Shareholder’s Right to Inspect Documents in Texas Corporations
by Jason Fulton
When things go poorly, people start asking tough questions. So, in tough economic times, many shareholders in Texas corporations, particularly closely held corporations, want more information about the finances and operations of corporations in which they own shares. When relations with management or a controlling shareholder sour, shareholders should know that the Texas Business Organizations Code (TBOC) provides shareholders with powerful rights to inspect corporate books and records and requires the corporation to pay the shareholder’s attorney’s fees if they have to enforce their inspection right in court.
Section 3.153 of TBOC provides each owner of any entity filing a certificate of formation with the Secretary of State with the right to “examine the books and records” of the entity. Also, under Section 21.218(b), shareholders of for-profit corporations are “entitled to examine and copy . . . the corporation’s relevant books, records of account, minutes, and share transfer records.”
The right of inspection under Section 21.218(b) is open to any shareholder who: (a) makes a written demand; (b) states a proper purpose; and (c) has held shares for at least six months preceding the demand or holds at least 5 percent of the corporation.
To request records, the shareholder or counsel prepares a simple written request that states a proper purpose for the inspection. A proper purpose relates to the shareholder’s individual interest or protection of the corporation’s interest. Common proper purposes include: ascertaining the financial condition of the corporation; determining the value of shares; communicating with other shareholders; or investigating company management, waste of corporate assets, self dealing or other breaches of fiduciary duty.
Although not required, the written demand should also include categories of documents that relate to the proper purpose. If the corporation plans to organize records for review, then categories can facilitate that process. Having specific categories is also helpful should litigation become necessary after the corporation refuses.
Finally, the written demand should state a time and place for the inspection and indicate who will inspect. Shareholders can have the inspection performed by accountants, lawyers or other representatives. TBOC § 21.218(b).
The right to inspect documents extends to almost anything as the terms “books” and “records of account” are not defined in the statute. Courts and commentators typically take a broad interpretation. But shareholders should not expect to view communications between a corporation and its attorney. And, while nothing precludes a shareholder from inspecting proprietary or trade secret information, the shareholder should connect such requests to a proper purpose.
A corporation often responds to a demand to inspect records by: offering substitutes instead of underlying records; requiring a confidentiality agreement; issuing discovery-style objections; or refusing. Although the case law does not support these tactics, the expense and delay attendant in litigation justify attempts to negotiate acceptable terms before suing.
If the corporation refuses to produce records, a court can order the inspection and award the shareholder attorney’s fees and other expenses. But the TBOC provides no procedure for an expedited resolution of such a dispute. TBOC § 21.222(a). To enforce the statute, the shareholder should file a petition for writ of mandamus.
In response to a petition for mandamus, the corporation can raise defenses set out in Section 21.222(b). And if the corporation can raise a fact issue on whether a shareholder has a proper purpose, then the corporation is entitled to a jury trial.
Alternatively, if a shareholder has sufficient basis to bring claims for breach of fiduciary duty against the officer or directors, or claims for shareholder oppression against a majority shareholder, then the shareholder can add a claim for violation of the statute and a refusal to provide records as a ground of oppression. In this situation the shareholder can also use ordinary civil discovery to obtain access to the company’s books and records.
To avoid disputes over inspection of books and records, shareholders should enter shareholder agreements with powerful inspection rights and clear enforcement mechanisms. Shareholders should also regularly review books and records while business is good, and encourage the board of directors to adopt resolutions providing for shareholder access to records.
Jason Fulton is a partner in the Dallas office of Diamond McCarthy and handles commercial litigation including representation of shareholders in closely held companies. He can be reached at firstname.lastname@example.org.