The books and records proceeding often is the first time that a dispute between a minority shareholder and the majority enters the courtroom. Suspicious of misconduct or mismanagement, the minority shareholder demands to inspect certain records of the corporation, and the majority in control of those records, offended by the suggestion, stonewalls. Enter the books and records proceeding: a special proceeding under Article 4 of the CPLR which allows a court to summarily order the corporation to make the requested records available to the shareholder.

This blog has covered several decisions—including the First Department’s McGraw Hill and several 2018 cases—highlighting the expansion of the New York books and records proceeding from an ineffective use of time and resources to a more potent option in the minority shareholder’s playbook.

While the books and records proceeding is now a relatively speedy and cost-effective tool for the minority shareholder investigating misconduct or otherwise contemplating litigation against the majority, we see many cases where the petitioner gets tripped up in the web of different inspection rights and their correspondingly different scopes, conditions precedent, and required justifications.

Last month, Justice Platkin of the Albany County Commercial Division issued a decision in Galasso v Cobleskill Stone Products, Inc., 73 Misc 3d 1231(A) [Sup Ct 2021], providing an excellent primer on the statutory and common law regimes governing access to a corporation’s records and the different evidentiary showings required. The decision also sheds light on whether minority shareholders in a valuation proceeding—such as that conducted under BCL 1118 or 623—are entitled to access records of the corporation post-dating the applicable valuation date.

Galasso v. Cobleskill Stone

The books and records proceeding marks the third chapter in the feud between Cobleskill Stone Products (“CSP” or the “Corporation”) and the estate of Martin Galasso (the “Estate”), which owns 38.78% of the Corporation’s outstanding shares. The first was the Estate’s December 2015 derivative action against the majority shareholder alleging excessive compensation, self-dealing, and waste. The second was the Estate’s January 2019 petition for dissolution of the Corporation under BCL 1104(c) and 1104-a.

On March 28, 2019, the Corporation elected under BCL 1118 to purchase the Estate’s shares. Upon that election, the sole question in the litigation became the value of the Estate’s shares as of January 24, 2019—the date immediately preceding the Estate’s petition for dissolution. In April 2019, as covered on this post, the Third Department required the Estate to cough up an appraisal that it had prepared for its estate tax return. The parties are currently conducting expert discovery on the valuation of the Estate’s shares.

In August 2021, the Estate served a written demand (a prerequisite to a books and records proceeding) for inspection of the Corporation’s “CPA-prepared financial statements and income tax returns for the fiscal years ended June 30, 2019; June 30, 2020, and June 30, 2021.” The Corporation objected to the demand, prompting the Estate to file a books and records proceeding. The Corporation moved to dismiss the proceeding, arguing that the Estate was not entitled to financial information post-dating the valuation date of January 24, 2019; given the Corporation’s binding BCL 1118 election, the Corporation’s post valuation-date financials were simply irrelevant to the Estate, and the Estate had no proper grounds to inspect those records.

Justice Platkin’s December 14, 2021, decision includes a thorough analysis of each of the Estate’s requests:

Post-Valuation Date Financial Statements

BCL 624(e) governs a shareholder’s access to financial statements. It provides: “Upon the written request of any shareholder, the corporation shall give or mail to such shareholder an annual balance sheet and profit and loss statement for the preceding fiscal year, and, if any interim balance sheet or profit and loss statement has been distributed to its shareholders or otherwise made available to the public, the most recent such interim balance sheet or profit and loss statement.”

Justice Platkin noted that “there is nothing in the text of BCL 624(e) that expressly requires the shareholder to demonstrate that he or she is acting in good faith and for a proper purpose.” While subsection (b) of BCL 624, which governs inspection of minutes of shareholders meetings and a record of shareholders, requires that the inspection be made for a purpose “reasonably related to such person’s interest as a shareholder,” Justice Platkin held that “the limitation set forth in subdivision (b) of section 624 does not apply to subdivision (e) of section 624.”

Accordingly, because the Estate was still a shareholder with an absolute right to financial statements under BCL 624(e), the Court refused to dismiss the Estate’s petition insofar as it sought access to the Corporation’s financial statements.

