Enforcing shareholder rights to inspect books and records

Enforcement of the Shareholder Right to Inspect Books and Records

Just because a minority shareholder has common law and statutory rights to inspect the books and records of a corporation does not mean that the corporation will always comply. When the corporation refuses, the shareholder must turn to the courts for assistance.

Shareholder Rights to Inspect Books and Records: Judicial Remedies

Lack of information to shareholders is probably the most common violation of shareholder rights and almost always a component of a campaign of shareholder oppression. A shareholder faced with a cutoff of information and a refusal to allow inspection of books and records must seek judicial remedies designed explicitly to enforce these rights. Unfortunately, as demonstrated below, Texas law does not provide a procedural mechanism for expedited enforcement of these important rights. An aggrieved shareholder must file a lawsuit seeking a writ of mandamus to compel production. If the corporation is able to raise a fact issue as to whether the plaintiff has a proper purpose, then the corporation is entitled to a jury trial, and the shareholder is faced with a long and expensive battle just to get information. With most civil dockets in the state requiring years to move a case from Original Petition to jury trial, even an unsuccessful bid by a corporation to refuse inspection can effectively deny the shareholder’s information rights for a long period of time. 

Causes of Action for Violating the Shareholder Right to Inspect Books and Records.

A shareholder seeking to enforce inspection rights must sue for a writ of mandamus to compel the inspection.  The writ may be issued to enforce either the shareholder’s common law or statutory rights of inspection—the difference being that the statutory rights are narrower, but provide the shareholder with the benefit of certain presumptions and allow for the recovery of attorneys fees.

Elements of Common Law Cause of Action

To obtain a writ of mandamus enforcing a common law right of inspection, the plaintiff shareholder must prove the following: (1) that he is a record or beneficial shareholder (regardless of number of shares or length of time held); (2) that he made a demand on the corporation for inspection of documents (not necessarily in writing); (3) that his purpose for inspecting the records is proper (need not have been stated in demand) and that he is acting in good faith; and (4) that the corporation refused.  Some courts have suggested that if the shareholder seeks only inspection of the shareholders list, then a proper purpose is presumed; whereas the burden to prove proper purpose shifts to the shareholder with regard to all other books and records.

When the corporation refuses to comply with the director’s demand for inspection, the director need only show that (1) he is a director, (2) that he demanded to inspect the corporate books and records (need not be in writing or state a purpose), and (3) the right to inspection was refused by the corporation.  “The unqualified right of appellee as director to inspect the books of the corporation must be distinguished from the right of shareholders, which is not absolute.”

Statutory Cause of Action

To obtain mandamus relief under the statutory inspection rights, the plaintiff shareholder must prove the following: (1) that he is a shareholder or holder of a beneficial interest in a voting trust; (2) that he has owned his shares for at least six months or holds at least five percent of all the outstanding shares of the company; (3) that he has made a written demand for inspection; (4) that the demand stated a proper purpose; and (5) that the demand was refused.  The “proper purpose” requirement seems to place the burden on the shareholder to establish that the purpose stated is proper; however, the corporation retains the burden to prove that the shareholder is motivated by some other improper purpose.

A governing person (director) may enforce his right of access to corporate records by showing the following: (1) that he is a governing person; (2) that he demanded to inspect the corporate books and records (need not be in writing); (3) that his purpose for inspecting the corporate books and records was reasonably related to his service as a director (need not have been stated in the demand); and (4) the corporation refused his good faith demand to inspect the books and records. 

Absence of Adequate Remedy at Law

The remedies of mandamus and injunction are governed by equitable principles and therefore the plaintiff must also plead and prove the absence of an adequate remedy at law.

Attorneys’ Fees

A shareholder who prevails on the statutory claim is entitled to recover all costs and expenses, including attorney’s fees, incurred in enforcing his rights, in addition to any other damages or remedy afforded him by law.  For a director, the court may also award him his attorneys’ fees and any other relief that the court deems proper.  The trial court’s award of attorneys’ fees under the statute was affirmed in Chavco Investment Company, Inc. v. Pybus,  and in Bayoud v. Bayoud.  The shareholder or director must also establish that the attorneys’ fees were reasonable and necessary.  In Dobson v. Poor, the San Antonio court of appeals upheld an award of attorney’ fees to a shareholder and director from whom the books and records were withheld until the suit was filed, although the case was remanded for the plaintiff to properly segregate the attorneys fees incurred as a result of refusing inspection.

