A. LLC Recordkeeping and Member Access to Records

Business Divorce From Prenup to Break-up Michael P. Connolly mconnolly@murthalaw.com Murtha Cullina LLP 99 High Street Boston, MA 02110-2320 617-457-4078 (direct) 617-210-7026 (fax) www.murthalaw.com AN OVERVIEW OF OWNER ACCESS TO LLC AND CORPORATION RECORDS Disputes between a company and its owners sometimes arise when a company fails to provide access to company records upon an owner s request. Such conflicts frequently occur in closely held businesses where one or more of the owners are the principal day-to-day managers of the business while the other owners have a more limited role, or even no role, in the company s operations. Such outsider owners depend on the insider owners to provide them with full and accurate information and may become suspicious of the insider owners when the information provided is delayed or incomplete. For their part, the owner/managers may believe that information requests from other owners are a burden on the company s management or may view particular requests as overly broad or unrelated to the requesting owner s interests in the company. When making or responding to an owner s request for information, then, it is important for both the company and the owner to know their respective rights and obligations concerning the business records. The scope of an owner s right to request and receive a company s records is often spelled out in the company s governance documents, such as operating agreements or by-laws. A sample operating agreement provision for member inspection of LLC records is attached as Exhibit A. A sample by-law provision for shareholder access to corporate records is attached as Exhibit B. In the absence of any agreement that specifically addresses access to records, the provisions of the applicable state statute concerning the entity type will control the process for entity document requests and production. What follows is an overview of the statutory rights and obligations of entities and their owners in the context of LLCs and corporations. This overview addresses Massachusetts LLC and corporate statutes for discussion purposes. While many states statutes contain provisions similar to the Massachusetts General Laws, parties should pay close attention to the provisions of their specific state s statutes in determining their rights and obligations concerning requests and production of business records. A. LLC Recordkeeping and Member Access to Records In Massachusetts, General Laws Chapter 156C, 9 sets forth the minimum recordkeeping requirements for LLCs. According to the Historical and Statutory Notes to Chapter 156C, 1, [t]his chapter is similar to 101 to 1206 of the Uniform Limited Liability Company Act. Under 9, each LLC is required to keep (1) a current list of the LLC s members and managers, (2) a copy of the LLC s certificate of organization, (3) copies of the LLC s tax

returns for the three most recent years, (4) copies of the effective written operating agreements and (5) information concerning member contributions, member distributions, and events upon which the LLC is to be dissolved. Records kept under 9 are subject to inspection and copying at the reasonable request and at the expense of any member or manager during ordinary business hours. Thus, the LLC s members are statutorily entitled to request and receive copies of the information required to be kept under 9, subject only to limitations as to the time and expense of the access. Chapter 156C, 10 provides LLC members with additional rights to access LLC information but subject to certain protections against unreasonable or overly burdensome requests. Specifically, 10 provides: Each member or manager of a limited liability company has the right... to obtain from the limited liability company from time to time upon reasonable demand in writing for any purpose reasonably related to the member s or manager s interest as a member or manager of the limited liability company (i) true and full information regarding the state of the business and financial condition of the limited liability company, (ii) promptly after becoming available, a copy of the limited liability company s federal, state and local income tax returns for each year, and (iii) other information regarding the affairs of the limited liability company as is just and reasonable. Section 10 thus attempts to balance an LLC member s interest in the company s business and financial condition with the LLC s and its management s need to not be overwhelmed by voluminous, repetitive, unnecessarily disruptive or bad faith requests by members. The central inquiry in reviewing a member s request for information, then, will be whether the purpose of the request is reasonably related to the member s interest as a member of the LLC. A sample demand for LLC records is attached as Exhibit C. No Massachusetts court has issued a published decision articulating the standards by which the stated purpose of the request will be deemed reasonably related to the member s interest. However, by looking at the analogous Massachusetts corporate statute (see Section B, below), it is likely that a member could demonstrate that his purpose for requesting certain documents is reasonably related to his interest in the LLC by referring to concerns over the proper management of the company or the value of the member s membership interests. The Court of Chancery in Delaware recently reached such a conclusion in reviewing a records request by a member of a Delaware LLC. While the Delaware statute governing access to LLC records (6 Del. C. 18-305) is not identical to 10, it does contain the requirement that the request be made for any purpose reasonably related to the member's interest as a member of the limited liability company. In Sanders v. Ohmite Holding, LLC, Vice Chancellor Laster determined that [v]aluing one s ownership interest is a proper purpose for seeking books and records. 17 A.3d 1186, 1193 (Del. Ch. 2011)(citations omitted). The Vice Chancellor further determined that [i]nvestigating potential wrongdoing is also a proper purpose. Id. For this investigative purpose to be proper, the requesting member need not prove that any misconduct has actually occurred but instead must establish a credible basis to suspect wrongdoing. Id. at 1194.

