Source: https://www.farrellfritz.com/rss-post/inspection-rights-oral-operating-agreements-and-other-pop-diva-delights/
Timestamp: 2019-11-15 01:58:50
Document Index: 157156832

Matched Legal Cases: ['§ 624', '§ 1102', '§ 1104', '§ 1104', '§ 624', '§ 1102', '§ 1102', '§ 102', '§ 1102', '§ 624', '§ 624']

Inspection Rights, Oral Operating Agreements, and Other Pop-Diva Delights - Farrell Fritz, P.C.
But first, a quick refresher on the subject matter at hand…
Books-and-records proceedings and inspection rights generally
In New York, the books-and-record proceeding – much like the dissolution and appraisal proceedings with which readers of this blog surely are familiar – is a “special proceeding” under Article 4 of the Civil Practice Law and Rules. Special proceedings are expedited and summary in nature such that, in the language of CPLR 409, “[t]he court shall make a summary determination upon the pleadings, papers and admissions to the extent that no triable issues of fact are raised” and “may make any orders permitted on a motion for summary judgment.” In other words, the books-and-records proceeding is teed up from the outset for relief on an accelerated basis.
That relief is available with respect to all business forms – including corporations and limited liability companies, as well as co-ops, condominiums, and partnerships – and is governed by both statute and the common law. When petitioning for relief under the Business Corporation Law, BCL § 624 requires the petitioning shareholder first to have made a pre-suit demand upon the company complete with an affidavit of proper purpose. There’s no such analogue in the Limited Liability Company Law’s counterpart, LLCL § 1102.
As with dissolution and appraisal proceedings under BCL §§ 1104, 1104-a and 623, venue for the books-and-records proceeding typically is fixed in “the supreme court in the judicial district where the office of the corporation is located.” There’s no standing requirement, as in dissolution proceedings under BCL §§ 1104 and 1104-a, that the petitioner possess some minimum stock ownership percentage before running into court.
Unlike directors and managers, whose rights of inspection are “absolute and unqualified” to allow them carry out their fiduciary responsibilities in operating the business, the inspection rights of minority shareholders and members are limited in nature. This is particularly true under the governing statutes – say, BCL § 624 and LLCL § 1102 – which specifically (and with some admitted paucity) delineate the kinds of records to which a shareholder or member is entitled.
The common law is more generous, extending minority owners’ inspection rights beyond the materials itemized in the statutes and ultimately leaving the matter of scope to the presiding judge’s discretion. That scope recently has been expanded to include, for example, the right of a petitioning shareholder of a holding company to inspect the records of the company’s wholly-owned subsidiary in which the petitioner has no ownership interest (Matter of Pokoik v 575 Realties, Inc., 143 AD3d 487 [1st Dept 2016] [discussed here]). As with common-law dissolution, the common-law right of inspection was supplemented, not superseded, by subsequent statutory rights.
The standard a books-and-records petitioner must meet is one of “good faith and proper purpose.” As noted in the “boost” and “on a roll” references above, the definition of “proper purpose” also has been expanded of late to include, for example, the right of a minority owner to seek litigation fodder on the basis of suspected control-owner misconduct, “even if the inspection ultimately establishes that the board engaged in no wrongdoing” (see Retirement Plan for Gen. Empls. of City of N. Miami Beach v. McGraw Hill Cos., Inc., 120 AD3d 1052 [1st Dept 2014]; see also Novikov v Oceana Holdings Corp., 46 Misc3d 561 [Sup Ct, Kings County 2014] [discussed here]). Other commonly-asserted proper purposes include the right to obtain information in order to determine the value of one’s stock or to investigate the propriety (or impropriety) of a company’s dividend/distribution policy (or lack thereof).
If the books-and-records petitioner is able to establish that her demand for company information is relevant and necessary and for a valid purpose, then the burden shifts to the company and its control-owners to show bad faith and an improper purpose – for example, that the petitioner’s overbroad demand was meant only to harass or to obtain trades secrets or other proprietary business information to aid a competitor. In the event of sharply-conflicting and equally-persuasive allegations, the court may hold a hearing to determine issues concerning proper purpose and scope.
Now, back to our regularly-scheduled program…
Inspection rights are a gas, gas, gas!
Earlier this month, in Atlantis Management Group II LLC v Nabe (2018 NY Slip Op 32460[U] [Sup Ct, NY County, October 1, 2018]), Manhattan Commercial Division Justice Saliann Scarpulla, whose insightful decisions are no strangers to this blog, found that an outside investor-member of four NYC gas stations organized as LLCs was entitled to the books and records specifically listed in LLCL § 1102 and the parties’ operating agreement.
