It’s been a while since the Business Court devoted a full opinion to a shareholder’s rights to inspect corporate records. But last week, Judge Bledsoe filled that gap with his Order and Final Judgment in Sharman v. Fortran Corp., 2018 NCBC 27.
Fortran? If you are thinking that Fortran Corp. must control the rights to the Fortran computer coding language, like I was, you are wrong. This Fortran Corporation is a "telecommunications system integrator dedicated to designing, sourcing, implementing and maintaining complex communications solutions." That’s what its last Annual Report says.
The Sharman Opinion deals with the request of multiple Fortran shareholders to inspect a wide swath of Fortran’s corporate records. I can’t think of another area of the law where you get a statutory right to discovery before filing a lawsuit (though it’s limited to what the statute says you can get). And you are entitled to a response in five business days! No thirty or sixty days waiting for a response. Plus you might be entitled to recover your attorneys’ fees. I wonder why every claim by a shareholder against a director or officer for, say, a breach of fiduciary duty, isn’t preceded by the use of this powerful tool.
There are two "separate and distinct categories" of inspection requests. Op. ¶16 (quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 10.0 1(7th ed.2017)). These are generally referred to as "absolute rights of inspection" (per. G.S.§55-16-02(a), and "qualified rights of inspection (per. G.S. §55-16-02(b)).
Absolute Right Of Inspection
Section 55-16-01(e) of the General Statutes lists certain records which a corporation is required to keep. A shareholder is "entitled" to inspect these records:
(1) Its articles or restated articles of incorporation and all amendments to them currently in effect;
(2) Its bylaws or restated bylaws and all amendments to them currently in effect;
(3) Resolutions adopted by its board of directors creating one or more classes or series of shares, and fixing their relative rights, preferences, and limitations, if shares issued pursuant to those resolutions are outstanding;
(4) The minutes of all shareholders’ meetings, and records of all action taken by shareholders without a meeting, for the past three years;
(5) All written communications to shareholders generally within the past three years and the financial statements required to be made available to the shareholders for the past three years under G.S. 55-16-20;
(6) A list of the names and business addresses of its current directors and officers; and
(7) Its most recent annual report delivered as required by G.S. 55-16-22.
"Absolute" Doesn’t Mean Automatic
Not every shareholder has these "absolute" inspection rights. Only "qualified shareholders" can exercise them. Only those who have held their shares for more than six months before making their demand for inspection, or who hold at least five percent of any class of the corporation’s shares are "qualified." N.C. Gen. Stat. §55-16-02(g).
"Qualified" Rights Are Tougher To Obtain
Those shareholders trying to exercise the "qualified rights" of Section 55-16-02(b) have to satisfy a more difficult standard. The requesting shareholder must show that his:
1) demand ‘is made in good faith and for a proper purpose,’ (2) ‘[the qualified shareholder] describes with reasonable particularity his purpose and the records he desires to inspect,’ (3) ‘[t]he records are directly connected with [the qualified shareholder’s] purpose.’
Op. ¶23 (quoting N.C. Gen. Stat. §55-16-02(c). Plus, these inspection rights are limited to the three items specified in Section 55-16-02(b).
Judge Bledsoe paced through each of those three requirements to gain "qualified rights." First, a "proper purpose" is "a purpose that is reasonably relevant to the demanding shareholder’s interest as a shareholder.” N.C. Gen. Stat.§ 55-16-02 Op. ¶25 (quoting Official Comment 3).
Showing a "proper purpose" is virtually a gimme for a shareholder alleging that improper transactions by the corporation have occurred, as Sharman was claiming with regard to the Defendant corporation. The Comment to the statute says that:
[a]s a practical matter, a shareholder who alleges a purpose in general terms, such as . . . to determine whether improper transactions have occurred, has been held to allege a ‘proper purpose.
Op. ¶25 (quoting Official Comment 3). The NC Supreme Court held in Parsons v. Jefferson-Pilot Corp, 333 N.C. 420, 426 S.E.2d 685 (1993) that "proper purpose could include ‘determining any possible mismanagement of the Company or any possible misappropriation, misapplication or improper use of any property or asset of the Company.").
But that doesn’t guarantee a victory for the requesting shareholder. The corporation can rebut the claimed proper purpose by showing "that the shareholder is motivated by some improper purpose." Fortran took a run at that, claiming that one of the requesting shareholders, who had a judgment against the corporation, was trying via his inspection request to compel it to pay the debt and force a shareholder buyout. Fortran also said that the requesting shareholders might have the improper purpose of gathering information for a derivative action.