For its part, the company may initially decide not to produce the requested documents, but instead to challenge the factual bases presented in support of the stated purpose of the request. The company may also argue that the documents requested are not reasonably related to the stated purpose. Finally, the company may assert that the requesting member already possesses the information sought through prior requests upon the company or through other sources. In any event, both members who request records and LLC management and controlling members who receive records requests should be careful to articulate in writing the precise grounds for their requests or refusals to produce documents requested. Such a developed record will also assist a court in determining whether a member s request was proper and whether the LLC should be ordered to produce any documents in response to that request. B. Corporation Recordkeeping and Shareholder Access to Records Massachusetts General Laws Chapter 156D, 16.01 sets forth the statutory requirement for corporate recordkeeping. As noted in the Comments to the Introduction to Chapter 156D, this statute is based on, but is not identical to, the American Bar Association s Model Business Corporation Act. The Model Act is the basis for the corporate statutes of a substantial majority of the states, including all the other New England states. Parties should, of course, review their specific state statutes, even those based on the Model Act, in order to determine the requirements applicable to their corporation. Under 16.01(e), a corporation must keep copies of its articles of organization, its bylaws, the minutes of all shareholders meetings for the past three years, all written communications to shareholders generally within the past three years, a list of the names and business addresses of its current directors and officers and its most recent annual report as delivered to the Secretary of State. Under Chapter 156D, 16.02, shareholders of a corporation have the right upon written request to inspect and copy those books and records that a corporation is required to maintain pursuant to 16.01(e) provided the shareholder gives the corporation written notice of his demand at least five business days before the date on which he wishes to inspect and copy. The statute does not provide any further restrictions or limitations of a shareholders access to the documents required to be kept pursuant to 16.01. Under 16.01(a), a corporation must also keep as permanent records all minutes of meetings of its shareholders and board of directors, a record of all actions taken by the shareholders or board of directors without a meeting, and a record of all actions taken by a committee of the board of directors in place of the board of directors on behalf of the corporation. A corporation shall also maintain appropriate accounting records, pursuant to 16.01(b), and a record of its shareholders, organized by name and number and class of shares held, pursuant to 16.01(c). Section 16.02 sets forth a heightened standard for a shareholder s request to inspect records concerning board of director or shareholder minutes, accounting records of the corporation or records of shareholder identities. Specifically, 16.02(c) provides that a shareholder may copy and inspect such documents only if: (1) his demand is made in good faith and for a proper purpose;

