Delaware Chancery Court Rulings Interpret Member Rights to Inspect LLC's Books and Records
Last year I wrote about the uncertainty surrounding the rights of members of New York LLCs to gain access to company books and records primarily due to the paucity of court decisions construing the inspection statute, LLC Law Section 1102 (read here). At the time I knew of only two, significant New York cases on the subject, Matter of Hay and Matter of O'Neill, which took markedly different approaches to the problem.
It's been over a year since, and those apparently remain the only two cases of significance. However, in the last few months there have been several, interesting decisions by the Delaware Chancery Court resolving disputes over access to LLC books and records. (HT: Delaware Corporate and Commercial Litigation Blog) The decisions address important issues concerning standing to seek inspection; the meaning of the phrase "books and records" as commonly used in inspection provisions in operating agreements; whether the right of access includes the right to photocopy records; and, perhaps most importantly, the degree to which a court will scrutinize the "proper purpose" basis for the member's inspection demand. Given the similarities between the Delaware and New York statutes, these decisions could be persuasive in resolving books and records actions in the New York courts. Here's a summary:
1. Court may consider evidence outside the operating agreement to determine if party is a "member" entitled to demand access to books and records.
Section 18-305(a)(1) of Delaware's LLC Act gives each LLC "member" defined rights to obtain LLC records, as does its New York counterpart. In a letter ruling in Mickman v. American International Processing, LLC, Del. Ch. C.A. No. 3869-VCP (Apr. 1, 2009), Vice Chancellor Parsons denied the defendant LLC's motion for summary judgment seeking to dismiss a books and records action on the ground that the plaintiff was not listed as a member in the operating agreement and therefore lacked standing under the statute. The plaintiff, who was divorced from one of the two members identified in the operating agreement, submitted an LLC tax return identifying her and her ex-husband as co-owners of a membership interest. She also submitted her ex-husband's Offer in Compromise to the IRS in which he stated under oath that his "only assets are his house . . . and stock in a number of closely held companies owned jointly by Taxpayer and his wife."
Continue Reading...Court Orders Hearing On Minority Shareholder's Petition for Common Law Dissolution
Minority shareholders in closely held New York corporations, unlike many other states, must hold at least 20% of the corporation’s voting shares to petition for judicial dissolution on grounds of oppression under Section 1104-a of the Business Corporation Law. There’s little if any legislative history to explain the arbitrary 20% threshold. I imagine it was included as a compromise to satisfy legislators opposed to judicial interference with traditional corporate majority rule.
Shareholders with less than 20%, and without any claim for breach of shareholders' agreement, have limited options to right perceived wrongs by the controlling shareholders. They may bring a derivative action under BCL Section 626 for corporate waste, diversion of assets or other wrongs causing injury to the corporation, but first they either must make proper demand upon the board of directors or demonstrate demand futility. BCL Section 627 also requires a derivative plaintiff-shareholder with less than a 5% interest to give security for the corporation's costs including legal expenses. Furthermore, depending on the circumstances, commencing a plenary action for breach of shareholders' agreement or asserting derivative claims for recovery on the corporation's behalf may not provide sufficient leverage to induce a buy-out of the plaintiff's shares, assuming the plaintiff is pursuing an exit strategy.
The below-20% shareholder has one other option: common law dissolution. It carries no minimum ownership percentage. It's harder to establish than statutory oppression under BCL 1104-a, and rarely successful, but under the right circumstances it may give such a shareholder at least a toe-hold toward dissolution, which also may be enough to induce serious buy-out negotiations.
A recent decision by Queens County Commercial Division Justice Orin R. Kitzes presents one of the relatively rare instances in which a claim for common law dissolution successfully advances past the pleading stage. The case, Matter of Mouzakitis (Pearl Nightlife, Inc.), Index No. 28420/08 (Sup Ct Queens County Feb. 24, 2009), was previously featured on this blog when the court initially dismissed without prejudice a common law dissolution petition because the plaintiff's husband, who co-owned the shares as tenants by the entirety, was not a party to the action. Husband and wife thereafter filed a new action as co-plaintiffs, again suing for common law dissolution.
Continue Reading...Court Adds Accounting Remedy to LLC Members' Arsenal
A year ago, in Tzolis v. Wolff, 10 NY3d 100 (2008), New York's highest court recognized the common law right of LLC members to bring a derivative action on the LLC's behalf. Late last month, in Gottlieb v. Northriver Trading Co., LLC, 58 AD3d 550 (1st Dept 2009), an intermediate appellate court cited Tzolis in support of its decision recognizing the right of LLC members to seek an equitable accounting under common law.
The "equitable action on account" has a rich legal history in early English and American law, reflecting a time when forms of pleading and the scope of judicial powers made sharp distinctions between actions "at law" and those "in equity." In modern usage, the accounting action allows a trust beneficiary, partner, etc. to compel a fiduciary entrusted with property to render an account of his or her actions and for the recovery of any balance found to be due. The accounting involves more than simply turning over existing financial records. In New York practice, if the court grants an accounting, it may order the fiduciary to prepare a "long accounting" with detailed schedules of income and expenses over a defined period, followed by the filing of objections to the accounting, followed by proceedings before a court-appointed referee to hear and determine the accounting. (To view a form of order of reference to determine an account, click here.)
Continue Reading...Statute and Cases Create Uncertainty Over LLC Member's Right to Inspect Books and Records
Strained relations between managing and non-managing members of limited liability companies (LLC) sometimes lead to fights over the former's denial to the latter of access to company records. Section 1102 of the New York Limited Liability Company Law (LLCL) sets forth a three-part scheme governing the maintenance of, and member access to, LLC records.
The first part, Section 1102(a), requires that every LLC maintain five specific categories of records:
(1) if the limited liability company is managed by a manager or managers, a current list of the full name set forth in alphabetical order and last known mailing address of each such manager;
(2) a current list of the full name set forth in alphabetical order and last known mailing address of each member together with the contribution and the share of profits and losses of each member or information from which such share can be readily derived;
(3) a copy of the articles of organization and all amendments thereto or restatements thereof, together with executed copies of any powers of attorney pursuant to which any certificate or amendment has been executed;
(4) a copy of the operating agreement, any amendments thereto and any amended and restated operating agreement; and
(5) a copy of the limited liability company's federal, state and local income tax or information returns and reports, if any, for the three most recent fiscal years.
Note that the preceding list limits financial information to recent tax returns. This becomes more important under the second part, Section 1102(b), which provides for member access to LLC records including all the records mandated under Section 1102(a), as follows:
Continue Reading...Any member may, subject to reasonable standards as may be set forth
in, or pursuant to, the operating agreement, inspect and copy at his or her
own expense, for any purpose reasonably related to the member's interest
as a member, the records referred to in subdivision (a) of this section, any
financial statements maintained by the limited liability company for the three
most recent fiscal years and other information regarding the affairs of the
limited liability company as is just and reasonable.
