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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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  1. I like the concept. Seems like a good idea and really inexpensive to manage.

  2. I don't agree that this is an extreme case. There are more of these people than you realize - people that are vindictive and/or with psychological issues have clogged the system with baseless suits that are costly to the defendant and to taxpayers. Restricting repeat offenders from further abusing the system is not akin to restricting their freedon, but to protecting their victims, and the court system, from allowing them unfettered access. From the Supreme Court opinion "he has burdened the opposing party and the courts of this state at every level with massive, confusing, disorganized, defective, repetitive, and often meritless filings."

  3. So, if you cry wolf one too many times courts may "restrict" your ability to pursue legal action? Also, why is document production equated with wealth? Anyone can "produce probably tens of thousands of pages of filings" if they have a public library card. I understand this is an extreme case, but our Supreme Court really got this one wrong.

  4. He called our nation a nation of cowards because we didn't want to talk about race. That was a cheap shot coming from the top cop. The man who decides who gets the federal government indicts. Wow. Not a gentleman if that is the measure. More importantly, this insult delivered as we all understand, to white people-- without him or anybody needing to explain that is precisely what he meant-- but this is an insult to timid white persons who fear the government and don't want to say anything about race for fear of being accused a racist. With all the legal heat that can come down on somebody if they say something which can be construed by a prosecutor like Mr Holder as racist, is it any wonder white people-- that's who he meant obviously-- is there any surprise that white people don't want to talk about race? And as lawyers we have even less freedom lest our remarks be considered violations of the rules. Mr Holder also demonstrated his bias by publically visiting with the family of the young man who was killed by a police offering in the line of duty, which was a very strong indicator of bias agains the offer who is under investigation, and was a failure to lead properly by letting his investigators do their job without him predetermining the proper outcome. He also has potentially biased the jury pool. All in all this worsens race relations by feeding into the perception shared by whites as well as blacks that justice will not be impartial. I will say this much, I do not blame Obama for all of HOlder's missteps. Obama has done a lot of things to stay above the fray and try and be a leader for all Americans. Maybe he should have reigned Holder in some but Obama's got his hands full with other problelms. Oh did I mention HOlder is a bank crony who will probably get a job in a silkstocking law firm working for millions of bucks a year defending bankers whom he didn't have the integrity or courage to hold to account for their acts of fraud on the United States, other financial institutions, and the people. His tenure will be regarded by history as a failure of leadership at one of the most important jobs in our nation. Finally and most importantly besides him insulting the public and letting off the big financial cheats, he has been at the forefront of over-prosecuting the secrecy laws to punish whistleblowers and chill free speech. What has Holder done to vindicate the rights of privacy of the American public against the illegal snooping of the NSA? He could have charged NSA personnel with violations of law for their warrantless wiretapping which has been done millions of times and instead he did not persecute a single soul. That is a defalcation of historical proportions and it signals to the public that the government DOJ under him was not willing to do a damn thing to protect the public against the rapid growth of the illegal surveillance state. Who else could have done this? Nobody. And for that omission Obama deserves the blame too. Here were are sliding into a police state and Eric Holder made it go all the faster.

  5. JOE CLAYPOOL candidate for Superior Court in Harrison County - Indiana This candidate is misleading voters to think he is a Judge by putting Elect Judge Joe Claypool on his campaign literature. paragraphs 2 and 9 below clearly indicate this injustice to voting public to gain employment. What can we do? Indiana Code - Section 35-43-5-3: Deception (a) A person who: (1) being an officer, manager, or other person participating in the direction of a credit institution, knowingly or intentionally receives or permits the receipt of a deposit or other investment, knowing that the institution is insolvent; (2) knowingly or intentionally makes a false or misleading written statement with intent to obtain property, employment, or an educational opportunity; (3) misapplies entrusted property, property of a governmental entity, or property of a credit institution in a manner that the person knows is unlawful or that the person knows involves substantial risk of loss or detriment to either the owner of the property or to a person for whose benefit the property was entrusted; (4) knowingly or intentionally, in the regular course of business, either: (A) uses or possesses for use a false weight or measure or other device for falsely determining or recording the quality or quantity of any commodity; or (B) sells, offers, or displays for sale or delivers less than the represented quality or quantity of any commodity; (5) with intent to defraud another person furnishing electricity, gas, water, telecommunication, or any other utility service, avoids a lawful charge for that service by scheme or device or by tampering with facilities or equipment of the person furnishing the service; (6) with intent to defraud, misrepresents the identity of the person or another person or the identity or quality of property; (7) with intent to defraud an owner of a coin machine, deposits a slug in that machine; (8) with intent to enable the person or another person to deposit a slug in a coin machine, makes, possesses, or disposes of a slug; (9) disseminates to the public an advertisement that the person knows is false, misleading, or deceptive, with intent to promote the purchase or sale of property or the acceptance of employment;

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