(2) he describes with reasonably particularity his purpose and the records he desires to inspect; (3) the records are directly connected to his purpose; and (4) the corporation shall not have determined in good faith that disclosure of the records sought would adversely affect the corporation in the conduct of its business.... In light of the language of 16.02, the inquiry in many disputes over shareholder requests for information focuses on whether the request is made in good faith and for a proper purpose. The Comments to 16.02 define a proper purpose to mean a purpose that is reasonably relevant to the demanding shareholder s interest as a shareholder. The statutory right to request documents, therefore, is not a license to embark upon an unbounded fishing expedition. For example, a blanket request for all documents relating to the company s finances and operations would likely be impermissibly broad and unjustified. Shareholders nonetheless do have a legitimate interest in reviewing the financial and operational condition of the business and ensuring that the corporation is being managed appropriately by the directors and officers. Indeed, shareholder requests for documents identified in Sections 16.01(a) (c) are often made in the context of potential or actual claims of director or officer misconduct and harm to the corporation or its shareholders. In such a case, the statute simply requires that the shareholder seeking access to corporate records articulate the reason for his or her request for each category of documents. This is not an insurmountable hurdle. As one Massachusetts Superior (trial) Court judge recently determined in the context of a shareholder s request for records from a close corporation, [a] reasonable articulation of suspected facts, not mere speculation, supporting an inference of possible mismanagement or wrongdoing should be enough. Bernstein v. Pritsker, 30 Mass. L. Rep. 636 at 12-13 (Mass. Super. Ct. 2013). A sample demand for access to corporate records is attached as Exhibit D. For its part, a corporation s initial response to any request that appears not to comply with Section 16.02(c) may be to refuse to produce any documents or to limit its response to those documents that fall within the scope of the statute. A sample response to a shareholder s overly broad records request is attached as Exhibit E. In such a case, the remedy available to a shareholder who thinks his request was improperly rejected is set forth in 16.04. That section provides that if a corporation does not produce documents to a shareholder in response to a proper request, the shareholder may apply to the appropriate superior court for an order to permit inspection and copying of the records demanded. The court shall then dispose of an application under 16.04 on an expedited basis. Further, if the court orders inspection and copying of the records demanded under 16.02 it shall also order the corporation to pay the shareholder s costs including reasonable counsel fees incurred to obtain the order unless the corporation proves that it refused inspection in good faith because it had a reasonable basis for doubt about the right of the shareholder to inspect the records demanded. In light of the specific requirements the statute prescribes for shareholder requests for records, a shareholder should spell out in as much detail as possible the precise documents he seeks and the particular, good faith purpose for which he seeks each category of documents. For its part, given the potential costs and interruption to business operations in becoming embroiled

in litigation over the matter, a corporation should carefully review any request it receives from a shareholder for a corporation s records. Such a review should entail both whether the shareholder has complied with the procedure set forth in 16.02 and whether the request is made in good faith and for a proper purpose. Finally, all parties will want to document their positions in order to establish an appropriate record in the event a court later needs to determine the propriety of either a shareholder s request or a corporation s response to such a request. CONCLUSION Whether one is an owner or a manager of a business, it is important to understand the rights and obligations that entities and their owners have with respect to company recordkeeping and access to such records. Specifically, a company s management needs to know what it is obligated to produce in response to a records request and what it can legitimately withhold. Conversely, an owner must know what documents he is entitled to receive without exception and which records are subject to the heightened standard of a proper purpose reasonably related to his ownership interest. A company may be able to avoid many disputes over requests for inspection of documents by implementing consistent practices with respect to access to the company s records and by developing a culture of transparency with its owners. However, not all companies will be able to do so. Further, even in the best run companies, some disputes may be inevitable. It is therefore important to know the standards by which any later decision to request, produce or refuse to produce company documents will be evaluated. For those standards, the parties should refer to their governance documents or the applicable state statute, as described above.

Exhibit A Sample Inspection Rights Clause for LLC Operating Agreement Books and Records; Inspection. The Company shall keep, or cause to be kept, complete and accurate books and records of account of the Company. The Company shall maintain at its principal business office: (i) a writing setting forth the Members full name and last known business address; (ii) a copy of this Agreement and the Certificate, and all amendments thereto, and executed copies of any powers of attorney pursuant to which this Agreement and the Certificate and all amendments thereto have been executed; (iii) copies of the Company s federal, state, and local income tax returns and reports, if any, for the three (3) most recent Fiscal Years of the Company; (iv) copies of any financial statements of the Company for the three (3) most recent Fiscal Years of the Company; and (v) all other records required to be maintained pursuant to the Act. A Member shall have the right, at all reasonable times and upon reasonable notice during usual business hours, to audit, examine, and make copies of or extracts from the books of account of the Company for any purpose reasonably related to such Member s interest as the member of the Company. Such right may be exercised through any agent or employee of such Member designated by it or by a certified public accountant designated by the Member. The Member shall bear all expenses incurred in any examination made for such Member s account.

