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Condominium Law FLASHPOINTS February 2019

February 15, 2019Print This Post Print This Post

Kenneth Michaels, Jr., Bauch & Michaels, LLC, Chicago
312-588-5000 | E-Mail Kenneth Michaels, Jr.

Condominium Directors Have Greater but Qualified Right To Examine Association Records

This month’s column addresses the question of whether condominium association directors have an unqualified right to examine the condominium association’s books and records. While no statute or case is directly on point, the likely answer is that an association’s director has greater rights than a unit owner to examine books and records, but this right is not absolute and the association bears the burden of proof against the director’s right to examine.

Applicable Illinois Statutes on Examining Books and Records

Section 19 of the Condominium Property Act (Condominium Act), 765 ILCS 605/1, et seq., prescribes the books and records an association must, at a minimum, maintain and the rights of association members to inspect and examine different classes of books and records. 765 ILCS 605/19. As any practitioner is aware, a well-managed association maintains books and records beyond those described in §19. For a further discussion on substantial changes made to §19, which became effective on January 1, 2018, see Condominium Law FLASHPOINTS January 2018 (available in the IICLE® Online Library to subscribers). These 2018 amendments removed the requirement of showing any reason or proper purpose to examine association records regarding all but two classes of documents or information. With regard to those two classes of records, the necessity of showing a proper purpose has been eliminated.

The General Not for Profit Corporation Act of 1986 (NFP Act), 805 ILCS 105/101.01, et seq., is more general than the Condominium Actin describing the books and records that a not-for-profit corporation must maintain. Along with “correct and complete books and records of account” and membership names and addresses, the NFP Act requires the corporation to “keep minutes of the proceedings of its members, board of directors and committees having any of the authority of the board of directors.” 805 ILCS 105/107.75(a). Voting members are entitled to examine these books and records of account and minutes, but the voting member’s right to examine is qualified by the member showing a “proper purpose.” Id. Proper purpose is a historical standard adopted throughout the states in connection with shareholder rights to examine corporate records.

Section 18.3 of the Condominium Act provides that “[t]he association, whether or not it is incorporated, shall have those powers and responsibilities specified in the [NFP Act] that are not inconsistent with this Act or the condominium instruments.” 765 ILCS 605/18.3. Section 18.4 of the Condominium Act provides: “The board of [directors] shall exercise for the association all powers, duties and authority vested in the association by law or the condominium instruments except for such powers, duties and authority reserved by law to the members of the association.” 765 ILCS 605/18.4. Neither the Condominium Act nor NFP Act addresses the rights of directors to examine books and records of an association or NFP corporation.

The Business Corporation Act of 1983 (Corporation Act), 805 ILCS 5/1.01, et seq., is similar to the NFP Act in describing the books and records that a business corporation must maintain. The corporation must keep (1) “correct and complete books and records of account”; (2) “minutes of the proceedings of its shareholders and board of directors and committees thereof”; and (3) “a record of its shareholders, giving the names and addresses of all shareholders and the number and class of the shares held by each.” 805 ILCS 5/7.75(a). Shareholders are permitted to examine “the corporation’s books and records of account, minutes, voting trust agreements filed with the corporation and record of shareholders,” but the shareholder’s right to examine is qualified by the shareholder showing a proper purpose for the records. 805 ILCS 5/7.75(b).

For a discussion of the historical background of the proper purpose standard, which formerly applied to §19 of the Condominium Act, see Taghert v. Wesley, 343 Ill.App.3d 1140, 799 N.E.2d 377, 78 Ill.Dec. 659 (1st Dist. 2003). The Taghert court reviewed proper purpose caselaw from business corporations in construing the applicable standard to apply under the Condominium Act.

It has long been established in Illinois that a shareholder in a corporation has the right to examine the records, books and papers of the corporation after stating a “proper purpose.” Stone v. Kellogg, 165 Ill. 192, 46 N.E. 222 (1896); Weigel v. O’Connor, 57 Ill.App.3d 1017, 15 Ill.Dec. 75, 373 N.E.2d 421 (1978); Hagen v. Distributed Solutions, Inc., 328 Ill.App.3d 132, 262 Ill.Dec. 24, 764 N.E.2d 1141 (2002). A proper purpose is shown when a shareholder has an honest motive, is acting in good faith, and is not proceeding for vexatious or speculative reasons. However the purpose must be “lawful in character and not contrary to the interests of the corporation.” Sawers v. American Phenolic Corp., 404 Ill. 440, 89 N.E.2d 374 (1949). “A proper purpose is one that seeks to protect the interests of the corporation and as well as the interests of shareholder seeking the information.” Weigel, 57 Ill.App.3d at 1025. Taghert, 799 N.E.2d at 381.

Additionally, as the Taghert court observed, in an earlier incarnation §19 of the Condominium Act specifically referenced and incorporated §107.75 of the NFP Act. Id.