As to the derivative action argument, Judge Bledsoe said that "obtaining corporate records to investigate and prepare a derivative action is not improper and generally encouraged." Op. ¶28. In fact, fifteen years ago, Very First NC Business Court Judge Tennille said that: "[f]ailure to use inspection of books and records may result in a finding that [a derivative] suit was not meritorious when filed." In re Quintiles Transnational Corp. Shareholders Litig., 2003 NCBC 11 at ¶28.). Judge Bledsoe didn’t spill much ink on whether Plaintiffs’ requests had a direct connection to their proper purpose. Instead, he focused on whether they met the "reasonable particularity" requirement. "Particularity" is a word that gets a lot of attention in the world of civil procedure. Rule 9(b) of the NC Rules of Civil Procedure requires that fraud claims be stated with "particularity.". When you are taking a Rule 30(b)(6) deposition, the matters on which the deposition is requested must be identified with "reasonable particularity." The NC Business Court requires trade secrets claims to be framed around trade secrets identified with "sufficient particularity." Aecom Technology Corp. v. Keating, 2012 NCBC 10 at ¶19.
What those words mean in the context of a shareholder inspection request are “that the designation be sufficient to apprise a man of ordinary intelligence what documents are required ." Op. ¶32 (quoting Parsons. supra, 333 N.C. at 429, 426 S.E.2d at 691).
That is addressed on a case by case basis, but the Opinion outlines a few things that a shareholder is not entitled to receive in a records request.
Requests Which Were Disallowed By Judge Bledsoe
There were a few requests made by the Plaintiffs which Judge Bledsoe refused to enforce.
Plaintiffs had asked for "all records relating to a specified board action. Even though that might be "reasonably particular," the statute says that a "qualified shareholder is entitled to “[r]ecords of any final action” by the board of directors or a committee of the board ― not “all records relating to any board action.” Op. ¶33 (referencing G.S. §55-16-02(b).The result on this one might be different under the Model Act, which refers to "excerpts from minutes." The drafters of the NCBCA substituted the words "final action taken" for "excerpts from minutes"with "the intent of excluding discussions and preliminary actions by the board and its committees." Op. ¶33.
Plaintiffs tried to narrow the range of one of their requests (for all records relating to Fortran’s CEO’s use of Fortran assets for his own personal benefit) by identifying specific transactions in their Motion to compel inspection. Judge Bledsoe said that "our courts are clear that the Court’s assessment of “reasonable particularity” must focus on the Qualified Plaintiffs’ actual demand, not on any subsequent court filings." and denied that particular request. Op. ¶36.
Plaintiffs had also requested for financial statements older than three years. Judge Bledsoe said that request was "contrary to applicable law and denied it. See N.C. Gen. Stat. § 55-16-01(e)(5)(requiring retention of “the financial statements required to be made available to shareholders for the past three years”)." Op. ¶38.
What Are "Accounting Records"?
A qualified shareholder meeting the necessary requirements of G.S. §55-16-02(c) is entitled to inspect the "accounting records" of the corporation. N.C. Gen. Stat. §55-16-02(b)(2). What are those?
According to the Official Comments to the statute, they are: "records that permit financial statements to be prepared which fairly present the financial position and transactions of the corporation.” Op. ¶39. That’s not very enlightening, but the NC COA has said that:
accounting records. . . are generally defined as ‘the formal journals and ledgers, and the vouchers, invoices, correspondence, contracts, and other sources or support for such records[.]
Op. ¶39 (quoting Parsons, 106 N.C. App. at 318-19, 416 S.E.3d at 921 ((citing Kohler’s Dictionary for Accountants 13–14 (W.W. Cooper & Y. Ijiri eds., 6th ed. 1983)).
That may leave you wondering what exactly an "accounting record is." All you can take away from the Sharman Opinion is that "general ledgers" are included (Op. ¶39) and that "communications relating to" UCC filings are not. Op. ¶40.
A qualified shareholder is entitled to "[t]he record of shareholders of the corporation." N.C. Gen. Stat. §55-16-02(b)(3).
But the statute doesn’t specify the format in which that information should be delivered.
Judge Bledsoe held that "a fair reading of the statute would require that the list include alphabetically the names and business addresses of shareholders and the number of shares held by each." Op. ¶42 (quoting Russell M. Robinson, II, Robinson on North Carolina Corporation Law § 10.03 (7th ed. 2017)).
Shareholders should have the same opportunity to communicate with other shareholders as the corporation does. Op. ¶¶41-44.
Plaintiffs also recovered some of their attorneys’ fees in pursuing their inspection requests. I would write about that, but this post has been way too long already. suffice to say that fees "shall be" awarded under G.S. §55-16-04(c):
unless the corporation proves that it refused inspection in good faith because it had a reasonable basis for doubt about the right of the shareholder to inspect the records demanded.
Fortran was unable to show that it had a reasonable basis for doubt. Op. ¶49. The amount of fees to be awarded will be dealt with at "a later date" by the Business Court. Op. ¶52(b)(vii)