Corporate, boards management and shareholders, and especially minority shareholders, should understand the Illinois ground rules for a shareholder’s right of inspect corporate records, and how this right can relate directly or closely to the issues of self-dealing by majority shareholders, the breaches of fiduciary duty and self-executing duties of disclosure which the self-dealing shareholder has.
In shorthand, or common parlance, one might say there is a statutory right to an “accounting” under Section 7.75 of the Illinois Business Corporation Act of 1983 (805 ICLS 5.1, et seq.). To be precise, Section 7.75 provides a right of shareholder inspection. Our discussion of the common law right or claim to an accounting is here.
Any shareholder of record can inspect books, records, and minutes. The purpose of this statutory right is to promote corporate transparency. The issue to avoid fighting about is what is the proper purpose for and scope of an inspection. Some situations are obvious. For example, a shareholder with only a few shares who makes a burdensome inspection demand will likely be found to have an improper purpose. Conversely, a shareholder who has good faith reason to believe, and who may (though not required by the statute) also have nearly or in fact has prima facie evidence of self-dealing by a controlling or majority shareholder or by a director, will have a proper purpose for an inspection.
The pertinent provisions of Section 7.75 are:
(b) Any person who is a shareholder of record shall have the right to examine, in person or by agent, at any reasonable time or times, the corporation's books and records of account, minutes, voting trust agreements filed with the corporation and record of shareholders, and to make extracts therefrom, but only for a proper purpose. In order to exercise this right, a shareholder must make written demand upon the corporation, stating with particularity the records sought to be examined and the purpose therefor.
(c) If the corporation refuses examination, the shareholder may file suit in the circuit court of the county in which either the registered agent or principal office of the corporation is located to compel by mandamus or otherwise such examination as may be proper. If a shareholder seeks to examine books or records of account the burden of proof is upon the shareholder to establish a proper purpose. If the purpose is to examine minutes or the record of shareholders or a voting trust agreement, the burden of proof is upon the corporation to establish that the shareholder does not have a proper purpose.
The potential quantifiable remedy for a corporation’s refusal is potentially meaningful or meaningless depending on the circumstances. It should be expected that if a corporation refuses to allow the inspection, the requesting (minority) shareholder will be told his or her shares are worthless. The remedy is a penalty “up to ten per cent of the value of the shares owned by such shareholder,…” The non-quantifiable remedy for the corporation’s refusal to allow the inspection is “any other damages or remedy afforded him or her by law.” Again, this is highly fact specific depending not the circumstances.
If a shareholder inspection demand is refused, jurisdiction is in the circuit court in the county in which the corporation has its registered agent or has its principal place of business. If such a matter is litigated, the relevant inquiry is whether the requesting shareholder has a made good faith allegations of his or her reasons to inspect. The shareholder must have made the required written demand, and wisely specified with great with particularity the documents for desired inspection and their purpose.
It is the shareholder’s burden to show the demand is good faith, and honest. In many cases the issue will be the shareholder’s belief, which he or she must articulate, as to why he or she believes a director or officer is a self-dealer. The burden is not so high as effectively to require the shareholder to articulate a derivative claim. The inspection may well help a shareholder define a derivative claim, and that alone is no defense or justification to refuse the inspection.
Section 7.75 Relationship to Self-Dealing and Duties to Establish FairnessGood faith fears of self dealing or mismanagement satisfy the burden; specifics are not necessary, especially when specific evidence in the hands of the defendant. Also, if there is evidence the shareholder is on a fishing expedition, i.e., an improper purpose, even a facially plausible reason for inspection may not pass muster with a court. Once a shareholder establishes a proper purpose for the inspection (as opposed to a proper purpose on a per document basis, which is not required), then the scope of permissible inspection is broad with the goal of protecting the shareholders’ interests.
In the case of suspected self-dealing, the shareholder’s good faith belief that there has been has been unfair self-dealing and mismanagement is an entirely proper basis for inspection. Anything a controlling shareholder does with the company, directly or indirectly for himself, is “self-dealing” by definition. And this direct implicates the issue of a Director, majority or controlling shareholder’s fiduciary duty to the company and position conflicts of interest. And with that fiduciary duty come the independent duty to account for and make full disclosure of all self-dealing transactions - apart from the statutory right of the shareholder to inspect under Section 7.75.
Moreover, the alleged self-dealer bears the burden of proving the all self-dealing transactions were “fair.” In other words, this duty exists independently and no shareholder request under Section 7.75 is required or any kind of condition precedent for the duty to establish the fairness of self-dealing. The self-dealer’s duty to establish fairness to the corporation is an affirmative duty, even if doing so results in disclosure of the fiduciary’s own negligence or breaches of duty.
Typical indicia and possibly prime facie evidence of self-dealing by a person with a fiduciary duty to the corporation are book entries or corporate records showing a large receivable owed the corporation by the fiduciary, yet the corporation may only acknowledge a debt to the fiduciary by the corporation. A fiduciary’s salary may indicate self-dealing if it is facially excessive or odd given the fiduciary’s experience or time dedicated to the corporation, especially at time when the corporation may be performing poorly.
Other similar indicia can be if the fiduciary has used corporate assets to pay for personal expenses, undue charitable contributions, luxury items, or to pay for expense of people not directly connected to the enterprises, or expenses of other enterprises or entities that do not directly benefit the corporation. An important concomitant inquiry in such circumstance is whether the corporation is at the same time paying any dividends to shareholders, or making disbursements to cover taxes on pass-through income.
A shareholder’s desire to learn the reasons for any of the foregoing circumstances would justify a suspicion of mismanagement or self-dealing to establish a right of inspection under Section 7.75, and to trigger the independent obligation by the fiduciary to establish fairness. A shareholder who might establish even some of the foregoing would certainly not be on a fishing expedition with an improper purpose for an inspection.
The business and commercial litigation attorneys at Lubin Austermuehle have over thirty years of experience defending and prosecuting accounting actions, corporate and LLC freeze-out and breach of fiduciary duty lawsuits. We are knowledgeable regarding the changes and complexities of this evolving area of the law. We are committed to fighting for our clients' rights in the courtroom and at the negotiating table. We have successfully tried a number of these cases to verdict or settled the cases after the start of trial for large six and seven figure dollar judgment or settlements. Conveniently located in Chicago and Elmhurst, Illinois, we have successfully litigated business separation, accounting and breach of fiduciary duty case for clients all over the Chicago area. To schedule a consultation with one of our skilled attorneys, you can contact us online or give us a call at 630-333-0333.