Document Discovery: The Achilles’ Heel of Shareholder Activism in Europe

Regulators and scholars have recognized the beneficial effects of activism on companies’ performance and value. Numerous initiatives in Europe, such as the proliferation of stewardship principles and codes for institutional investors and reforms strengthening shareholder rights, seek to encourage shareholders to increase their engagement with investee companies and police management. A notable example is the revised Shareholder Rights Directive, also known as SRD II. Policymakers’ attention is thus focused on the one hand on reducing frictions between agents (institutional investors) and their principals (clients and beneficiaries) and on the other hand on removing barriers to the exercise of shareholder rights. Nevertheless, an overlooked but crucial aspect of shareholder activism is document discovery and Europe’s inhibiting legal regime for discovery. Shareholders seeking to challenge conflicted transactions by controlling shareholders and/or management before courts are faced with the insurmountable obstacle of accessing crucial information from the company and third parties, such as investment banks. Evidence of conflicts of interest and self-dealing are usually hidden in financial projections, shareholder agreements, board minutes and resolutions, internal communications and other documents.

Shareholder inspection rights are one potential avenue for shareholders seeking to access information, in order to uncover corporate wrongdoing. Indeed, shareholders in the US are increasingly making use of section 220 of the Delaware General Corporation Law, which allows them to access corporate books and records for a proper purpose, such as investigating suspected mismanagement. It should be noted that inspection rights do not extend to third parties, such as investment banks. Delaware courts have taken an expansive approach to section 220 with shareholders having to demonstrate only some credible basis for suspected wrongdoing and able to access a wide variety of materials, including officers’ personal emails. In contrast, shareholder inspection rights are severely restricted in Europe. For example, in Germany public company shareholders’ inspection rights are limited to asking questions during the general meeting related to a topic on the agenda.

As a result, shareholders in Europe challenging corporate wrongdoing before courts are left with the option of relying on the limited discovery offered by European jurisdictions. A fundamental difference between the US and European civil law systems is the expansive and liberal discovery of American federal civil procedure. Discovery refers to a pre-trial procedure according to which parties to a litigation can obtain evidence, including documents, from opponents. Parties have broad authority to obtain from each other discovery regarding any nonprivileged matter relevant to a claim or defence. Discovery can also be sought from non-parties that are not involved in the proceedings. The discovery process is driven and managed by the parties themselves, which make requests to each other for the disclosure of documents. They have a duty to disclose even documents that can be detrimental to their own case. The court becomes involved only when cooperation between parties breaks down. The discovery process furthers the US system of adversarial litigation by giving both parties the fullest possible knowledge of all facts before trial.

In contrast, European civil law systems follow a fundamentally different approach with US-style discovery being an alien concept. Litigants disclose only the documentary evidence necessary to support their own case. Moreover, parties are not required to disclose damaging documents. Judges are typically granted the power to compel discovery under limited circumstances. Document requests must specifically identify each document sought. For instance, under section 142 of the German Civil Procedure Code, the court may order that a party or a third party disclose specific documents to which one of the parties has referred and that are in the other party's or the third party's possession.

As a result, in Europe there is a significant imbalance between on the one hand corporates and their officers and on the other hand minority shareholders, which seek to challenge conflicted transactions and mismanagement. Shareholders are unable to access crucial documentary evidence in possession of the company, its management and third parties, such as investment banks. A solution that is increasingly used by private actors faced with constraints by their own legal systems is seeking discovery assistance from US courts. Section 1782 of Title 28 of the United States Code authorizes US district courts to order discovery from a person who resides or is found in the district of the court to which an application for discovery is made for use in civil or criminal proceedings in a foreign or international tribunal. Companies with a presence in the US can thus become targets of section 1782 requests. Nevertheless, there is still uncertainty regarding whether discovery from a corporation with presence in the US can target documents located outside the US.

A request can be made by any interested person, including a party to foreign litigation. The applicant need only show that the information has some relevance as a general matter to the foreign proceedings. The courts have wide discretion in deciding whether to grant discovery. In Intel Corporation v. Advanced Micro Devices Inc. the Supreme Court specified four discretionary factors a court must consider namely 1) whether the documents sought are within the non-US tribunal reach and accessible without US assistance, 2) the receptivity of the foreign court to US assistance, 3) whether section 1782 request is an effort to circumvent foreign proof-gathering restrictions and 4) whether the request is unduly intrusive or burdensome. Under the first Intel factor, the court will consider whether the target of a discovery request is a participant in the foreign proceedings. Consequently, the first factor acts as a significant deterrent for shareholders challenging corporations before European courts, which seek US discovery assistance. Courts will consider whether the evidence is within the reach of the foreign tribunal. For example, where a subsidiary is party to a foreign proceeding but the parent is the discovery target, the first Intel factor will weigh against granting the discovery since the evidence is within the tribunal’s jurisdictional reach. Nevertheless, courts typically find that this factor weighs in favour of granting discovery where the target is a not a party to the litigation. For instance, in the context of M&A litigation, shareholders can obtain discovery from a US investment bank, which has provided a fairness opinion.

Overall, the lack of US-style discovery and the limitations of section 1782 discovery have a chilling effect on shareholder activism in Europe. Shareholders are running an uphill battle since most of the evidence needed to prove corporate wrongdoing and mismanagement will be in the possession of corporations, insiders or third parties and often not known to shareholders. This information asymmetry and imbalance of power between corporations and shareholders makes regulatory intervention necessary. It is interesting to note that the European legislator has recognized the issue of information asymmetry in the context of private antitrust proceedings. The Antitrust Damages Directive 2014/104/EU introduced a new regime for the disclosure of evidence in private antitrust proceedings that is influenced by the US system of discovery and seeks to ensure a minimum level of effective access to evidence in private antitrust proceedings throughout the EU. A similar initiative in the area of corporate disputes would significantly enhance investor protection. Finally, the introduction of EU-wide shareholder inspection rights would align with the EU’s goal of strengthening and harmonizing shareholder rights across the EU.

Alexandros Seretakis is Assistant Professor of Law and Fellow Trinity College Dublin.