A recent decision by Manhattan Supreme Court Justice Paul G. Feinman in a shareholder dispute pitting brother against brother dealt with an interesting question: How should a court balance the discovery rights of a litigant seeking to obtain evidence supporting his contested claim of stock ownership against the corporation’s interest in limiting access to its books and records to bona fide shareholders?
The court’s unpublished decision in Ng v. Ng, Memorandum Decision and Order, Index No. 114291/10 (Sup Ct NY County Apr. 17, 2012), concerns a pair of family-owned realty corporations known as Chouk King Co. formed in 1970 and Tien Yick Co. formed in 1989. By complaint filed in March 2011 (read it here), William Ng and his father, Chouk Ng, sought to compel an accounting by William’s two brothers, Steven and Wilson Ng, with respect to the financial affairs of the corporations and to pay William and Chouk their portion of the net profits. The complaint alleges without further detail that William and Chouk “have legal and equitable ownership interests” in the two corporations and “are officers and directors” of the corporations. The complaint also alleges that Steven and Wilson “without authority seized control” of the corporations and their business records in 2000, and that they have refused demands by William and Chouk to furnish them with financial reports and pay them their profit shares.
In May 2011, the father, Chouk, for undisclosed reasons withdrew as a plaintiff and, apparently, switched his support to his defendant sons, Steven and Wilson. In November 2011, the now-solo plaintiff William served a subpoena on the corporations’ outside accountant (read it here) demanding production of all corporate tax returns, financial statements, and all other financial records for the period 2000 to date. Steven and Wilson promptly filed a motion to quash the subpoena.
In their answer to the complaint and in their motion, Steven and Wilson denied that William is or ever was a shareholder or officer of the corporations. The father, Chouk, also submitted an affidavit denying that William ever held an equity interest in the corporations. Steven and Wilson thus contended that the subpoenaed documents were unavailable to William based on his failure to establish standing either as a shareholder or as an officer of the corporations.
In response, William argued that the only way to determine his ownership interest in the corporations is by obtaining access to the corporate, financial and tax records. William alleged that the corporations were family owned and operated from inception; that he was actively involved in managing the corporations for 15 years before his ouster in 2000; that he previously issued and signed corporate checks, executed contracts, and had authority to bind the corporations in the conduct of business; that he had received regular disbursements from the net profits of the corporations until 2000; and that he never relinquished his “beneficial interest” in the corporations. He also offered documents identifying himself as head officer, managing agent, emergency contact, responsible person and authorized agent to accept service of process on the corporations’ behalf.
At the oral argument of the motion (read transcript here), counsel for Steven and Wilson argued that William’s discovery request for corporate records was “putting the horse before the cart,” i.e., that allowing William access to the records essentially constituted a grant of summary judgment on his complaint for an accounting. William’s counsel countered that the standard on a motion to quash is relevance; that the corporations’ K-1s and other tax and financial records were relevant to share ownership; and that William was prepared to enter into a confidentiality agreement.
In his ruling, Justice Feinman notes that §624 of the Business Corporation Law sets forth the rules concerning the maintenance of, and shareholder rights to inspect, a corporation’s books and records, including stock ownership information. Initially, he concludes that William’s assertion of an ownership interest is inadequate to require the accountant to comply with the subpoena, writing as follows:
Here, where plaintiff’s entitlement to access records of the two corporations is sharply disputed, and his proof is currently insufficient to establish his status as a shareholder or corporate officer, defendants’ argument is persuasive that the documents requested by the subpoena to be produced by defendants’ accountant, namely financial and tax records, need not be produced.
Is that the end of the road for William? Not quite. Justice Feinman strikes a balance between William’s legitimate discovery rights and the corporations’ interest in limiting access to shareholders by ordering the corporations — not the accountant — to produce for the court’s inspection only (“in camera review”) the corporate records from inception identifying all shareholders “including the number and class of shares held by each and the dates when they respectively became the owners of record . . . and any minute books or other documentation that would show the history of the two corporations’ structure and leadership”.
Justice Feinman further orders the defendants to submit to the court a “document-by-document explanation of what each particular document shows, including the year it was created and the reason for its production.” He also orders an explanation of “[a]ny gaps in documents that are statutorily required to be created and maintained,” adding that “the inference will be, unless shown otherwise, that the missing documents would show that plaintiff was likely a shareholder or an officer during the period of time for which no documents are provided.”
The in camera submission was required to be made by May 16, 2012. A week later, the court held a preliminary conference at which it ordered the parties to complete all discovery in August 2012. The conference order does not state whether the documents submitted in camera must be turned over to William or otherwise comment concerning the court’s inspection of the documents.
The Ng case is another in a seemingly endless stream of litigation over the ownership of closely held business entities in which the business partners pay little or no attention to corporate formalities, such as the issuance of shares and the maintenance of a stock ledger, until hostilities break out, by which time it may or may not be too late for the partner on the outside trying to get back in.