In Atlantis, the investor-member sued the defendant control-owners for an accounting and sought to inspect the companies’ books when the gross receipts and profits of one of the gas stations allegedly shot up after a neighboring station shut down. The control-owners countered for declaratory relief, claiming that the parties orally had amended their operating agreement under which the investor-member allegedly agreed to a flat $10K per month in lieu of any profit distributions and otherwise agreed to dispense with the control-owners’ duty to provide financial information.
Justice Scarpulla would have none of it. Never mind that, under LLCL § 102, oral operating agreements aren’t recognized in New York – an argument that the investor-member apparently didn’t make and that the court didn’t sua sponte raise in its decision – the court found not only that the investor-member had an “unconditional and distinct” right to inspect under LLCL § 1102 and the parties’ written operating agreement, but also that the control-owners’ stiff-arm tactics were “inconsistent with their fiduciary duties.”
Inspection rights and the attorney-client privilege
Speaking of the nonexistence of oral operating agreements in New York, last month in Jarmuth v Leonard (2018 NY Slip Op 32155[U] [Sup Ct, NY County, September 5, 2018]), Manhattan Supreme Court Justice Kelly O’Neill Levy – architect of the increasingly infamous Shapiro doctrine, which allows for the unilateral adoption without prior notice of an operating agreement by a majority – found that a shareholder-resident in a NYC co-op was entitled under BCL § 624 to introduce at the deposition of a board member meeting minutes allegedly memorializing advice from the co-op’s counsel given to the board.
In Jarmuth, the resident-shareholder sued the co-op and its board of directors for fiduciary breach and corporate waste when the directors decided at a board meeting to settle an underlying property-damage case against the co-op and one of the directors individually and to assume all of the co-op’s related legal fees. The shareholder-resident sought to confront the defendant-board member with a copy of the minutes at her deposition. The co-op objected on the basis of privilege, arguing in an attorney “briefirmation” that the minutes “memorializ[ed] counsel’s strategic discussions with the Board concerning the wisdom of a potential settlement of the [underlying] litigation and the ratification by the Board.”
Justice O’Neill Levy didn’t buy the co-op’s argument, particularly given the fact that the minutes otherwise were available to all of the co-op’s shareholders and thus weren’t intended to be confidential. The court then went on to cite the plaintiff’s rights of inspection under BCL § 624 and the common law and found that “[s]ince shareholders not on the Board have access to the meeting minutes, they are not privileged and may be introduced at further depositions.”
Inspection rights and pop divas
Finally, earlier this summer in Madonna Ciccone v One West 64th Street, Inc. (2018 Slip Op 31372[U] [Sup Ct, NY County, June 25, 2018]) (yes, that Madonna), Manhattan Supreme Court Justice Gerald Lebovits – who, in addition to issuing well-written and reasoned decisions, offers practitioners informative tips on legal writing and all matters New York practice in his monthly NYSBA Journal column, “The Legal Writer” – arguably bucked the recent trend in favor of shareholder inspection rights, finding that Madonna’s demand to inspect her co-op’s books and records didn’t meet the requisite standard.
In Ciccone, Madonna sued her co-op a little over two years after the board amended its proprietary lease – allegedly with the pop diva specifically in mind – to preclude her children and domestic workers from living in her apartment unless she too was “in residence.” Madonna alleged that the co-op breached the covenant of good faith and fair dealing and sought to have the amendment declared unenforceable. She also sought to inspect all documents related to amendment.
In a prior decision and order, the court dismissed Madonna’s causes of action for declaratory relief and breach of the implied covenant on the basis of the four-month limitations period for proceedings against a “body or officer” under CPLR 217. Despite the fact that the guts of her case had been dismissed, Madonna persisted with her books-and-records claim, arguing that her desire “to investigate how and why her lease was amended so she can protect her children so that they can live in [the apartment] as a family” was a proper purpose.
Justice Lebovits disagreed, finding that Madonna “does not need those materials anymore to prove a case that, by law, she is no longer allowed to prove” and that “[t]o seek the records at this phase is merely harassing.” The court stopped short of dismissing Madonna’s lone remaining claim, however, hinting that the defendant co-op hadn’t asked him to do so. According to the case docket as of the date of this post, the defendant apparently didn’t get the hint.