Legal Research Memo:
Issue and facts from attorney customer
There is an S corporation with a 49% shareholder and a 51% shareholder. The 49% shareholder has been fired from the company, and is making demands to see 10 years of books and records, employee contracts, and customer contracts. My feeling on this after doing a brief amount of research is that the fired employee has no right to see any contracts of corporation whatsoever, but has the right to see some books and records, based on a fiduciary responsibility of the majority shareholder. What I’m less sure about, is whether the minority shareholder has rights to digital copy of the company’s web app files, which go back 20+ years. It would seem reasonable to me to provide non-digital copies of records for some limited, reasonable period of time.
Short Answer: Shareholder has more rights
In Left Hand Ditch v Hill, 933 P.2d 1, 5 (Colo. 1997), the court remarked: “Shareholders have a common law right to inspect the books and records of the corporation.” (citing Dines v. Harris, 291 P. 1024, 1027-28 (Colo. 1930)). The Dines court construed predecessor statutes of the Colorado Business Corporation Act, C.R.S. §§ 7-101-101 to 7-117-105 (1996), as “declaratory of the common law, and our decision here is little else than a rehabilitation of the common-law rule from which there should have been no departure in the first place, and from which we now believe the Legislature never intended to depart.” 291 P. at 1027-28.
The Dines court held: the “statutes should be liberally construed in favor of stockholders, and their rights should be zealously guarded.” Id., at 1028. The rehabilitation of the common law enforcing shareholder inspection rights was advanced by the Left Hand Ditch court by way of this holding: “The court of appeals held that the shareholders could inspect the ditch company’s shareholder list pursuant to the Colorado Corporation Code, §§ 7-1-101 to 7-10-113, 3A C.R.S. (1986) (the Colorado Corporation Code). Although we affirm the court of appeals, we do so on the grounds that the shareholders have a common law right to inspect the ditch company’s shareholder list.” 933 P.2d at 2.
Interestingly, the “reversion to the common-law rule … makes motive and good faith material in an application for inspection of corporate books.” Id., at 1029. That common law rule is codified in C.R.S. § 7-116-102:
(3) A shareholder may inspect and copy the records described in subsection (2) of this section only if: … (b) The demand is made in good faith and for a proper purpose….”
C.R.S. § 7-116-102 provides that the records demanded must directly be connected with the described purpose, and “Proper purpose” means a purpose reasonably related to the demanding shareholder’s interest as a shareholder. If a “proper purpose” is advanced by the shareholder seeking to exercise inspection rights, then good faith is largely assumed unless there is evidence of bad faith. Left Hand Ditch, 933 P.2d at 6. See e.g., Beam ex rel. Mauney v. Beam Rest Home, Inc., 2014 WL 4748600, at *3 (N.C. Super. 2014)(“North Carolina courts have previously found a shareholder’s ‘good faith desire to (1) determine the value of his stock; (2) investigate the conduct of the management; and (3) determine the financial condition of the corporation’ as proper purposes supporting a demand for corporate records.”).
Citing Dines again, the Left Hand Ditch court declared: “The rationale for this rule [that statutory shareholder rights should be liberally construed] derives from the notion that “the books are not the private property of the directors or managers, but are the records of their transactions as trustees for the stockholders.” 933 P.2d at 5. To be sure, the Left Hand Ditch court acknowledged that “The Colorado Corporation Code was repealed and reenacted effective July 1, 1994, and is now known as the “Colorado Business Corporation Act.” See §§ 7-101-101 to 7-117-105, 3A C.R.S. (1996 Supp.). The facts of this case arose before this statutory change went into effect and are not affected by the Colorado Business Corporation Act.” 933 P.2d at 6 n3. The Left Hand Ditch court also noted that “mutual ditch companies exist as special purpose corporations falling outside the reach of the Colorado Corporation Code.” Id. at 3.
Nonetheless, there is a dearth of Colorado jurisprudence on the scope of a shareholder’s corporate records inspection rights post-Left Hand Ditch (1997), post-Dines (1930). Hence, Colorado courts likely will consider more recent extra-jurisdictional case law, especially if such case law relies on either Hand Ditch or Dines. A 2004 case from Connecticut, Pagett v. Westport Precision, Inc., 845 A.2d 455 (Conn. App. 2004), cites Dines for the general rule: “Statutes providing for inspection by shareholders should be liberally construed in favor of shareholders. See Dines v. Harris, 88 Colo. 22, 34, 291 P. 1024 (1930).” Pagett, 845 A.2d at 459.