Award Against Individuals

One court has permitted an award of attorney’s fees for refusal to allow inspection directly against the majority shareholders/directors who were responsible for the refusal, although the court noted that the individuals could escape liability if their refusal was based on the advice of counsel under the safe harbor provisions. More recently, a court of appeals has held that the inspection statute only authorizes an award of attorney's fees against the corporation.

Defining the Issue of Proper Purpose

The single issue in dispute in virtually every case is whether or not the plaintiff shareholder had a “proper purpose.” The inspection statute permits a corporation to assert the affirmative defense that the shareholder “was not acting in good faith or for a proper purpose in making [his demand]”  The corporation may seek to prove that the shareholder’s stated purpose is not “proper” in that it is unrelated to his status as a shareholder. In that case, it would be immaterial whether the purpose was “improper” in the sense of harmful to the interests of the corporation. For example, the shareholder might be seeking information that is useful to him only in another capacity. Courts in other jurisdictions have generally held that a purpose that serves the personal interests of the shareholder, unrelated to his share ownership is not “proper,” even if it is not otherwise wrongful or harmful to the corporation. For example, in Lynn v. EnviroSource, Inc., the Delaware court held that a shareholder did not have a proper purpose where his sole purpose was to gather evidence for use in an administrative appeal regarding his pension benefits.

Assuming that the shareholder has met his burden to state a purpose and to establish that the stated purpose is proper, what then must the corporation prove? Logically there are two alternatives: (1) the shareholder is not actually motivated by the stated proper purpose;  (2) whether or not the shareholder is motivated by the stated purpose, he also has an improper purpose. The statutory language, requiring that the corporation prove that the shareholder “was not acting in good faith or for a proper purpose” seems to point only to the first alternative. As a practical matter, however, negating the fact that the shareholder is acting for a proper purpose is essentially impossible. How can a corporation possibly prove that the shareholder does not want to know what his shares are worth? The second alternative may be easier to prove, but it raises the question of why a shareholder who is asserting a valid right (inspection for a proper purpose) should be denied that right because he has other purposes. Does the improper purpose have to be the “real” or primary purpose? Does the potential harm to the corporation from the improper purpose have to outweigh the shareholder’s rights arising from the proper purpose? Or does the mere existence of an improper purpose disqualify the shareholder from exercising his rights?

Problem of Mixed Motives

Frequently, the shareholder’s motives are mixed. A shareholder may have a truly proper purpose, but also a secondary purpose that is unrelated to his status as a shareholder or that is “improper” and harmful to the corporation. For example, a shareholder might wish to obtain information for purposes that are proper, such as ascertaining the value of his shares, but also for purposes that are more questionable, such as harassment of management for purposes of attempting to force a settlement of private litigation. In such a case, the question will be whether a finding of any proper purpose will be sufficient to uphold the right of inspection, or whether the finding of any improper purpose will defeat the right of inspection, or whether the Court must make a finding of what the true or principal purpose really is. In Citizens Association for Sound Energy v. Boltz,  the court termed the defendant’s burden as one of proving the “lack of a proper purpose.” This language would seem to indicate that the existence of a proper purpose (“I want to know what my stock is worth”) would permit inspection despite the existence of other highly improper motives. Some Delaware decisions seem to indicate that this may be the standard.

While Texas courts have not squarely addressed this issue, the language of most of the cases seems to suggest that the court must determine whether the shareholder’s “real” or primary purpose is improper:

[W]hen the corporation pleads, and is able to establish by proof, a state of facts sufficient to convince the court that the stockholder is not seeking the information which might be revealed by the desired inspection for the protection of his interest as a stockholder, or that of the corporation, but that he is actuated by corrupt or unlawful motives, the court will not, by the issuance of its writ of mandamus, aid him to consummate such corrupt and unlawful purposes.

“Obviously, substantial and difficult factual issues may arise as to a shareholder’s true purpose. The issue may come down to predominant motive and intent.”

Burden of Proof

A shareholder enforcing his common law rights has the burden to plead and prove that he has a proper purpose.  Under the statutory rights, however, a shareholder need only prove that he has stated a proper purpose in his written demand.  “Section B contains no requirement that such a shareholder of record must prove a ‘proper’ purpose, merely that he must ‘state’ his purpose.”  The corporation resisting inspection has the burden to prove the absence of a proper purpose.  The statute makes clear that absence of a proper purpose or bad faith on the part of the shareholder are affirmative defenses that must be pleaded and proved by the corporation.

The situation is somewhat different with respect to directors. It seems that under the common law, the purpose of the inspection is either irrelevant.  However, the corporation must certainly be able to raise this issue in the affirmative defense of unclean hands. Under the statute, on the other hand, the director has the burden of proving that his purpose is “reasonably related” to his service as a director  and that the demand was made in good faith.

