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DTCI: Representing minority shareholders

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If you do business litigation long enough, you are bound to run into a minority shareholder dispute regarding a closely held corporation. A closely held corporation is one that is not publicly traded and has relatively few shareholders. Barth v. Barth, 659 N.E.2d 559 (Ind. 1995). Despite a minority shareholder having limited voting power, he still has the right to be treated openly and fairly, be involved with the corporation, and be given a return on his investment. Id. at 562 (shareholders of a closely held corporation, like partnerships, stand in a fiduciary relationship to one another). Title 23 is Indiana’s Corporations Law which, inter alia, governs the relationships among shareholders of a closely held corporation. Traditional, domestic for-profit corporations fall under the purview of Article 1 of Title 23. The discussion herein focuses upon a tremendously important procedure for information gathering as well as a powerful remedy available to a minority shareholder in the gathering of evidence for his case against a corporation in either a direct or derivative action.

Direct versus derivative actions

For clarity of discussion, a direct action is a “lawsuit to enforce a shareholder’s right against a corporation.” G&N Aircraft, Inc. v Boehm, 743 N.E.2d 227 (Ind. 2001) (citing Black’s Law Dictionary, 472 (7th ed. 1999)). A direct action may be brought in the name of a shareholder “to redress an injury sustained by, or enforce of duty owed to, the holder.” G&N Aircraft, 743 N.E.2d at 234. These types of actions are usually used to enforce voting rights, to compel dividends, to prevent the impression of fraud against minority shareholders, to inspect corporate record books, and to compel shareholder meetings. Id. Conversely, derivative actions are suits “asserted by shareholder on the corporation’s behalf against a third party … because of the corporation’s failure to take some action against the third party.” Id. (citing Black’s at 455). Derivate actions are brought “to redress an injury sustained by, or enforce a duty owed to, a corporation.” Id. Derivate actions are brought in the name of the corporation and are governed by Trial Rule 23.1 and I.C. 23-1-32-1. In addition to the above, there are certain statutory prerequisites that must be established to maintain such an action. A discussion of these elements is beyond the scope of this article, but the reader should know that they exist. This article will discuss two chapters of Indiana’s Corporations Law regarding inspection rights, a powerful tool to compel those rights, and the way to avoid certain pitfalls that await the unwary.

I.C. 23-1-52 and I.C. 23-1-53

The statutory chapters that control inspection of corporate records are I.C. 23-1-52, et seq. (corporate meeting and accounting records) and I.C. 23-1-53, et seq. (annual financial statements to shareholders). I.C. 23-1-52-1 and I.C. 23-1-53-1 should be reviewed to learn exactly which documents are discussed and available for review. However, suffice it to say, a full review of the documents listed should give a very good picture of the corporation.

In order to review the documents identified in these chapters, one should look at I.C. 23-1-52-2 for the procedures and conditions before doing so. I.C. 23-1-52-2 provides, as follows:

(a) Subject to section 3(c) [IC 23-1-52-3(c)] of this chapter, a shareholder of a corporation is entitled to inspect and copy, during regular business hours at the corporation’s principal office, any of the records of the corporation described in section 1(e) [IC 23-1-52-1(e)] of this chapter if the shareholder gives the corporation written notice of the shareholder’s demand at least five (5) business days before the date on which the shareholder wishes to inspect and copy.

(b) A shareholder of a corporation is entitled to inspect and copy, during regular business hours at a reasonable location specified by the corporation, any of the following records of the corporation if the shareholder meets the requirements of subsection (c) and gives the corporation written notice of the shareholder’s demand at least five (5) business days before the date on which the shareholder wishes to inspect and copy:

(1) Excerpts from minutes of any meeting of the board of directors, records of any action of a committee of the board of directors while acting in place of the board of directors on behalf of the corporation, minutes of any meeting of the shareholders, and records of action taken by the shareholders or board of directors without a meeting, to the extent not subject to inspection under subsection (a).

(2) Accounting records of the corporation.