The Pagett court elaborated:
We are persuaded by authority from sister states that have construed similar statutes and concluded that a shareholder’s status as an owner is the spring from which statutory inspection rights flow. “The basis of a shareholder’s right to inspect the books and records of a corporation is his ownership of the corporate property and assets through his ownership of shares; as an owner, he has the right to inform himself as to the management of the corporate property by directors and officers who are his trustees in direct charge of the property.” Tucson Gas & Electric Co. v. Schantz, 5 Ariz. App. 511, 513, 428 P.2d 686 (1967). A corporation is not an entity that can be separated from its members, for in reality those running the corporation “are merely the agents of the [shareholders]….” Cooke v. Outland, 265 N.C. 601, 610, 144 S.E.2d 835 (1965); see also Bank of Giles County v. Mason, 199 Va. 176, 181, 98 S.E.2d 905 (1957). Furthermore, “[a shareholder] in a corporation has, in the very nature of things and upon principles equity, good faith, and fair dealing, the right to know how the affairs of the company are conducted and whether the capital of which he has contributed a share is being prudently and profitably employed.” … State ex rel. Fussell v. McLendon, 109 So.2d 783, 786 (Fla. App.1959).
845 A.2d at 459–60 (underscoring added).
Courts recognize certain particular constraints on what a shareholder demands to inspect. For example, the court in Dresty v. Clearwater Sys. Corp., 2013 WL 6038354, at *4 (Conn. Super. Ct. 2013), held: “Accounting records encompasses a broad spectrum of documents, from tax returns to employee payroll records. It is probable that some accounting records may be unrelated to the plaintiff’s stated purpose of valuing his stock. A shareholder must describe the records related to his purpose with reasonable particularity; the burden is not upon the defendant to determine which ‘records are directly connected with this purpose.’” (citing Pagett).
But case law generally does not limit shareholder inspection rights to the terms in statutes. For example, “‘Under New York law, shareholders have both statutory and common-law rights to inspect a corporation’s books and records, so long as the shareholders seek the inspection in good faith and for a valid purpose.’ Statutory inspection rights complement, but do not eliminate, common-law inspection rights, which potentially encompass a far greater range of records.” Pomerance v. McGrath, 38 N.Y.S.3d 164, 166 (N.Y. App. Div. 2016)(internal citation omitted)(underscoring added). See also Pomerance v. McGrath, 38 N.Y.S.3d 164, 166 (N.Y. App. Div. 2016)(“Corporate shareholders seeking to inspect more extensive records may proceed under their common-law inspection rights, and courts may grant an in-person examination of the relevant records, or require the corporation to deliver records to the shareholder.”).
A shareholder’s inspection rights extends to electronic records, presumably including QuickBooks records. Pomerance, 38 N.Y.S.3d at 168 (“plaintiff’s common-law right to make paper copies … extended plaintiff’s inspection rights to include the right to receive from defendants paper and, if the records are maintained in electronic form, electronic copies”)(underscoring added). See also Beam ex rel. Mauney v. Beam Rest Home, Inc., 2014 WL 4748600, at *4 (N.C. Super. Sept. 25, 2014)(“Under modern practice, shareholders … typically receive duplicate copies of requested documents, either in hard copy or digital form.”).
In Pederson v. Arctic Slope Reg’l Corp., 331 P.3d 384, 396 (Alaska 2014), the court held: “even if electronic accounting records were somehow less accessible than traditional printed ledgers, the inaccessibility of documents is not relevant to the legal determination of what documents fall within ‘books and records of account,’ because, as a leading treatise notes, ‘the corporation cannot fail to keep books.’” The court rejected the corporation’s argument “that we should avoid this holding for fear that ‘the statute [would] require corporations to provide shareholders access to a computer so that they may browse the corporation’s electronic financial records.’” The Pederson court found that the shareholder “never asked to use a computer to browse the Corporation’s accounting software. Rather, he asked for copies of documents containing specific information, copies that could be (and, under the statute, must be capable of being) printed in writing.” 331 P.3d at 396. See C.R.S. § 7-116-101 (4): “A corporation shall maintain its records in written form or in another form capable of conversion into written form within a reasonable time.”). See also Worman v. Inv. Co. of Santa Monica, 2017 WL 3048463, at *2 (Cal. App. 2017)(noting that a “stipulated judgment … accords [shareholder] the right to inspect ‘corporate minute books, … electronic accounting records, [and] contracts (to the extent not privileged)’”).