Exhibit B Sample Corporate Records Clause for By-laws Section 1. Records to be Kept. ARTICLE CORPORATE RECORDS (a) The Corporation shall keep as permanent records minutes of all meetings of its shareholders and Board of Directors, a record of all actions taken by the shareholders or Board of Directors without a meeting, and a record of all actions taken by a committee of the Board of Directors in place of the Board of Directors on behalf of the Corporation. The Corporation shall maintain appropriate accounting records. The Corporation or its agent shall maintain a record of its shareholders, in a form that permits preparation of a list of the names and addresses of all shareholders, in alphabetical order by class of shares showing the number and class of shares held by each. The Corporation shall maintain its records in written form or in another form capable of conversion into written form within a reasonable time. (b) The Corporation shall keep within The Commonwealth of Massachusetts a copy of the following records at its principal office or an office of its transfer agent or of its Secretary or Assistant Secretary or of its registered agent: (i) its Articles or Restated Articles of Organization and all amendments to them currently in effect; (ii) its Bylaws or restated Bylaws and all amendments to them currently in effect; (iii) resolutions adopted by its Board of Directors creating one or more classes or series of shares, and fixing their relative rights, preferences, and limitations, if shares issued pursuant to those resolutions are outstanding; (iv) the minutes of all shareholders' meetings, and records of all action taken by shareholders without a meeting, for the past three years; (v) all written communications to shareholders generally within the past three (3) years, including the financial statements furnished under Section 16.20 of the MBCA for the past three years; (vi) (vii) a list of the names and business addresses of its current Directors and officers; and its most recent annual report delivered to the Massachusetts Secretary of State. Section 2. Inspection of Records by Shareholders. (a) A shareholder is entitled to inspect and copy, during regular business hours at the office where they are maintained pursuant to Section 1(b) of this Article, copies of any of the

records of the Corporation described in said Section if he or she gives the Corporation written notice of his or her demand at least five business days before the date on which he or she wishes to inspect and copy. (b) A shareholder is entitled to inspect and copy, during regular business hours at a reasonable location specified by the Corporation, any of the following records of the Corporation if the shareholder meets the requirements of subsection (c) and gives the Corporation written notice of his or her demand at least five business days before the date on which he or she wishes to inspect and copy: (1) excerpts from minutes reflecting action taken at any meeting of the Board of Directors, records of any action of a committee of the Board of Directors while acting in place of the Board of Directors on behalf of the Corporation, minutes of any meeting of the shareholders, and records of action taken by the shareholders or Board of Directors without a meeting, to the extent not subject to inspection under subsection (a) of this Section; (2) accounting records of the Corporation, but if the financial statements of the Corporation are audited by a certified public accountant, inspection shall be limited to the financial statements and the supporting schedules reasonably necessary to verify any line item on those statements; and (3) the record of shareholders described in Section 1(a) of this Article. (c) only if: A shareholder may inspect and copy the records described in subsection (b) above (1) his or her demand is made in good faith and for a proper purpose; (2) he or she describes with reasonable particularity his or her purpose and the records he or she desires to inspect; (3) the records are directly connected with his or her purpose; and (4) the Corporation shall not have determined in good faith that disclosure of the records sought would adversely affect the Corporation in the conduct of its business. (d) For purposes of this Section, "shareholder" includes a beneficial owner whose shares are held in a voting trust or by a nominee on his or her behalf. Section 3. Scope of Inspection Right. (a) A shareholder's agent or attorney has the same inspection and copying rights as the shareholder represented. (b) The Corporation may, if reasonable, satisfy the right of a shareholder to copy records under Section 2 of this Article by furnishing to the shareholder copies by photocopy or other means chosen by the Corporation including copies furnished through an electronic transmission.

(c) The Corporation may impose a reasonable charge, covering the costs of labor, material, transmission and delivery, for copies of any documents provided to the shareholder. The charge may not exceed the estimated cost of production, reproduction, transmission or delivery of the records. (d) The Corporation may comply at its expense, with a shareholder's demand to inspect the record of shareholders under Section 2(b)(3) of this Article by providing the shareholder with a list of shareholders that was compiled no earlier than the date of the shareholder's demand. (e) The Corporation may impose reasonable restrictions on the use or distribution of records by the demanding shareholder. Section 4. Inspection of Records by Directors. A Director is entitled to inspect and copy the books, records and documents of the Corporation at any reasonable time to the extent reasonably related to the performance of the Director's duties as a Director, including duties as a member of a committee, but not for any other purpose or in any manner that would violate any duty to the Corporation.

