The Latin maxim, scientia potentia est, translated as “knowledge is power,” is commonly attributed to the English philosopher Sir Francis Bacon (1561-1626) who, it so happens, also was a prominent lawyer and jurist before his career ended in disgrace for accepting gifts from litigants. Likely he never had occasion to rule in a legal proceeding by the minority owner of a closely held business to gain access to company books and records, but if he had, his maxim would have come in quite handy as an encapsulation of the interests at stake when company managers resist disclosure of information to outsider owners.
In New York, Delaware and most if not all other states, rights of access to company information by shareholders of business corporations and members of limited liability companies (LLC) are governed by statute and common law, subject to any different or broader rights that may be spelled out in a shareholders or operating agreement. The statutes also may provide, as they do in New York and Delaware, for summary proceedings designed to allow expedited resolution of a books and records dispute.
The statutes not surprisingly require the petitioner in a books and records proceeding to be a shareholder of the corporation or a member of the LLC whose information is sought. This seemingly black-and-white requirement has not dissuaded company managers from contesting petitioners’ standing to bring a books and records proceeding, or to restrict the temporal scope of the information required to be produced, under a variety of special circumstances. Decisions in three recent cases — one from New York and the other two from Delaware — are illustrative.
Does an LLC Member’s Exercise of Put Rights Defeat Standing to Compel Access to Books and Records Pending the Buyout?
That is the question posed and answered in the negative by Nassau County Commercial Division Justice Ira B. Warshawsky in his ruling last month in Rodeo Family Enterprises, LLC v. Matte, Short Form Order, Index No. 600378/10 (Sup Ct Nassau County Apr. 22, 2011).
Rodeo involves an LLC holding company known as Oyster Bay Group LLC (OBG) whose subsidiaries buy at discount and collect large pools of non-performing consumer debt. Plaintiff Samir Shah, through his own holding company, owns a 25% membership interest in OBG. After a falling out with the majority manager, Shah resigned his position as manager and exercised his put rights under a complex formula-based buy-sell agreement. Shah’s resignation notice expressly stated that he was “not withdrawing my membership interest in [OBG].” Shah and his holding company brought suit alleging that the majority owner unilaterally altered the valuation formula and refused to proceed in good faith with the buyout.
When the defendants refused to turn over documents demanded pursuant to an inspection request, Shah asked the court to compel their production under Section 1102 of New York’s LLC Law. (Read here my prior post on the very few decisions construing the statute.) Defendants argued that Shah’s resignation converted his (or his holding company Rodeo’s) status to one of “economic interest holder” and that he was no longer a “full fledged member” of OBG with inspection rights. As summarized by Justice Warshawsky, the defendants “acknowledge that Rodeo has a status as a ‘member’ of OBG, but dispute the attributes of membership.” The defendants further contended that Shah was misusing Section 1102 to obtain financial information post-dating the valuation date “to ascertain the viability of a judgment which they are seeking.”
After quoting the language of Section 1102(b), Justice Warshawsky dispatches defendants’ standing argument in only three sentences:
However one chooses to classify Rodeo’s membership in OBG, it is a member. As such it is entitled to the three most recent fiscal year’s records. The motion to compel defendants to grant access to the books and records of OBG is granted.
Elsewhere in his decision Justice Washawsky limits the plaintiffs’ additional, litigation discovery requests to the period up to, but not after, the June 30, 2009 valuation date, so it appears that the Section 1102 inspection rights granted by the court enabled the plaintiffs to obtain post-valuation date information otherwise unobtainable in normal discovery.
Can the Plaintiff in a Pending Derivative Action Bring a Later-Filed Books and Records Proceeding?
In King v. VeriFone Holdings, Inc., No. 330 (Del. Sup. Ct. Jan. 28, 2011), the plaintiff shareholder filed a books and records proceeding in Delaware Chancery Court under Section 220 of the Delaware General Corporation Law after he filed a shareholder’s derivative action in another venue. Chancery Court dismissed the proceeding as precluded by the plaintiff’s prior “election” to bring the derivative lawsuit. The Delaware Supreme Court reversed and reinstated the complaint, holding that it would be an improper intrusion upon legislative perogative for the court to create a per se prohibition against a later-filed books and records proceeding when the statute contained no sequential requirement that a books and records proceeding be brought first.
The stated purpose of the inspection request in VeriFone, upheld by the Supreme Court, was to obtain information to enable the plaintiff to amend his complaint in the derivative action to plead demand futility. VeriFone does not appear to limit its holding to that specific purpose.
Click here to read Francis Pileggi’s in-depth analysis of the Verifone case.
Is an LLC Member Entitled to Inspect Books and Records that Pre-Date Membership?
In Sanders v. Ohmite Holding, LLC, C.A. No. 5145-VCL (Del. Ch. Feb. 21, 2011), the Delaware Chancery Court enforced an LLC member’s demand to inspect records for a period that pre-dated the member’s acquisition of his interest.
The opening paragraphs of the court’s opinion, written by Vice Chancellor Laster, nicely summarize the facts, issues and outcome:
Plaintiff Max Sanders seeks books and records from Ohmite Holding, LLC pursuant to Section 18-305 of the Delaware Limited Liability Company Act. When the Company was formed, Sanders loaned $2 million to one of its members and received a security interest in the member’s units as collateral. In February 2007, the member transferred his remaining units to Sanders. In October 2008, Sanders discovered that his resulting interest was not the 7.75% stake that he believed and had been told that he owned, but rather a nigh microscopic 0.000775%. Sanders understandably sought to investigate how this happened. Ohmite refused to provide any information, contending that the dilutive event pre-dated when Sanders formally became a member and that Sanders had no right to obtain books and records form the pre-membership period.
Sanders has a proper purpose for inspecting books and records. He is entitled to inspect those books and records that are necessary for him to fulfill his purpose, regardless of whether they pre-date when he formally acquired member status. Summary judgment is granted for Sanders. [Parentheticals omitted.]
In rejecting the company’s temporal objection, Vice Chancellor Laster took guidance from analogous case law under DGCL Section 220 governing shareholder inspection rights for corporations, writing as follows:
In the analogous corporate context, the Delaware Supreme Court has held that “[i]f activities that occurred before the [date on which the plaintiff became a stockholder] are ‘reasonably related’ to the stockholder’s interest as a stockholder, then the stockholder should be given access to records necessary to an understanding of those activities.” Saito v. McKesson HBOC, Inc., 806 A.2d 113, 117 (Del. 2002). The bright-line temporal bar that Ohmite advocates has been rejected, and Ohmite has not suggested any credible reason grounded in the language, structure, or policy of the LLC Act for a different rule to apply to LLCs.
For further commentary on Sanders, click here for Pileggi’s discussion.