If a minority shareholder is being treated unfairly by the majority, she should first request an inspection of the corporation’s records. An inspection allows the shareholder to objectively assess and verify any suspicions of financial impropriety. People may sometimes misuse or misunderstand corporate terminology, e.g. confusing dividends with shareholder distributions and/or employee wages. Inspecting corporate records is frequently the easiest (and cheapest) way to clarify a misunderstanding. Second, inspecting corporate records provides a mechanism for conducting some basic discovery and investigation without actually having to file a lawsuit. If a lawsuit becomes necessary, you may not need to compel the corporation to provide this information through arduous discovery procedures in court. Third, it provides an effective avenue for contacting the opposing party, and opening up a dialogue before any litigation begins. When faced with the prospect of shareholder rights litigation, both minority and majority shareholders will (almost) always be better off if they can settle the matter before going to court.
- What kind of corporate records can be inspected?
The scope of inspection rights depends on whether the requester is a director or a non-director shareholder.
Director’s Inspection Rights
If the minority shareholder is currently a director, he or she has “the absolute right at any reasonable time to inspect and copy all books, records and documents of every kind and to inspect the physical properties of the corporation of which such person is a director and also of its subsidiary corporations, domestic or foreign.” (Corp. Code, § 1602.) The inspection “may be made in person or by agent or attorney and the right of inspection includes the right to copy and make extracts.” (Corp. Code, § 1602.) The statute provides directors with an “absolute right” of inspection, but there are occasionally circumstances when a protective order limiting access is appropriate. However, such restrictions are only appropriate “in extreme circumstances where a preponderance of the evidence establishes the director’s clear intent to use the documents to commit an egregious tort—one that cannot be easily remedied by subsequent monetary damages—against the corporation.” (Saline v. Superior Court (2002) 100 Cal.App.4th 909, 915.)
Shareholder’s Inspection Rights
Although not as broad as directors, shareholders in California corporations have substantial rights of inspection, provided the shareholder owns at least five percent in the aggregate or one percent individually of the outstanding shares of the corporation. (Corp. Code, § 1600, subd. (a).) Shareholders who meet these requirements may “inspect and copy the record of shareholders’ names and addresses and shareholdings during usual business hours upon five business days’ prior written demand.” (Ibid.) Furthermore, any shareholder is entitled to inspect and copy the record of shareholders, accounting books and records and minutes of the board, committees thereof and shareholders’ meetings after a written demand on the corporation stating a proper purpose related to the shareholder’s interest as a shareholder. (Corp. Code, §§ 1600, subd. (c); 1601.) Corporations Code section 1501, subdivisions (a) and (c), also provide that any shareholder has the right to inspect a copy of the Corporation’s financial statement for the prior fiscal year within 30 days of a written request. (Corp. Code, § 1501, subd. (a) & (c).)
Shareholders who are (or were) employees of the corporation have independent rights under the California Labor Code to inspect all records the corporation must maintain under, inter alia, Labor Code section 226, subdivisions (a) and (b), and Labor Code section 1174, subdivision (d). Finally, the articles of incorporation may provide additional inspection rights or describe different categories of corporate records to which the statutory inspection rights would apply.
The inspection rights afforded under Corporations Code sections 1501, 1600 and 1601 will usually apply to the following types of records:
- Articles of Incorporation of the corporation, or amendments thereto;
- Bylaws of the corporation, or amendments thereto;
- Records of shareholders’ names, addresses and shareholdings;
- Accounting books and records of the corporation which although not specifically defined may include the following: tax returns, corporate filings, corporate check registers, corporate bank statements, records of real property, equipment leases and the like;
- Annual reports and accompanying financial statements of the corporation;
- Financial statements of the corporation from the last fiscal year to the present;
- Minutes of shareholders meetings; and
- Resolutions or records of corporate actions.
2. What happens if the Corporation does not let the minority shareholder inspect the records?
Contact an attorney to help you enforce rights. You can petition the court for an order compelling the inspection. The court also has the power to appoint an accountant to audit the books and records, and investigate the property, funds and affairs of the corporation. The court may award the petitioner(s) their attorney fees and costs incurred to enforce these statutory inspection rights. (See e.g. Corp. Code, §§ 1603, 1604.)