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:
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.
The third part, Section 1102(c), authorizes limitations on member access to LLC records to protect trade secrets and other confidential information, if set forth in the operating agreement, as follows:
If provided in the operating agreement, certain members or managers shall have the right to keep confidential from other members for such period of time as such certain members or the managers deem reasonable, any information which such certain members or the managers reasonably believe to be in the nature of trade secrets or other information the disclosure of which such certain members or the managers in good faith believe is not in the best interest of the limited liability company or its business or which the limited liability company is required by law or by agreement with a third party to keep confidential.
It’s worth taking a moment to compare Section 1102 to its counterpart under the New York Business Corporation Law (BCL). BCL Section 624 is less generous than LLCL Section 1102 in its specification of the types of records that shareholders may inspect, although courts also have recognized a broader, common-law right of inspection of corporate records. Section 624 also sets forth a more complicated procedural apparatus for asserting inspection rights, including a requirement that the shareholder furnish an affidavit that the inspection is not desired for any purpose other than the business of the corporation, and that the shareholder has not within five years sold or offered to sell a list of the corporation’s shareholders. LLCL Section 1102 has no affidavit requirement. Section 624, unlike Section 1102, also contains express authorization for a spurned shareholder to commence a special proceeding by order to show cause to enforce inspection rights.
My case research has uncovered only two decisions in proceedings by a non-managing LLC member to enforce inspection rights under LLCL Section 1102. The earlier of the two cases, Matter of Hay, Index No. 602587/06 (Jan. 16, 2007) (read decision here), arose from a family business dispute involving several real estate companies organized as LLCs in which the petitioners, John Hay and his Trust, held a one-third interest. Petitioner’s brother, Henry Hay, managed the LLCs. Prior to commencing the proceeding, John demanded that Henry permit inspection of various records including operating statements, lease-related documents, loan documents, appraisals, documentation of company expenses, and meeting minutes, articles of organization, etc. Petitioners claimed that the documents were needed to investigate possible mismanagement by Henry. Henry initially objected to the demand as burdensome, overbroad and harassing. Subsequently he turned over some of the records and agreed to produce the balance requested but only on condition that John pay charges for the time and expenses incurred by the LLCs’ management company and accounting firm, as well as copying expenses. John rejected the conditions and commenced the legal proceeding. Henry maintained his willingness to provide all the requested records upon the previously stated conditions, and asked the court to deny the petition if John refused to accept them.
In a decision by Justice Marilyn G. Diamond of the New York County Supreme Court, the court held that John failed to justify the broad scope of his inspection demand and did not adequately explain his refusal to absorb the expenses identified by Henry. The court ordered that Henry was entitled to inspect, at his expense, only those items falling within the five document categories specified in LLCL Section 1102(a), stating as follows:
Here, petitioners suggest that the phrase “just and reasonable” [as used in LLCL Section 1102(b)] should be broadly interpreted so as to allow them the right to inspect records which go well beyond the scope of the type of documents detailed in the Limited Liability Company Law. The court declines to do so. Petitioners have not offered any justification for their request to inspect documents such as leases, invoices and checks other than a vague interest in investigating the possibility that Henry Hay has defrauded or mismanaged the companies. Indeed, petitioners have offered no proof of any wrongdoing by Henry Hay and have not explained why the information they seek would not be available in a lawsuit and/or in an arbitration proceeding which is already pending and apparently involves at least some of the same parties. Petitioners also have not adequately explained the basis for their rejection of respondents’ offer to produce the documents at petitioners’ expense given that the statute itself provides that it is the requesting member who must bear the expense of any such inspection. Under the circumstances, petitioners’ inspection of records maintained by the three LLC respondents should be limited to the five categories of documents specifically mentioned in section 1102(a) of the Limited Liability Company Law and the inspection must be at their expense.
A more liberal approach to inspection rights of non-managing LLC members is reflected in the second decision, Matter of O’Neill, Index No. 15126/06 (May 9, 2007) (read decision here). In O’Neill, two non-managing members of an LLC, each with a 5% interest, brought a Section 1102 special proceeding to obtain access to the LLC’s books and records. The LLC operated a nursing home. The petitioners alleged that the LLC’s managing director improperly entered into a management contract with a certain third party in violation of Department of Health regulations. Petitioners contended that the contract jeopardized the LLC’s ability to acquire interests in other nursing homes. They also contended that inspection of records was needed because the managing director had sold, or was in the process of selling, his membership interest to the third party in violation of petitioner’s first refusal rights under the operating agreement.
The company opposed the petition. It argued that the petitioners offered no proof of the management contract’s illegality or of any sale or impending sale of the director’s membership interest. It also argued that the operating agreement gave the managing director full discretion to enter into management contracts. It further argued that petitioners were entitled to inspect only those documents specified in LLCL Section 1102(a)’s five categories.
The court’s ruling, by Justice Leonard B. Austin of the Nassau County Supreme Court Commercial Division, rejected the company’s restrictive reading of inspection rights and emphasized Section 1102(b)’s broadening of those rights beyond the five Section 1102(a) categories, to include inspection of financial statements “and other information regarding the affairs of the limited liability company as is just and reasonable”. Here’s the decision’s key passage:
Limited Liability Company Law Section 1102(b) also gives any member of a limited liability company the right to inspect all of the limited liability company’s records so long as such inspection is reasonably related to the member’s interest. See, 16 NY Jur2d Business Relationships Section 2070. Restrictions on a member’s right to inspect the records of a limited liability company must be contained in the operating agreement. Limited Liability Company Law Sections 1102(b), (c). Respondent does not assert any of these limitations are relevant to this application.
Respondent’s assertion that petitioners must demonstrate a need to review the records before such records are made available is without merit. The only statutory requirements for obtaining full access to the records is that the person demanding access is a member at the time the demand is made and that the demand is reasonably related to the member’s interest.
Under this standard, Justice Austin had no trouble finding that the O’Neill petitioners’ request for inspection based on their stated concerns, over the third-party management contract and possible impairment of their first refusal rights, was reasonably related to their membership interest.
It is possible to reconcile the different outcomes in Hay and O’Neill, if for no other reason, based on the refusal by the petitioners in Hay to pay the inspection expenses. The fact that there was a concurrent arbitration in Hay may also have suggested to the court that the proceeding was being used to bypass discovery restrictions in the arbitration. Nonetheless, it is hard to ignore the disparate approaches taken by the two courts on the core issue of statutory inspection rights under LLCL Section 1102. Hay places the burden squarely on the member seeking inspection to justify access to company records beyond the five categories listed in Section 1102(a). In contrast, O’Neill presumes broad inspection rights of all company records and places the burden on the company to justify restrictions based on either the operating agreement’s provisions or the need to maintain confidentiality, as provided in Sections 1102(b) and (c).
New York’s LLC Law is “only” 14 years old. Like so many other issues under the LLC Law, it will take more time for the courts to work out all the kinks, including the issue of inspection rights.