Shareholders of a corporation are often unpleasantly surprised to learn they do not have unfettered access to corporate records and information. In fact, shareholders’ rights to inspect corporate records are limited to two, specific categories of documents, some of which are only available if the shareholder articulates a “proper purpose” for requesting them. Even then, the corporation may refuse if it determines in good faith that disclosure presents a risk to the corporation. And even if it does not refuse the request, the corporation can put reasonable restrictions on the shareholder’s use of the documents.
To avoid disputes or at least to contain them, it is important for all involved to understand the relative rights and obligations of shareholders and corporations when a shareholder seeks corporate records.
The Massachusetts Supreme Judicial Court recently clarified the burden a shareholder must meet to inspect records under the Massachusetts Business Corporation Act, General Laws chapter 156D in Chitwood v. Vertex Pharmaceuticals, Inc. The decision is a good primer for companies, management, corporate counsel and shareholders, and presents a good impetus to brush up on shareholder inspection rights. <<Read more about Chitwood>>
In the context of family and other closely-held businesses, disputes among owners often erupt over disagreements about shareholder information requests.
Owners who work in the business typically have unrestricted access to corporate information. They are busy running the business, expect “outside” shareholders to trust them and may view requests for information as an unwelcome distraction.
Owners who do not work at the company must rely on “insiders” to keep them informed, and often feel that they are being kept intentionally uninformed while the insiders draw salaries, benefits and other company perks. This may give rise to suspicion and mistrust. Tensions run even higher when the owners are family. And suddenly, an issue that started as small as a request for information ends up in costly, multi-year litigation.
It is important for all involved to understand their legal rights and responsibilities when it comes to shareholder information requests before this happens. To avoid disputes, companies should have clear policies that reflect those rights and obligations and should follow them consistently. And when disputes do arise, everyone involved needs to understand how a court will evaluate the shareholder request and the company’s response to it.
The starting point for any analysis of a shareholder’s rights to inspect corporate documents and information is the corporate formation and governance documents – the company’s Bylaws and Articles of Incorporation, or a Shareholders Agreement may include provisions and procedures for shareholders to request and obtain broader access to corporate records and information than is required by law.
In the absence of such a provision, in Massachusetts, General Laws chapter 156D, spells out corporate record-keeping requirements and shareholder inspection rights in sections 16.01 through 16.04.
SHAREHOLDERS MAY INSPECT 2 CATEGORIES OF RECORDS
1. Category One:
Governance documents, ministerial documents regarding share classes and shareholder meetings and actions
Under section 16.02(a), a shareholder may inspect:
The Articles of Organization, Bylaws and all amendments
Resolutions adopted by the Board of Directors creating one or more classes of shares and setting the rights, preferences, and limitations of those classes of shares (where the shares issued are outstanding)
Minutes of all shareholders meetings
Records of all actions taken by shareholders without a meeting for the past 3 years
Written communications to shareholders within the past 3 years, including annual financial statements provided to shareholders for past 3 years
Names and business addresses of the corporation’s current directors and officers
Corporation’s most recent annual report delivered to the Secretary of State
The Shareholder’s Burden
Shareholders have the right to inspect and copy those records, without exception, with 5 days’ advance written notice. There is no good faith or proper purpose requirement.
2. Category Two:
Board actions, accounting records or audited financial statements and related backup, list of shareholders and holdings
Under section 16.02(b), the shareholder may inspect:
Excerpts of minutes reflecting actions taken by the Board of Directors or committee acting in place of the Board
Accounting records, except if the financial statements of the corporation are audited by a certified public accountant, inspection shall be limited to the financial statements and the supporting schedules reasonably necessary to verify any line items on those statements
List of names and addresses of all corporate shareholders, showing the number and class of shares held by each.
The Shareholder’s Burden
To inspect this category of records, the shareholder must (1) show that the demand is made in “good faith and for a proper purpose”; (2) describe with “reasonable particularity” the purpose and the records the shareholder desires to inspect; and (3) show that the records are “directly connected” with that purpose. (G.L. c. 156D, §16.02(c)).
