Corporate Litigation: Show Me The Records!

Business litigation attorneys who represent California corporations are often asked to advise their corporate clients on the rights of shareholders and directors to inspect the corporate records. Usually a request is part of a larger disagreement by a minority shareholder relating to the operation of the company. In smaller corporations, the shareholder dispute may be more akin to a partnership dispute. The request is often a precursor to a breach of fiduciary duty lawsuit or some other type of corporate litigation. Those running the corporation—realizing that a lawsuit or at least a battle for control is brewing—are reluctant to let the dissident shareholders view any records or to share any corporate information with them. For those running the corporation, here are the basic guidelines when responding to a request to inspect documents.

The corporate response should comply with the California Corporations Code requirements. To ensure that you comply with the legal regulations, you should hire an experienced business litigation attorney. More importantly, if this is the opening act of an upcoming shareholder lawsuit, you should consult with a lawyer sooner rather than later so that you can develop a strategy for dealing with the dispute. Because emotions often run high in shareholder and partner disputes in small companies, a corporate litigation attorney may help the corporation analyze the dispute more dispassionately. You may be able to resolve the issue before a lawsuit is filed.

What documents must a corporation maintain?

A corporation must maintain accounting records (adequate and correct books and record of account), tax records (permanent books of accounts or records, including inventory, that are sufficient to establish the information required on its tax returns), shareholders lists (showing names, addresses, number of shares and class of shares), minutes (of meetings of shareholders, the Board of Directors and committees of the Board) and bylaws.

What are a director’s and a minority shareholder’s rights to inspect corporate documents?

Corporate shareholders and directors have a right to inspect the corporate records without the need for a lawsuit. Directors have an absolute right at any reasonable time to inspect corporate books, record and physical properties in order to fulfill their fiduciary duty. A shareholder, on the other hand, has an absolute right to inspect the corporation’s articles and bylaws but has only a limited right to inspect the corporation’s financial records. The shareholder must make a demand that is reasonably related to the shareholder’s interests as a shareholder. The inspection right only includes accounting records and director minutes. The shareholder does not have a right to inspect the corporation’s contracts (such as loan documents and leases) or correspondence.

When will a demand be “reasonably related to the shareholder’s interests as a shareholder”?

Typically, the stated purpose will be to determine the fair value of the shares. This is broad and all-encompassing and so should include a wide variety of documents. The purpose may also be to investigate whether there is malfeasance by management. Often, however, a corporation will have a concern that a shareholder seeks inspection for competitive reasons (i.e., they are establishing a competing business). The most resisted demand is that of the shareholder list. A dissident shareholder often wants to contact other shareholders to force change at the corporation. Management, understandably, does not want the dissident shareholder stirring up trouble. A shareholder owning at least 5% of the stock has an absolute and unconditional right to inspect the shareholder list. Shareholders with less than 5% must, again, show a purpose reasonably related to the shareholder’s interests as a shareholder.

A corporation that refuses to comply with these shareholder inspection rights can be compelled to produce these documents by a court and be assessed a penalty as well. Moreover, the shareholder’s attorney can point to management’s stonewalling in any later lawsuit to show yet another example of how the corporation was trying to cover up its malfeasance or how it was mistreating its shareholders. A corporation’s attorneys should think through how these early skirmishes will reflect on the corporation later during a trial.

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