Case law extends a shareholder’s inspection rights to the corporation’s contracts. In Heinrichs v. 356 Registry, Inc., 70 N.E.3d 91, 102–03 (Ohio App. 2016), for example, the court determined: “In order to ascertain the state of the corporation’s finances, a member of a nonprofit corporation must be able to view the contracts the corporation has entered into. See Paul v. China MediaExpress Holdings, Inc., Del.Ch. C.A. No. 6570–VCP, 2012 WL 28818 (Jan. 05, 2012)(in an action to inspect the books and records of a corporation under 8 Del.C. 220, the court concluded the shareholder was ‘entitled to production of documents constituting any contracts,’ and noted that the ‘existence, or nonexistence, of these contracts and documents would affect directly the Company’s revenue and net income’). Accordingly, under the facts of this case, we conclude that the trial court erred in determining that plaintiff’s R.C. 1702.15 examination right did not include the right to examine contracts.”)(underscoring added).
In No-Burn, Inc. v. Murati, 2011-Ohio-5635, ¶ 20, the court held: “Contracts (employment, consulting, transactional, leases, guarantees, loans) and offers to contract (loan applications) provide a picture of management’s utilization of corporate resources and willingness to assume risks. Such information is highly relevant to the ascertaining of a corporation’s general condition and state of affairs.” See also Heinrichs v. 356 Registry, Inc., 70 N.E.3d 91, 102 (Ohio App. 2016)(“contracts ‘provide a picture of management’s utilization of corporate resources and willingness to assume risks. Such information is highly relevant to the ascertaining of a corporation’s general condition and state of affairs.’”).
In Oregon, the court deciding Meyer v. Ford Indus., Inc., 538 P.2d 353, 358 (Or. 1975), held: “Based upon our examination of the foregoing decisions … deciding the intended scope and application of the statutory provisions which were the antecedents of the similar provision of the Oregon Business Corporation Act, it appears that the term ‘records and books of account’ … and the term ‘books and records of account,’ as in the subsequent Illinois Business Corporation Act (upon which the Model Business Corporation Act was based), were both held by the Illinois courts not to be limited to ‘books and records of account’ in any ‘ordinary,’ literal or otherwise limited sense, but to be the subject of a broad and liberal construction so as to extend to all records, contracts, papers and correspondence to which the common law right of inspection of a stockholder may properly apply.” See also Coleman v. Coleman Bros. Shows, Inc., 2008 WL 2930396, at *5 (Conn. Super. Ct. 2008)(“plaintiff … seeks contracts for new purchases, clearly related to the issue of whether the corporation is purchasing assets for the personal use of certain officers and directors”)(extending Pagett); Frank v. LoVetere, 363 F. Supp. 2d 327, 341 (D. Conn. 2005)(“The [shareholder] request for Board meeting minutes and accounting records concerning specific corporate transactions is sufficiently particular and within the enumerated documents subject to Conn. Gen.Stat. § 33–946(b). Finally, there is an obvious connection between the minutes and accounting records regarding [the corporation’s] approval of these transactions and the Franks’ desire to review the propriety of the transactions”)(citing Pagett).
As for the temporal scope or range of the records a shareholder may demand, there is a 3-year limit as to financial statements: C.R.S. § 7-116-101 (g):
“All financial statements prepared for periods ending during the last three years that a shareholder could have requested under section 7-116-105.” But C.R.S. § 7-116-102 provides shareholders the right “to inspect records to the same extent as any other litigant if the shareholder is in litigation with the corporation,” and does not limit the “power of a court, independent of articles 101 to 117 of this title, to compel the production of corporate records for examination.”