Post-Valuation Date Tax Returns

BCL 624 does not provide a minority shareholder with a statutory right to review a corporation’s tax returns. That right stems from a shareholder’s common-law right “to inspect the books and papers of the corporation, for a proper purpose and under reasonable circumstances” (In re Steinway, 159 NY 250, 258 [1899]).

A shareholder’s common-law inspection rights extend to other corporate documents, such as records of wholly-owned subsidiaries of the corporation, contracts, and account records (see Leisner v Kent Inv’rs Inc., 62 Misc 2d 132, 135 [Sup Ct 1970] [holding that the common law right of inspection applies to “books of account, contracts and correspondence.”]; Novikov v Oceana Holdings Corp., 46 Misc 3d 561, 570 [NY Sup 2014] [ordering production of tax returns, contracts, and documents sufficient to validate the figures on the petitioning shareholder’s K-1]).

While broader than the inspection rights under BCL 624(e), the common law right to inspect a corporation’s books and records is qualified, and (unlike the absolute right under BCL 624[e]) it can only be asserted where the shareholder is acting in good faith and has established that inspection is for a proper purpose.

Investigating alleged misconduct by management and obtaining information that may aid legitimate litigation are proper purposes for a request, even if the inspection ultimately finds no wrongdoing (Retirement Plan for Gen. Employees of City of N. Miami Beach v McGraw-Hill Companies, Inc., 120 AD3d 1052, 1056 [1st Dept 2014]). Other “proper purposes” include to determine the value of the petitioner’s shares in anticipation of some sale or offer (Leviton Mfg. Co., Inc. v Blumberg, 242 AD2d 205, 207 [1st Dept 1997]) or to lawfully influence or challenge management policy (Venner v New York Life Ins. Co., 111 AD 183, 184 [1st Dept 1906]). By contrast, “Improper purposes are those which are inimical to the corporation, for example, to discover business secrets to aid a competitor of the corporation, to secure prospects for personal business, to find technical defects in corporate transactions to institute ‘strike suits,’ and to locate information to pursue one’s own social or political goals” (Matter of Tatko v Tatko Bros. Slate Co., Inc., 173 AD2d 917, 918 [3d Dept 1991]).

In Cobleskill, the Estate justified its request for its post-valuation date tax returns on the ground that they supposedly would “confirm what a hypothetical buyer may have forecasted as of the valuation date.”

Justice Platkin rejected the Estate’s argument:

“The Court finds that petitioner’s alleged desire to use the tax returns in the Valuation proceeding is not a proper purpose.”

The Court also noted that the Estate was effectively attempting to use the books and records proceeding to get a second bite at discovery in the valuation proceeding. The Estate had every opportunity during discovery in the valuation proceeding to request all the information relevant to the fair value of the Estate’s shares, and that discovery concluded more than 18 months ago. Citing mostly to Delaware law, including Vice Chancellor McCormick’s decision in CHC Investments, LLC v. Firstsun Capital Bancorp, Justice Platkin held that “The common-law right of inspection cannot be used to circumvent limitations on the scope or timing of disclosure in pending litigation” (No. 2018-0610 [Del Chancery 2019]).

Closing Thoughts

I see two important takeaways from Galasso:

First, Galasso demonstrates the unusual irony in the interplay between a shareholder’s right of inspection and litigation against the corporation or other shareholders. On the one hand, contemplated litigation is a proper purpose justifying broad access to a corporation’s books and records. On the other hand, once the litigation is commenced, its existence may weigh against permitting a shareholder to exercise his common law right of inspection. Counsel contemplating a books and records proceeding as part of a broader litigation initiative would be wise to consider this interplay.

Second, Justice Platkin’s rejection of the valuation proceeding as a proper purpose for inspection of post-valuation date financials means that a minority shareholder in a valuation proceeding is entitled to post-valuation date records solely under their absolute right to financial statements as a shareholder under BCL 624(e). While this resulted in limited success for the Estate, in other valuation proceedings, such as those contemplated by BCL 623 or LLC Law 1002 which occur after a minority shareholder’s or member’s ownership interest is extinguished in a freeze-out merger, Galasso‘s reasoning may close the door to any post-valuation date inspection whatsoever.