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Fighting for transparency: Inspection demands and audit rights in shareholder disputes

A family owned business with relatives working side by side on a venture that they believe in can be a wonderful thing. But families, for all that binds them, aren’t immune to disputes. When problems do arise they can easily turn into ugly fights, with the minority shareholders in the company feeling like David before Goliath. What these minority shareholders as well as aggrieved directors need to know is that the law in many ways has their back. It provides them with certain rights and with powerful tools to enforce those rights.

Speaking more specifically, in my practice as a business attorney I often see controversies around issues of transparency in family owned or closely held businesses. In some of these cases, majority shareholders actually fail to provide the minority shareholders or directors with access to financial information or corporate records. In others, the minority shareholders allege wrongdoing by the majority shareholders and go out in search of written evidence to support their claim but often come up empty-handed. Both scenarios usually lead to protracted fights.

This is where the California Corporations Code and the right to inspect certain corporate documents and financial information come in. The code specifies that every director in a corporation has “the absolute right at any reasonable time” to inspect and copy all books, records and documents and to inspect the physical properties of the corporation. It also addresses the rights of shareholders by stating that the accounting books, records and minutes of proceedings of the shareholders, board and committees of a corporation “shall be open to inspection” by shareholders of record. Here, restrictions apply: A shareholder must make his or her demand in writing, the inspection must take place “at any reasonable time during usual business hours,” and the purpose of the inspection must be “reasonably related” to the shareholder’s interests as a shareholder.

You may be wondering about a couple of things: What would a shareholder do if the company denies his or her request to audit? And what does “reasonably related” mean? To answer the second question, the courts have found that reasonable purposes exist e.g. in cases where a shareholder seeks to determine the financial standing of the firm or the value of her shares. They have also deemed requests reasonable if the shareholder is trying to understand whether the company’s directors and officers were engaged in self-dealing or acting against the interests of minority shareholders in another way. The burden of proof when it comes to the reasonableness standard is upon the shareholder seeking an audit.

And what happens if a company denies a shareholder’s or director’s request for inspection? She can litigate and ask the relevant superior court to enforce her right of inspection under the California Corporations Code. The court can then appoint inspectors or accountants to investigate or audit the company. If it finds that the corporation refused an inspection even though the demand was reasonable it can order the company to pay the plaintiff’s expenses for the case, including attorney’s fees.

By Kevin J. Moore