BUT, the corporation may still deny a request for inspection if it determines in good faith that disclosure of the records sought would adversely affect the corporation in the conduct of its business.
WHAT DOES ALL OF THIS MEAN?
- A proper purpose is one that protects the shareholder’s rights as an owner in the corporation and that advances the interests of the corporation itself. A shareholder’s purpose is improper where it is driven by “mere curiosity,” speculation or vexatious motives.
- Good faith paired with proper purpose means that the stated purpose also must be the true purpose for the request.
The requirements that a shareholder state his or her purpose and the records sought with reasonable particularity, and that the records sought be directly connected with that purpose “allow a fact finder to test whether the shareholder’s true purpose is a proper purpose.” If the specified records have no relevant connection to the shareholder’s stated purpose, this may give rise to an inference that the stated purpose for inspection is not the true purpose, and that inspection is sought for another, unstated, improper purpose.
If the corporation refuses a shareholder’s inspection request, section 16.04 allows a court to order inspection (“summarily” for the first category of records and on an “expedited basis” for the rest). If it does so, it must (“shall”) also order the corporation to pay the shareholder’s reasonable costs, including attorney’s fees, associated with enforcing its inspection rights unless the corporation proves it refused inspection in good faith.
Although the statute anticipates swift resolution of inspection lawsuits, they nevertheless often turn into full blown, multi-year litigation. That is just what happened in Chitwood and it is not where any corporation or shareholder wants to end up.
A cautionary tale lies in the SJC’s description of the two plus years of litigation that ensued over a dispute about a shareholder’s inspection request in Chitwood: “Viewed from the perspective of the appellate bench, this was an expensive litigation war of attrition that was fought over nearly nothing.” No matter which side a party is on, no one wants to fight a battle that ends with a description like that from the state’s highest court.
For the company, management and corporate counsel:
The big takeaway is that shareholders have inspection rights and the company should take seriously and be prepared to answer requests for information in a timely and reasonable fashion. The company has the right to protect itself from requests made in bad faith or for an improper purpose and to refuse to turn over information if it determines that production will harm the company or its business. It may charge a reasonable amount for copies or other costs associated with access, it may satisfy the request by electronically transmitting information and it may put reasonable restrictions on the shareholder’s use and dissemination of the information.
If inspection creates a real danger, the company should protect itself. The company should not, however, simply ignore or routinely deny shareholder information requests. It does so at the risk of costly and distracting litigation that may end with a court order to produce all or some of the information, and an order that the corporation pay for the shareholder lawyers and other costs.
For “outside” shareholders:
Ownership does not give shareholders unfettered access to corporate information. Unless there is agreement otherwise, chapter 156D governs in Massachusetts and provides somewhat limited access to shareholders to certain categories of information subject to a certain requirements and potential restrictions. On the other hand, a shareholder is entitled to access information to allow the shareholder to evaluate its ownership interest in the corporation, including, in some instances, by investigating wrongdoing that may affect share value.
A shareholder should consider an inspection request carefully before making it, including what records are needed, whether they fall into the categories spelled out in chapter 156D and what purpose the request will serve. Once these questions are answered, the shareholder should put the request in writing and is well served to omit any accusations against corporate insiders and to separate any anger or other emotions from the request. The request should ideally reference the applicable statute, assert good faith, specify which documents are sought, the purpose for seeking them, and articulate briefly how the documents are tied directly to that purpose. If the purpose for seeking documents is to investigate wrongdoing, this should be stated, but it need not be stated in an inflammatory manner. The point is to create a record of a request that complies with the statute, not to point fingers.
None of this is not to say that shareholders should never ask for information beyond what they are entitled to under the statute. There are times when there is room for negotiation on what is received, shareholders sometimes wear other hats that may entitle them to more information and the company or its management may have reasons to agree to provide more. Each request for information needs to be considered and crafted with the longer view of what happens next.
This is for informational purposes and does not constitute legal advice. Please read our disclaimer.
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