This issue of a purpose being “reasonably related” to service as a director would seem to be a lower standard than a “proper” purpose, and conceivably a director’s improper purpose might still be “reasonably related.”

Defending Against a Shareholder Inspection Rights Claim

Defending against shareholder rights to inspect books and records

In every case, the ultimate factual issue will come down to the corporation’s evidence that the shareholder’s true purpose is improper. This is true even when the plaintiff has the burden of proving a proper purpose because it will always be relatively easy for the plaintiff to introduce proof of a proper purpose. The plaintiff shareholder can always testify, “I want to ascertain the value of my shares.”  And the courts have made clear that the subjective testimony of the shareholder is sufficient.  Therefore, regardless of which party has the ultimate burden, the case will always turn on what proof the corporation is able to introduce evidencing that the plaintiff’s true purpose is improper.

Improper Purposes Generally

Generally, a proper purpose is one that is reasonably related to the protection of stockholder’s interest as a shareholder (including protection of the corporation’s interests that affect the shareholder indirectly); conversely an improper purpose is one that seeks to injure to the corporation or the shareholders.  As one New York court summarized:

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.

Bad Faith

The inspection statute explicitly states that proof of the failure of the plaintiff to make the request in good faith is a defense.  Several courts have noted the absence of good faith on the part of the plaintiff as one reason for denial of inspection rights.  However, the motives of a nonshareholder with a close relationship to the plaintiff-shareholder “should not prevent [plaintiff] from exercising its right as a shareholder to inspect the corporation’s books and records.”

Fishing Expedition

A frequent claim is that the shareholder’s purposes are entirely speculative, that he is on a “fishing expedition” to “dig up dirt.” In Citizens Association for Sound Energy v. Boltz,  the Court rejected the argument that inspection should not be allowed for a speculative purpose. Johnson Ranch Royalty Co. v. Hickey  held: “It is not necessary that the stock holder should first show that there is mismanagement where he wishes to make the examination in good faith for the purpose of seeing whether the affairs of the corporation are properly managed.” However, the court in Grayburg Oil Co. v. Jarratt, noted the correctness of the following “abstract propositions of law”:

A stockholder under the guise of a statutory right should not be permitted to examine the books of a corporation for speculative purposes, or to gratify curiosity, or for the purpose of obtaining a list of stockholders with their addresses so that he might communicate with such stockholders making false and untrue charges against the officers of the company, or relative to the management of the affairs of the company, based upon rumors, without any investigation whatsoever on the part of such stockholder as to the truth and correctness of such rumors, thereby injuring the business and being detrimental to the interests of other stockholders, and the extraordinary remedy of mandamus should be denied. 

Information Is Not Needed

The corporation will frequently assert that the shareholder has no legitimate need for the information sought. Typically, the shareholder will have a different perspective, especially where the information sought will help shed light on the financial condition of the company and the competence of its management. In Fownes v. Hubbard Broadcasting Inc.,  the court held refusal could not be justified on the ground that the information was available form other sources or was not needed.

Obtaining Competitive Advantage

Courts have been extremely sensitive to risk that shareholders who own competing businesses will use their inspection rights to conduct industrial espionage. In Uvalde Rock Asphalt Co. v. Loughridge,  the Texas Supreme Court held that the corporation’s allegation that the shareholder was a competitor of the corporation and sought by its inspection to obtain a competitive advantage in the area in which the shareholder and the corporation competed raised an issue as to whether the shareholder acted with an improper purpose.

However, proof of this improper purpose requires more than merely establishing that the information sought is confidential or that the shareholder is affiliated with a competitor. There is no blanket trade secrets or confidentiality privilege to shareholder inspection. The Fort Worth court of appeals upheld a discovery order requiring production of customer and supplier lists and pricing and discount information to a plaintiff who was employed by the corporation’s chief competitor on the grounds that the plaintiff was a shareholder and would be entitled to inspect those documents under the TBCA.  In State ex rel. G.M. Gustafson Co. v. Crookston Trust Co.,  the Minnesota Supreme Court held that the shareholders of a bank had the common law right of inspection of the banks records, notwithstanding the bank’s objection that the shareholder would have access to information regarding depositors’ business that the bank had an obligation to keep confidential. “Furthermore, the mere fact that a shareholder is a competitor, without more, does not defeat the shareholder’s right of inspection.”