Exhibit C Sample demand for LLC records VIA ELECTRONIC AND REGULAR MAIL [Addressee] [date] Re: Demand for Inspection of Company Records Dear, This office represents John Doe ( Member 3 ). I write to you in your capacity as counsel to Member 1 and Member 2 in connection with the management and operation of Company, LLC ( Company ). As you know, Member 3 is the owner of forty percent (40%) of the outstanding membership interests in Company. Member 3, individually, is also designated as the managing member of Company pursuant to Company s Operating Agreement. Pursuant to Mass. Gen. Laws c. 156C, 10, Member 3, as both a member and manager of Company has the right to obtain from Company upon written demand true and full information regarding the state of the business and financial condition of the limited liability company. For at least the last month, certain information regarding Company s operations and finances has been in the sole possession of Member 1 and/or Member 2 and has not been provided to Member 3. As such, Member 3 has been deprived of vital information concerning the ongoing state of Company s condition. Member 3 therefore demands the production of the following information: 1. The names of all current Company customers; 2. The names of all potential customers from whom Company has solicited business; 3. The names of all current Company vendors; 4. Copies of all contracts Company has entered within the past ninety (90) days; 5. The location and account numbers of all bank accounts opened on Company s behalf in the past ninety (90) days; 6. The issuers and account numbers of all credit cards opened on Company s behalf in the past ninety (90) days; and 7. A full accounting of all of Company s financial transactions within the past ninety (90) days, including all accounts receivable and accounts payable and including a reconciliation of such transactions to any bank accounts maintained by Company. All of the above information is reasonably related to Member 3 s interest as member of Company because, among other things, such information bears upon the current and future value of his 40% membership interest in the company. All of the above-information is also reasonably

related to Member 3 s interest as manager of Company because, without access to such fundamental financial and operational information, Member 3 cannot perform his managerial functions on behalf of Company as contemplated by the Operating Agreement. Since both Member 1 and Member 2 each have ready access to the requested information, such information should be delivered immediately to Member 3, and within the next two (2) days at the latest. Please call me upon receipt of this letter to arrange for the delivery of the requested information to Member 3. Very truly yours, cc: Member 3

Exhibit D Sample demand for corporate records [Date] VIA OVERNIGHT MAIL James Jones, President XYZ, Inc. 1 Main Street City, MA 00000 Re: Demand for Inspection of Company Records Dear Mr. Jones: This office represents John Smith ( Smith ). As you know, Smith is the owner of thirty percent (30%) of the outstanding shares of XYZ, Inc. (the Company ). We write this letter pursuant to Massachusetts General Laws Chapter 156D, Sections 16.01 and 16.02, on behalf of Smith in his capacity as one of the Company s shareholders. Demand is hereby made upon the Company to make available to Smith all accounting records of the Company for the period from June 30, 2008 (when Smith first became a shareholder) through the present (collectively, the Records ). The Records to be produced should include any and all balance sheets, income statements, tax returns, check registers, bank statements, and any other written or electronic statements or compilations of the Company s financial activity and/or condition, including any schedules or exhibits thereto, for the requested time period. We request that the Records be made available for inspection and copying on July 26, 2010, which, as required by statute, is at least five (5) business days after the delivery to the Company of this written request. The purpose for this request is three-fold. First, Smith needs to review the Records in order to determine whether he has received all of the benefits and compensation properly due to him under his Compensation Agreement with the Company, dated September 28, 2007. Under the Compensation Agreement, Smith was entitled to yearly bonuses, payable no later than February 1 st of each year, consisting of a percentage of the Company s net income, equal to his percentage ownership of the Company. Despite his eligibility for such bonuses during the last two years, Smith never received any such bonuses. He nonetheless believes that there were, or at least should have been, sufficient funds for such bonuses to be paid. The Records are also necessary to allow Smith to determine whether he should have been entitled to the issuance of additional shares of the Company, pursuant to Section 3 of the Compensation Agreement, on account of any increases in the level of the Company s gross sales.

