 798 (“The same [unchanged standard] applies for a Rule 23.1 motion.”).
49
Id. at 797 (“A plaintiff generally is master of its complaint and can choose what it wants to
plead.”).
50
See, e.g., Yahoo! 132 A.3d at 797.

7
is whether I should do so here. This Court has imposed Incorporation Conditions in

connection with several recent Section 220 demands.51 The Plaintiff argues that such

conditions are pernicious, in that they permit companies to manipulate the universe

of documents produced and thereafter frustrate prosecution of meritorious cases52 by

“promising only to produce a self-selected subset of documents of [their] choosing,

without any punishment for failing to produce [harmful] documents.”53 Of course,

a similar argument could be made about the record on a motion for summary

judgment, for instance; it is possible that a defendant may receive a judgment

wrongfully by withholding inculpatory documents from discovery, in bad faith. The

Plaintiff’s point here is that in a Section 220 demand, a stockholder has substantially

less ability to test the sufficiency of production, compared with a litigant receiving

discovery. Assuming that this is so, does the risk of such potential malfeasance

outweigh the benefits of allowing the court to eliminate complaints involving

misleading citations to a limited subset of records? Our Court has several times

answered that question in the negative.54 The Plaintiff has given me no persuasive

reason to distinguish those cases or to depart from that precedent.

51
See, e.g., Elow, 2017 WL 2352151, at *9.
52
See Pl. Opening Br. 11–12, 17 n.18; Pl. Answering Br. 1, 5.
53
Pl. Opening Br. 17 n.18.
54
See, e.g., Yahoo!, 132 A.3d at 798 (Vice Chancellor Laster); Elow, 2017 WL 2352151, at *1
(Vice Chancellor Montgomery-Reeves); Gamco Asset Mgmt. Inc. v. iHeartMedia Inc., 2016 WL
6892802, at *5 (Del. Ch. Nov. 23, 2016) (Vice Chancellor Slights).

8
 The imposition of an incorporation condition is in any particular case within

this Court’s discretion. The concerns raised by the Plaintiff here are not frivolous.

On balance, however, I find that the interests of judicial and litigants’ economy

outweigh the potential detriment to which the Plaintiff points. As noted, the standard

for dismissal in any follow-on complaint remains plaintiff friendly, and this Court, I

think, can through proper application of that standard eliminate much of the risk of

gamesmanship and improper dismissal that concern the Plaintiff here.

IV. CONCLUSION

For the foregoing reasons, I grant the Defendant’s request that production of

document here be subject to an incorporation condition. The Parties should confer

on the appropriate language for such a condition, provide an appropriate order, and

inform me of any remaining issues in this matter.

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