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Business Law FLASHPOINTS March 2020

March 13, 2020Print This Post Print This Post

Business Law FLASHPOINTS March 2020
Eric N. Macey | Novack and Macey LLP, Chicago
312-419-6900 | E-mail Eric N. Macey

Below is an excerpt from §5.5 of DISPUTES INVOLVING CLOSELY HELD COMPANIES 2020 EDITION.

Rights of Access To Inspect Company Records in Corporations and General Partnerships

Under the Business Corporation Act of 1983, only a shareholder of record has the right to examine the company’s books and records. The Uniform Partnership Act (1997) and the Limited Liability Company Act likewise limit the inspection right to partners and members, with limited exceptions. In many instances, it will be obvious whether the individual requesting a records inspection has the proper standing to do so. However, there have been some circumstances in which this question has caused dispute and litigation.

The most important factor is that, in order to obtain a records inspection, the shareholder must be a current shareholder. This was made clear in West Shore Associates, Ltd. v. American Wilbert Vault Corp., 269 Ill.App.3d 175, 645 N.E.2d 494, 206 Ill.Dec. 489 (1st Dist. 1994), in which a corporate shareholder sued to inspect company records and for damages under §§7.75(b) and 7.75(d) of the BCA following the corporation’s purported wrongful denial of access to its records. Due to a corporate transaction, the shareholder was divested of its shares while an appeal was pending in the lawsuit. The corporation then moved to dismiss the appeal, arguing that the now former shareholder was no longer entitled to records access. The appellate court found that, because the former shareholder was no longer an active shareholder, it was not permitted to inspect the corporation’s books and records. 645 N.E.2d at 497 – 498.

Despite this, the former shareholder’s claim for statutory damages under §7.75(d) of the BCA was allowed to continue because it would still be a violation of the statute if the corporation wrongfully denied access to its books and records while the plaintiff was a valid shareholder. Id. Thus, a claim for statutory damages under §7.75(d) of the BCA survives divestiture of the shares.

Another question that sometimes arises is whether a shareholder of a parent corporation can inspect the books and records of a subsidiary corporation. In Logal v. Inland Steel Industries, Inc., 209 Ill.App.3d 304, 568 N.E.2d 152, 156, 154 Ill.Dec. 152 (1st Dist. 1991), the court found that such an inspection is not permitted unless the subsidiary is “the mere instrumentality or dummy” of the parent corporation. In Logal, the shareholder owned shares of Inland Steel Industries, Inc. (Parent), which was the parent corporation or holding corporation for three subsidiaries, including Inland Steel Company (Subsidiary). The shareholder sought inspection of certain of Subsidiary’s books and records, purportedly to determine whether fraud or gross mismanagement occurred in connection with the closing of one of Subsidiary’s steel plants and, if so, to pursue a derivative action. The shareholder conceded that he was not a shareholder of Subsidiary but claimed that Subsidiary was a “mere alter ego” of Parent and that he was therefore entitled as a shareholder of Parent to inspect Subsidiary’s records.

The court held that the shareholder could not get Subsidiary’s records unless he could prove a corporate veil-piercing theory. This would require the shareholder to prove that Parent “so controls the affairs of [Subsidiary] that the [Subsidiary] is the mere instrumentality . . . of the [Parent] and that, under the circumstances, the observance of the fiction of separate corporate existences would sanction a fraud or promote injustice.” Id. In conducting this analysis, the court identified the following traditional veil-piercing factors: (1) inadequate capitalization; (2) failure to observe corporate formalities; (3) commingling of funds; (4) absence of corporate records; and (5) failure to maintain arm’s-length relationships between the entities. Id. Analyzing these factors, the Logal court determined there was insufficient evidence to pierce the corporate veil and that the factors generally established this was a typical parent-subsidiary relationship. 568 N.E.2d at 156 – 157. Thus, the shareholder of Parent was not permitted to inspect Subsidiary’s records.

Another question addressed by the courts is what right does a corporate director have to demand inspection of corporate books and records. The issue was addressed head on in Munroe-Diamond v. Munroe, 2019 IL App (1st) 172966. There, two sisters who were corporate directors demanded access to 24 categories of business records, but the corporation — controlled by their two brothers — refused. The BCA is silent on the issue, and as the court noted, no statute has ever existed regarding corporate director access to books and records. Consequently, the court followed prior decisions addressing the question under the common law and held that “corporate directors have the presumptive right to inspect corporate books and records, and the burden falls on the corporation to show that the request is for an improper purpose.” 2019 IL App (1st) 172966 at ¶27.

For more information about business law, see DISPUTES INVOLVING CLOSELY HELD COMPANIES 2020 EDITION. Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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