Attempt to "Destroy the Company"

A corporation will not be required to assist a disaffected shareholder whose true purpose is to destroy the company. The Dallas court of appeals dealt with a dispute in which a shareholder, who had served as president, resigned in the course of a heated dispute with the other shareholders. The corporation later refused the former president’s inspection demand, in part, on the grounds that his true intent was to destroy the company. The court held that testimony of specific instances of the plaintiff’s improper cash payments to himself and others, of his failure to maintain financial records, of conduct detrimental to the company, and of threats to put the company out of business were sufficient to raise a fact issue as to plaintiff’s proper purpose.

Campaign of Harassment or Extortion

Those in control of corporations tend to view every request for information from shareholders as “harassment.” However, the courts have recognized that inspection rights can be misused to harass, particularly when the shareholder’s inspection demands are combined with an effort to force the purchase of his shares at a grossly inflated price. In Uvalde Rock Asphalt Co. v. Loughridge,  the Texas Supreme Court held that evidence that the shareholder’s demand for inspection was a means to continue a program of studied harassment of the corporation in order to force the corporation to purchase the shareholder’s stock at a grossly inflated price or to sell to the shareholder significant assets of the corporation at a grossly inadequate price raised a fact issue as to whether the shareholder acted with an improper purpose.

In Perry v. Perry Brothers, Inc.,  the court held the following facts were sufficient to support the jury finding of an improper purpose: that plaintiff had previously filed, and then dismissed, a lawsuit to prevent the company from destroying records based on an employee’s conversation which he overheard; that he had made repetitious and disruptive inspections—eleven separate requests over a period of nine months; that he formed a group of “concerned stockholders” that made additional requests during the same period; that he gave about seventy-five people one share of stock apiece, which cost the corporation additional money and labor transferring, preparing and mailing four quarterly dividend payments; that he sent out false and misleading information to many shareholders that indicated the company was overdrawn by one-and-one-half million dollars; and that he offered to sell his stock (8 to 8 1/2 % of the total outstanding stock) to the company for $30.00 per share as a way “to put an end to all these problems,” even though he believed the book value of the stock was around $20.00 and had acquired much of it six months earlier for $7.70 per share.

Evidence of Animosity Is Not Sufficient

In Citizens Association for Sound Energy v. Boltz,  the court held that a demonstration of hostility between the officers of a nonprofit corporation and certain members requesting inspection of documents was not “indicative of an improper purpose.” The Court relied on a Texas Commission of Appeals case, Moore v. Rock Creek Oil Corp.,  which upheld the inspection rights of a shareholder in a for-profit corporation, and rejected a corporation’s argument that the animosity between the corporation and the stockholders seeking the right of inspection was a ground for denying an examination of the corporate books.  In Johnson Ranch Royalty Co. v. Hickey,  the court held it irrelevant to the right of inspection that there was a “great deal of evidence in the record which shows a want of harmony and in some cases open hostility and antagonism” among the parties and noted the fact that the controlling shareholder “bitterly opposes a thorough examination and inspection of the books would naturally tend to increase the suspicions which plaintiffs assert they already have.”

Repeated Requests

While an excessive number of prior inspection requests was a factor in Perry, repeated requests are not necessarily evidence of improper motive. The statute does not limit or specify the number of times a shareholder may inspect corporate records. “In the absence of a showing that the right of inspection has been used by a member for harassment or to impede the management of the corporation, the right of inspection is not limited in number and certainly not to only one inspection.”  As one Texas appellate court noted:

The right of inspection . . . is not limited to one occasion; it may be exercised at any reasonable time so long as the relation of the stockholder exists. The mere fact that appellant had, about twenty days prior to the demand here under consideration, made some sort of inspection of the books, and that opportunity to continue the same was at that time afforded and not used, does not of itself show that this demand was, as to time, unreasonable.

Improper Communications With Shareholders

Corporations are frequently especially concerned about shareholders obtaining access to shareholder records for the purpose of communicating with other shareholders. However, communications regarding the corporation, particularly truthful communications critical of management, are far from improper:

Nor is it any reason for denying such examination that plaintiffs in error hope to find something alarming in the affairs of the company, which they intend to communicate to other stockholders. If in truth and in fact no alarming condition exists, presumably it will not be found through any examination made by plaintiffs in error. If there is existent anything in the financial affairs of the company which would be reasonably calculated to alarm the stockholders in general, we see no reason why plaintiffs in error could not properly communicate such fact to other stockholders. The stockholders of a corporation are the beneficial owners of the corporate property, and are therefore vitally interested in knowing the true condition of its affairs. If a condition exists which is calculated to alarm the stockholders, they are legitimately entitled to know such fact, and there would be nothing improper should plaintiffs in error communicate the information thus obtained to other stockholders.