(3) The record of shareholders.

(c) A shareholder may inspect and copy the records identified in subsection (b) only if:

(1) The shareholder’s demand is made in good faith and for a proper purpose;

(2) The shareholder describes with reasonable particularity the shareholder’s purpose and the records the shareholder desires to inspect; and

(3) The records are directly connected with the shareholder’s purpose.

(d) The right of inspection granted by this section may not be abolished or limited by a corporation’s articles of incorporation or bylaws.

(e) This section does not affect:

(1) The right of a shareholder to inspect records under IC 23-1-30-1 or, if the shareholder is in litigation with the corporation, to the same extent as any other litigant; or

(2) The power of a court, independently of this article, to compel the production of corporate records for examination. Burns Ind. Code Ann. § 23-1-52-2. [emphasis added]

The interaction between I.C. 23-1-52 et seq. and I.C. 23-1-53 et seq. becomes very clear when one cross-references the statutes. See I.C. 23-1-52-4; see also I.C. 23-1-52-4(a), I.C. 23-1-52-2(a), I.C. 23-1-52-1(e), I.C. 23-1-52-1(e)(5). In addition, the statute allows the use of discovery of corporate documents to glean additional information that the statute may not address. I.C. 23-1-52-2(e). Ultimately, the analysis mandates a finding that, with a few exceptions and the proper showing, a shareholder is entitled to see all corporate documents as well as all corporate financials of the corporation.

I.C. 23-1-52-2(a) and the ‘good faith showing’

I.C. 23-1-52-2(c) contains what is referred to as the “good faith and proper purpose” requirement. Section (c) requires that, in order to have inspection rights, a shareholder’s demand must (1) be made in good faith and for a proper purpose; (2) describe with reasonable particularity his purpose and the records he desires to inspect; and (3) show that the records are directly connected with the shareholder’s purpose. See I.C. 23-1-52-2(c). It is important to note that I.C. 23-1-52-2(a) is not subject to the “good faith and proper purpose” required showing of I.C. 23-1-52-2(c). Only subsection (b) is. Over and above the inspection and copying rights conferred upon a shareholder under I.C. 23-1-52-2, I.C. 23-1-52-3 further allows the shareholder’s attorney the same inspection and copying rights. See I.C. 23-1-52-3(a).


 

What satisfies the requirements of I.C. 23-1-52-2(c)

As to a demand for inspection, Indiana common law holds:

[w]hen the stockholder is asking the right to inspect the corporate books, records, papers, and documents, or the corporate property, such request is attended by a presumption of good faith and honesty of purpose until the contrary is made to appear by evidence produced by the officers or agents who are seeking to defeat such inspection. The burden of proof on this question should not be borne by the stockholder but should be borne by agents or officers objecting to the inspection. Indianapolis S. R. Co. v. State, 203 Ind. 534, 540, 181 N.E. 365(Ind. 1932) (citing William Coale Development Co. v. Kennedy, 170 N.E. 434 (Ohio 1930)); see also I.C. 23-1-52-2.

In addition to the above, valuation and a present need for the same is a proper purpose for I.C. 23-1-52-2. Wrights Beauty College, 576 N.E.2d 626, 630 (Ind. App. 1991). A shareholder’s interest in extricating itself from a minority stockholder position in a corporation with which it is no longer in a friendly relationship renders the shareholder’s purpose valid in fact as well as in law. Wrights Beauty College, 576 N.E.2d 626 (Ind. App. 1991) (citing Helmsman Mgmt. Services, Inc. v. A & S Consultants, Inc., 525 A.2d 160 (Del. Ch. 1987)). All of this is especially true in direct actions where, as stated, a fundamental purpose of such an action is to enforce voting rights, to compel dividends, to prevent the impression of fraud against minority shareholders, to inspect corporate record books, and to compel shareholder meetings. G&N Aircraft, 743 N.E.2d at 234.

