Court Rules Business Judgment Rule Cannot Preclude Statutory Inspection Rights

Purchasing stock in a corporation entitles a shareholder to certain rights to access and inspect the books and records of the corporation under certain circumstances. In a recent decision, a court concluded that a board of directors could not hide behind the business judgment rule to prevent a shareholder from exercising these statutory rights.

The defendant in the case was a corporation that owns and operates a country club. The plaintiff, Mark Erwin, was a member of the club and had been a shareholder of the defendant corporation since 2008. In 2020, the corporation’s board approved plans to renovate the club. The renovation came with a $27 million price tag that was to be paid by imposing assessments and fees on the members. Erwin was not on board with the project and sought various records from the corporation related to the proposed renovation project, invoking his statutory inspection rights. Despite Erwin’s request, the board refused to produce certain documents to him.

In response, Erwin filed suit and requested judicial assistance in obtaining the requested documents. The board responded by arguing that it had no obligation to comply because the plaintiff lacked a proper purpose for making the inspection request. The board argued that the plaintiff was seeking to assert his inspection rights for the improper purpose of second-guessing the board’s decision to approve the renovation project. This, the defendant contended, violated the business judgment rule.

The Court did not agree. As the Court explained, the defendant misunderstood both the purpose of the business judgment rule and the focus of the inquiry into the validity of a denial of a shareholder’s inspection demand. The business judgment rule, the Court explained, operates primarily as a rule of evidence or judicial review that creates a presumption that a corporation’s board acted with the necessary due care in its dealings. On the other hand, the focus of an inquiry into the validity of an inspection demand is the demand itself, not the care of the board. In other words, the Court was being tasked with determining whether Erwin had a proper purpose for making the request, not reviewing whether a board’s actions in approving the project were proper. As such, the business judgment rule was not even implicated, the Court concluded.

Having determined that the business judgment rule did not apply to a situation where a shareholder requested the opportunity to inspect the corporation’s books and records, the Court returned its focus to the inquiry of whether Erwin had a proper purpose for making his request. Erwin’s inspection demand identified six different reasons for seeking access to the books and records requested. Generally, these reasons were to determine if the renovation project was in the best interest of the corporation, whether the board acted within its authority in approving the project, and to gather sufficient information about the project to share with other shareholders and club members. These purposes were typically accepted as being proper, the Court explained. Ultimately, the Court ordered the board to produce many of the documents requested by Erwin.

The Court’s full opinion is available here.

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