But communications with shareholders for other purposes tend to be found to be improper purposes. In State ex rel. Pilsbury v. Honeywell, Inc.,  the Minnesota Supreme Court held the plaintiff’s purpose in inspecting the share ledger to be improper where shareholder motivated by political, social interests rather than financial interests and was seeking to communicate with other shareholders to promote his political views that management should stop producing napalm used in Vietnam War. In Retail Property Investors, Inc. v. Skeens,  the court held that a request for shareholders list is not allowed for purpose of contacting other shareholders regarding possible lawsuit against corporation. In Shabshelowitz v. Fall River Gas Co.,  the Massachusetts Supreme Court held that a shareholder’s request to inspect and copy the stock ledger for the purpose of contacting other shareholders and soliciting the purchase of their shares was improper. The same result was reached by the Supreme Court of Maine in Chas. A. Day & Co. v. Booth.  However, in Madison Liquidity Investors 103 LLC v. Carey,  a New York appellate court permitted inspection of stockholder list where avowed purpose was to solicit purchases and where there was no evidence of wrongful intent or that anything other than market would dictate price.

Prior Misuse of Corporate Records

The inspection statute provides that a shareholder’s right to inspection is subject to the defense that (1) the shareholder has, within the past two years, sold or offered for sale a list of shareholders or of holders of voting trust certificates in consideration for shares of the corporation or any other corporation, (2) has aided or abetted a person in procuring a list of shareholders or of holders of voting trust certificates for selling it, or (3) has improperly used information obtained through a prior examination of the books and account records, minutes, or share transfer records of the corporation or any other corporation.  It is important to note that the shareholder’s current purposes are immaterial to this defense, and further that the plaintiff’s prior misuse of records could be based on his conduct with regard to a different corporation.

Unclean hands

Independent of the inquiry into improper purpose, a corporation may assert that the plaintiff is not entitled to equitable relief because he has unclean hands. “A court acting in equity will refuse to grant relief to a plaintiff who has been guilty of unlawful or inequitable conduct with regard to the issue in dispute.”

The clean hands doctrine requires that one who seeks equity, does equity.  Equitable relief is not warranted when the plaintiff has engaged in unconscionable, unjust, or inequitable conduct with regard to the issue in dispute.  The determination of whether a party has come to court with unclean hands is left to the discretion of the trial court. 

In the exercise of this right, the stockholders must come into court with clean hands, and, if a state of facts exist sufficient to convince the court or jury that the stockholder is not seeking the information which might be revealed by the desired inspection, for the protection of his interest as a stockholder or that of the corporation, but that he is actuated by corrupt or unlawful motives, the court will not aid him by writ of mandamus in such purpose. A mandamus is always a remedy to right a wrong, not to promote one. The right of inspection granted to a stockholder of a corporation, by statute, is clearly for the benefit of a corporation and the stockholders, and, when the exercise of that right is for the purpose of injuring the corporation or stockholders generally, the right will be denied.

However, the defense is not absolute.  The conduct on which unclean hands defense is based must involve the same transaction out of which the litigation arose, and the party asserting the doctrine must himself have been injured by the conduct.  The clean hands doctrine should not be applied unless the party asserting the doctrine has been seriously harmed and the wrong complained of cannot be corrected without the application of the doctrine.  Thus, prior misconduct by the shareholder when an employee or officer of the corporation cannot be the basis for denying his right to inspect corporate documents as a shareholder. In Dunnagan v. Watson,  the Court held that the unclean hands doctrine did not bar a partner who had been found liable for breach of his fiduciary duties from seeking judicial dissolution of the partnership. The Court held that the unconscionable, unjust, or inequitable conduct forming the basis of the defense must relate specifically to the cause of action asserted and that equitable relief is not limited by conduct that is derived from a cause of action independent from the plaintiff’s specific claim and is merely collateral thereto.

In granting equitable relief, a court is required to balance the equities.  Some courts have held that, even if the shareholder is seeking inspection for a proper purpose, the court must still balance the inspection rights of the shareholders against the contrary interests of the corporation in nondisclosure, which interests might include a legitimate need to keep certain information confidential, concern that disclosure might lead to legal difficulties with federal agencies, the probability that disclosure would reveal trade or business secrets of the corporation or give the shareholder an unfair advantage in litigation or otherwise.

Waiver by Corporation

In the event that the corporation allows inspection or otherwise provides documents to the shareholder, then the corporation waives any defense it may have had as to those documents, and the issue of whether plaintiff had a proper purpose becomes moot.