Introduction:
The role and power of minority owners in privately held corporations differs from state to state and those rights are most fully protected under the statutory scheme of California, New York and Illinois. Such states as Delaware are famous for limiting the rights of minority stock owners, which is one of the reasons many startup companies, who expect to have passive funders owning minority blocks of stock, use those states to avoid interference with their operation of the company.
This article shall discuss a particular set of rights granted by statute to minority stock holders in a California corporation, namely the right to gain access to corporate documents and financial information.
The Basic Law:
Specific statutes in the California Corporations Code provide shareholders the right to inspect bylaws, accounting books, records, minutes and financial statements. The California Corporations Code allows the court to enforce these rights.
In the case of accounting books, records and minutes the court may appoint an inspector or accountant to audit the books. The court also holds the discretion to force the corporation to pay for costs and fees if the failure to comply was done without adequate justification.
Bylaws and Corporate Books and Records:
Relevant Statutes
Information Required to be Maintained by Corporation
Corp. Code § 213 provides that “every corporation shall keep at its principal executive office in this state, the original or a copy of its bylaws as amended to date, which shall be open to inspection by the shareholders at all reasonable times during office hours.
Corp. Code § 1600(c) provides that the record of shareholders (which includes a list of shareholders’ names, addresses and shareholdings) shall also be open to inspection and copying by any shareholder at any time during usual business hours upon written demand on the corporation, for a purpose reasonably related to such holder's interests as a shareholder.
Shareholder Right to Inspection Corporate Records
Corp. Code § 1601 (a) provides that accounting books and records and minutes of proceedings of the shareholders and the board and committees of the board of any domestic corporation shall be open to inspection upon the written demand on the corporation of any shareholder at any reasonable time during usual business hours, for a purpose reasonably related to such holder’s interest as a shareholder. This right of inspection also extends to the records of each subsidiary of a corporation. Corp. Code § 1601(b) further provides that the request may be made in person or by agent or by attorney, and the right of inspection includes the right to copy. In addition, the right of the shareholders to inspect the corporate records may not be limited by the articles or bylaws of the corporation.
Enforcement of Right
Corp. Code § 1603 provides that upon refusal of a “lawful demand” for inspection, the court may enforce the rights of inspection with just and proper conditions or may, for good cause shown, appoint one or more competent inspectors or accountants to audit the books and records kept in this state and investigate the property, funds and affairs of any domestic corporation. Corp. Code § 1603(c) provides that all expenses of the investigation or audit shall be paid by the applicant unless the court orders them to be paid or shared by the corporation.
Corp. Code § 1604 provides that in any action under §1600 or §1601, if the court finds the failure of the corporation to comply with a proper demand thereunder was without justification, the court may award an amount sufficient to reimburse the shareholder the reasonable expenses incurred, including attorneys’ fees and costs, in connection with such action or proceeding.
Shareholder’s Rights to Inspect Financial Statements:
Definition of Financial Statement
Corp. Code § 114 provides “All references to assets, liabilities, earnings, retained earnings, and similar accounting items of a corporation mean those financial statements or comparable statements or items prepared or determined in conformity with generally accepted accounting principles then applicable, fairly presenting in conformity with generally accepted accounting principles the matters that they purport to present, subject to any specific accounting treatment required by a particular section of this division.”
Director Duty to Send Annual Report
Corp. Code § 1501(a) provides that the directors of a corporation must send to the shareholders an annual report on the business and financial condition of the corporation. However, Corp. Code § 1501(a)(1) states that if the corporation has fewer than 100 shareholders of record, this requirement may be expressly waived in the bylaws. Corp. Code § 1501(a)(1) further requires that the report must contain a balance sheet and an income statement and statement of cashflows for the fiscal year, accompanied by a report of independent accountants or a certificate of an authorized officer that the statement was prepared without audit from the books and records of the corporation. Corp. Code § 1501(c) provides that if the corporation fails to send an annual report, a shareholder may obtain, by written request, the financial statements required by Corp. Code § 1501(a).
The holders of 5% of any class of shares of the corporation may request, at specified intervals during the fiscal year, income statements and balance sheets and, if no annual report has been sent, the statements required by Corp. Code § 1501 (a).
Enforcement of Shareholder Right
To enforce this shareholder right, Corp. Code § 1501(e) provides that the court shall enforce the duty of making and mailing or delivering the information and financial statements required. Corp. Code § 1501(f) further states that in an action to enforce the right to receive an annual report, if the court finds the failure to comply was not justified, the court may award the shareholder reasonable expenses and attorneys' fees.
Attorney General Rights:
Corp. Code § 1508 provides that the California Attorney General, on complaint that a domestic corporation is failing to comply with the provisions of Ch. 15 (records and reports) and Ch. 16 (rights of inspection) of the General Corporation Law, may in the name of the people send to the corporation's principal executive office a notice of complaint.
If the corporation's answer is not satisfactory, the Attorney General may institute, maintain, or intervene in any actions or proceedings for relief by way of injunction, the dissolution of entities, the appointment of receivers or any other temporary, preliminary, provisional, or final remedies that are appropriate to protect the rights of shareholders or to undo the consequences of a failure to comply with the code provisions. In any action or proceeding in which the Attorney General participates, all persons and entities responsible for or affected by the alleged activities may be joined as parties.
Such involvement by the Attorney General is not common for the average privately held California corporation.
Conclusion:
To determine appropriate tactics as well as financial health of the company, access to the documents above are essential which is why the statutes provide means to obtain them. The wise director or officer of a company will not waste time and money and risk the alienation of the court by refusing to deliver the basic documents allowed by statute. That does not mean there will not be later fights over control or access to income; it simply means that the basic information as to structure and financial activities will have to be shared with the other owners. To contest that is to invite participation by an annoyed judge who may very well punish the officer or director for failing to comply with the law.
Do note that corporations from other states have very different requirements and access provisions and the local law should be reviewed when dealing with an entity from a different state.