Shareholder Rights Litigation

As an owner of the corporate enterprise, a shareholder generally holds inspection rights over certain information, including corporate documents relevant to their financial investment and interests in the corporation. A shareholder’s right to inspect corporate books and records is an integral part of managing corporate democracy. However, this right is limited by the fundamental principle that the corporation’s management and dealings lie within the board of directors’ responsibility and not the shareholders. If you are a shareholder in a corporation and you have questions about your rights, contact us at 800-767-8040 for a free and confidential consultation.

Process in Invoking and Enforcing Shareholder Inspection Rights

In New York, these rights are granted under common law and by statute. To invoke this right, a shareholder of a New York corporation must make a demand to the board of directors to inspect specific books and records.

There is no specific content required from the shareholder invoking their right to inspection. However, a corporation may demand that the shareholder submit an affidavit indicating that their requested inspection is not derived for a purpose in the interest of a business or object other than the corporation’s business. The affidavit may also be required to indicate that the shareholder has not sold or offered for sale any list of shareholders of any corporation of any kind within the past five years.

The corporation will then have to respond to the inspection demand within a reasonable period. Assuming the corporation denies the shareholder’s demand for inspection. In that case, the shareholder may elect to seek judicial relief by filing a petition for a writ of mandamus under Article 78 of the Civil Practice Law and Rules. Today, the New York courts have not explicitly decided whether shareholder inspection rights may be enforced pending the filing of the petition.

Requirements for Enforcing Inspection Rights

In New York, there are two substantive prerequisites to the enforcement of shareholder inspection rights. These two prerequisites are as follows:

Shareholder status at the time of the inspection demand

This requirement specifies that an individual is only entitled to exercise shareholder inspection rights if they were a shareholder when the inspection request was made.

Good faith and proper purpose in making the inspection demand

The common law and statute require that a shareholder act in good faith and with a proper purpose when invoking their right to shareholder inspection. This means that a corporation may deny a shareholder’s demand if it determines that it is not acting in good faith and with proper purpose.

Interestingly, a shareholder invoking their inspection rights under the common law has the burden of “pleading and proving” that the inspection is desired for “a proper purpose.” In contrast, the corporation is responsible for “showing an improper purpose or bad faith” if a shareholder asserts their inspection rights under the statute. Nonetheless, a court may order that an inspection demand be denied if it determines that the shareholder is not acting with good faith and proper purpose.

The term “good faith” appears to have a minimum legal definition in the context of shareholder inspection. Nonetheless, a bulk of the legal principle focuses on the term “proper purpose.”

To determine “proper purpose,” the court will conduct a fact-intensive inquiry whether the shareholder is reasonably seeking to safeguard their financial interest in a corporation and can be done by inspecting the corporate books and records. This purpose may include establishing the corporation’s financial condition, dividend distribution, calculating the value of the stock, investigating the management’s conduct, potential corporation mismanagement, or evidence to aid legitimate litigation.

Scope of the Inspection Rights

Both statutory and common laws provide the shareholder rights tot inspect corporate materials. However. these two sources’ scope of corporate documents has some differences.

Under the statutory right, a shareholder may examine the following corporate documents:

Minutes of the proceedings of a corporation’s shareholders or records of shareholders, and to make extracts from the documents listed above for any purpose reasonably related to the person’s interest as a shareholder
Annual balance sheet and profit and loss statement distributed to its shareholders or made available to the public
The most recent interim balance sheet or profit and loss statement

Records beyond the scope of the statutory right listed above may only be “relevant and necessary” to the demanding shareholder’s “proper purpose.”

However, it is essential to remember that a corporation may withhold documents that fall under the following exceptions:

Attorney-client and work-product privileges
Potentially sensitive materials