Recent Munroe-Diamond Opinion

A recent Illinois appellate court opinion examined the historical distinction between shareholders’ and directors’ common-law and statutory rights to access and inspect corporate books and records. Munroe-Diamond v. Munroe, 2019 IL App (1st) 172966. Two sisters who were minority shareholders and directors in a business corporation sued their brothers who were controlling shareholders and directors of the corporation to compel production of a broad array of corporate books and records. 2019 IL App (1st) 172966 at ¶¶6 – 8. The action, sounding in mandamus, was the result of the corporation’s retention of a management consulting firm to provide what the court described as a “fair market valuation” of the company’s stock. 2019 IL App (1st) 172966 at ¶4. Given the surrounding facts and actions of the parties, the valuation was more likely a “fair value” valuation (which is not the same as a fair market value valuation) in contemplation of avoiding or responding to appraisal rights litigation because of forced redemption or buyout of shares. The valuation report discounted the value of minority shares by more than 50 percent. Id. (Many jurisdictions, which have adopted the Model Business Corporation Act or American Law Institute standards, prohibit minority discounts in such situations.)

The defendant brothers raised an affirmative defense that the records requests were “overbroad, unduly burdensome and disproportionate requests for documents for the sole purpose of harassing Defendants and not for a good faith purpose in [their] role as Director of the Corporation.” 2019 IL App (1st) 172966 at ¶8. The plaintiff sisters moved to strike the affirmative defense and for judgment on the pleadings. The trial court entered an interim order compelling production of some of the requested records. Eventually, the trial court entered judgment for the plaintiffs on the pleadings, finding that the “[p]laintiff directors have an absolute and unqualified right to examine the books and records of the Corporation.” 2019 IL App (1st) 172966 at ¶9. As to the affirmative defenses, the trial court found that these defenses did not allege facts relevant to the inspection of the records and did not present valid defenses. Id.

On appeal, the appellate court saw “a pivotal question here is whether a corporate director has the unqualified right to examine corporate books and records, or whether that right is qualified by the director having a ‘proper purpose’ for doing so — and if it’s the latter, which party bears the burden of proof on the question.” 2019 IL App (1st) 172966 at ¶13. The court began with the history of shareholder rights in Illinois to examine corporate books and records. At common law, the shareholder had to show a specific interest or proper purpose to inspect the records. The General Incorporation Act of 1872, Ill.Rev.Stat. 1874, c. 32, §13, shifted the burden of showing an improper purpose to the corporation. Then the Corporation Act shifted the proper purpose burden back to the shareholder, which is where it lies today with the current incarnation of our Corporation Act. 2019 IL App (1st) 172966 at ¶14.

The appellate court found no legislative provision pertaining to corporate directors and only a few cases on the subject. 2019 IL App (1st) 172966 at ¶15. The court reviewed the common law of a director’s right to examine records. (Its careful review of cases on this subject is worth reading, but beyond the purpose of this article.) By 1896, both shareholders and directors had a presumptive right to inspect corporate records, unless the corporation could show that the object and purpose of the inspection was not legitimate or was to injure the corporation. 2019 IL App (1st) 172966 at ¶23. This was the year that the Illinois Supreme Court decided Stone v. Kellogg, 165 Ill. 192, 46 N.E. 222 (1896), which analyzed a requester’s rights as a shareholder and then articulated its conclusion based on the requester’s role as both a shareholder and director. 2019 IL App (1st) 172966 at ¶21. While the opinion may have been sloppy in its analysis, its conclusion became the common law of our land.

From 1896 to 1933, directors and shareholders had a presumptive right to examine records and the burden was on the corporation to show an improper purpose. 2019 IL App (1st) 172966 at ¶26. When the Corporation Act shifted the burden back to the shareholder, the statute was silent as to directors. “So for corporate directors, what was true in 1896 is true today: In Illinois, 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.

The appellate court examined carefully two subsequent appellate opinions, finding that one could be read as consistent with the Illinois Supreme Court’s decision in Stone, supra. However, in Semande v. Estes, 374 Ill.App.3d 468, 871 N.E.2d 268, 312 Ill.Dec. 868 (3d Dist. 2007), the appellate court found, relying on AMERICAN JURISPRUDENCE, that directors have an absolute and unqualified right to examine corporate records. 2019 IL App (1st) 172966 at ¶33. The Munroe-Diamond court rejected Semande on this proposition of law because it is inconsistent with Stone, supra. Munroe-Diamond, supra, 2019 IL App (1st) 172966 at ¶36.

The appellate court then analyzed the affirmative defense raised by the defendant brothers and construed it liberally to do substantial justice at the pleading stage to find that the defense was not invalid as a matter of law at the pleading stage. 2019 IL App (1st) 172966 at ¶48. The court emphasized that it was expressing no opinion on the merits of the defense and that the burden was on the defendants to establish an improper purpose. 2019 IL App (1st) 172966 at ¶49.

Takeaway. Given the lack of statutory authority, Illinois courts have looked to decisions regarding both business corporations and not-for-profit corporations to construe corporate governance issues pertaining to condominium associations. It is likely that if the question were presented under current law, a court would find that a condominium director has a right to review any books and records of an association unless the association can show that the director is acting for an improper purpose.

For more information on Condominium Law, see CONDOMINIUM LAW (ILLINOIS) — 2016 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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