Evidencing an entitlement to inspection rights

In any dispute over a right of inspection, a shareholder may seek the very powerful tool of a judicial order of inspection (as will be discussed below). However, a shareholder cannot merely jump to a petition for that relief upon being stalled by the corporation. As stated, a condition precedent to obtaining such an order is a demonstration that the shareholder is entitled to inspection rights. The most common aspects of a dispute are the actual meeting of the requirements of I.C. 23-1-52-2(c) and the showing of a present need for the information. Bacompt Systems, Inc. v. Peck, 879 N.E.2d 1 (Ind. App. 2008).

It is generally accepted that a Trial Rule 43(A) trial be conducted “before a factual determination as to the elements of Indiana Code section 23-1-52-2 supporting the grant or denial of the petition may be made.” Bacompt, 879 N.E.2d at 15. Likewise, a trial is also usually required for the “purpose of determining issues of fact concerning … [a shareholder’s] purpose and entitlement to inspect … corporate records” Id. at 5. Thus, it seems clear that when disputes arise over inspection rights, counsel for a minority shareholder should be prepared to evidence entitlement to such rights in an evidentiary trial and, if successful, request the remedies that necessarily flow from that petition. Failure to present at trial admissable evidence that an inspection demand was ingnored by the corporation is likely to prove fatal to a shareholder’s claim for inspection. It may also result in a mandated award of fees and costs.

A judicial order for inspection and copying under I.C. 23-1-52-4

A judicial order for inspection, when read in its entirety, mandates disclosure by the corporation of all documents that corporation is required to maintain under I.C. 23-1-52 et seq. and, arguably, I.C. 23-1-53 et seq. This is required even if the corporate documents and financials are in the possession of third parties, which is a different obligation from that under the trial rules.

If a shareholder demonstrates by trial that he is entitled to inspection rights and that the corporation has wrongfully refused the inspection, it is a mandate under I.C. 23-1-52-4(c) that, where a judicial order of inspection is entered, the court “shall” order payment of costs and fees. That is, a court is mandated by statute to order the corporation to bear the burden of both the expense of production of the documents contemplated by I.C. 23-1-52 et seq. and I.C. 23-1-53 et seq., and the shareholder’s attorney’s fees in obtaining the order. The statute states, in relevant part, as follows:

If the court orders inspection and copying of the records demanded, it shall also order the corporation to pay the shareholder’s costs (including reasonable counsel fees) incurred to obtain the order unless the corporation proves that it refused inspection in good faith because it had a reasonable basis for doubt about the right of the shareholders to inspect the records demanded. See I.C. 23-1-52-4(c).

The corporation’s “reasonable basis for doubt” defense is a burden on the corporation, but it is made more difficult by the presumption of good faith given to a minority shareholder’s request and the purpose behind the inspection rights statute, which is to protect those investors with limited voting rights and market share. Indianapolis S. R. Co., 181 N.E. 365 (Ind. 1932). This mandate of fees can be a tremendously effective tool in the conflict between a minority shareholder and a corporation. Careful use of the procedures set out by statute, asking only for what is set forth in the statute, and proper evidentiary presentation to the court can yield tremendous results against a recalcitrant majority.

Summary

There may be some who believe that a demand for inspection from a minority shareholder’s counsel is inadmissible hearsay at trial. While the author disagrees with that belief, it may be wise (out of an abundance of caution) to draft any demand with counsel’s guidance and to send it directly from the minority shareholder to the corporation. This should eliminate any hearsay or competency questions that may be raised at trial.

With these skills and a full understanding of the workings of these interwoven and complex statutes, minority shareholder clients will fare much better in a quick resolution of disputes with an obstinate majority.•

Jason M. Massaro is the owner of the Massaro Legal Group LLC in Fishers, Ind. He practices primarily in the areas of business and contract law and litigation. Jason is the vice-chair of the Business Litigation Section for DTCI as well as the chair of the Trial Tactics Section. He can be reached at 317-576-8414 or jmassaro@massarolegalgroup.com. The opinions expressed in this column are those of the author.
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