Second, Smith needs access to the Records in order to determine whether you, Mr. Jones, as an officer or shareholder of the Company, have received any benefits, compensation or other payments of Company funds to which you were not entitled. Specifically, Smith acknowledged in the Compensation Agreement that you would be entitled to an annual compensation of $200,000. To the extent you received cash payments or services valued in excess of $200,000 from the Company as compensation, Smith may have been improperly deprived of the bonuses and/or additional shares as described above. Third, and finally, Smith requires access to the Records in order to be able to properly determine the current value of his shares of the Company. Pursuant to Section 4 of the Compensation Agreement, upon the involuntary termination of Smith s employment with the Company (except in the case of a willful breach of the Compensation Agreement, which did not occur here), Smith is entitled to the redemption of his shares by the Company at their value as of the date of his termination. Smith s request herein is made in good faith and for a proper purpose, i.e., to protect his rights both under the Compensation Agreement and as a shareholder of the Company. Further, the Records requested herein are all directly related to these purposes, as described in detail above. Finally, the production of the requested Records will in no way adversely affect the Company in the course of its business. Based on the foregoing, I ask that you contact me upon receipt of this letter to confirm that the Records requested above will be made available to Smith, and/or this office on his behalf, for his inspection and copying on July 26, 2010. Very Truly Yours, cc: John Smith

Exhibit E Sample response to shareholder demand for corporate records Via Hand Delivery James Smith, Esquire Smith & Jones LLP 1 Main Street Anywhere, MA 00000 [Date] Re: Response to John Doe s request for corporate records Dear Mr. Smith: This office represents XYZ, Inc. (the Company ). We write in response to your January 24, 2013 letter on behalf of John Doe ( Doe ) as a shareholder of the Company. In that letter, you requested that the Company produce documents identified in twenty itemized categories, along with other documents described in additional paragraphs of the letter. As an initial point, your letter describes Doe s request for all the designated documents as being made under Mass. Gen. Laws c. 156D, 16.02 (the statute ) and Article XI, 3 of the Company s Bylaws. By their plain language, however, both the statute and the Bylaw provision provide for a shareholder s right to inspect only specifically identified and limited categories of documents. Your letter requests the production of categories of documents beyond those enumerated in the statute or the Bylaws: for example, categories 5 11 and 17. Through this letter, and notwithstanding the accompanying production of documents, the Company expressly reserves all its rights under the Bylaws and under the statute concerning its response to Doe s request for records. Further, your letter requests production of all documents identified within five business days. Both the statute and Bylaws actually provide that a shareholder must give written notice of her demand at least five business days before the date requested for inspection. As it has been in the past, the Company is willing to work with Doe to provide all available information to which he is entitled. However, the Company cannot allow this process to unreasonably and unnecessarily disrupt the Company s day-to-day business. Here, a mere five day notice of Doe s request for inspection is neither reasonable nor feasible, given the large volume of documents requested through your letter and in light of other business obligations of the Company s personnel. We note also that the Company has already made its files available to Doe s financial consultants, who had requested, reviewed and presumably copied many, if not all, of the documents that Doe again requests through your office. Further Doe has been the recipient of numerous direct communications from the Company concerning the Company s financial statements and other matters throughout the last several years. From all these prior

communications and productions, we expect Doe already has the vast majority of the documents he now requests again through your office. Nonetheless, the Company has begun to review its files once more for documents that may be responsive to the current extremely broad and repetitive requests. Once the Company has completed its review, we will then work with you to agree upon a reasonable timetable for the production of such documents. Subject to the foregoing objections, we produce herewith the following documents, as provided for by the Bylaws and the statute: 1. The Company s Articles of Organization and Articles of Amendment as filed with the Massachusetts Secretary of State s Office. 2. The Company s Amended and Restated Bylaws. 3. The Company s audited consolidated financial statements for the following years: (a) Year 1; (b) Year 2; and (c) Year 3. 4. Communications from the Company to shareholders generally concerning the Company s financial statements and business operations between Date 1 and Date 2. The Company is in the process of reviewing its files for additional communications to shareholders generally for this period and before. 5. Documents concerning Doe s share ownership in the Company. We will keep you apprised of the Company s progress in identifying additional responsive documents and the Company s expected timetable for any future production. Please feel free to call me with any questions concerning this matter in the meantime. Very truly yours, Enclosures cc: XYZ, Inc.