We’re often asked about what financial or other company information has to be disclosed to investors and stockholders, what information can be demanded, and what information can be kept internally. We’re kicking off a two-part series to clear up some commonly asked questions about financial inspection rights, starting with the inspection rights of corporate stockholders. In our second post, we’ll address the inspection rights of LLC members.
So what are “Stockholder Inspection Rights”?
The concept of inspection rights comes from the idea that since an equity holder owns part of the company and has the ability to vote on corporate decisions, they should also have the right, under certain circumstances, to review the financial records of the corporation. From the stockholder’s point of view, reviewing the corporation’s financial performance is a good way to keep track of and manage the investment. Each state has its own rules governing the information that has to be disclosed to a stockholder of company that is organized in that state. This is important because many company’s have their operations based in a state other than the state of incorporation. So, stockholders in a corporation organized under the laws of Delaware have rights granted to them by Delaware law (regardless of where the company is located).
If a stockholder requests information, what does the company have to provide?
At a minimum, you must acknowledge the request for inspection promptly. Delaware law gives the corporation a maximum of five business days to acknowledge the request, but it should be done as soon as possible. What documents the corporation has to provide depends on the state of incorporation, but usually includes the minutes of stockholders’ meetings, a list of stockholders, and some financial information, usually only what is necessary to satisfy the stockholder’s specific request for information. While most state law is fairly restrictive on what documents the corporation must provide to its stockholders, some states (such as Ohio) are require fairly broad disclosure, requiring that stockholders be allowed access to a wide range of financial documents and correspondence related to those documents.
What does a stockholder have to do?
A stockholder cannot simply walk into your business offices and demand to see the books and records of the company. The stockholder must provide a written request to the corporation stating that they are exercising their inspection rights and, usually, stating a reason as to why the stockholder is deciding to exercise their inspection rights at this point in time. Some states do not give a time window; New York law requires that the investor give the corporation at least five days’ notice. In Delaware, the demand must be accompanied by a statement under oath identifying the reason for the request. Although some stockholders may personally make the request, many requests to inspect documents come from a stockholder’s attorney. Failure by the stockholder to follow the statutory requirements for a records request may eliminate the need for the company to comply with the request.
What reasons do stockholders have to give?
Stockholders must give a good faith reason they are exercising their inspection rights, and usually, that request must be reasonably related to the stockholder’s interest in the company. A general inspection right is often not good enough for most states, but Ohio law does allow an investor an inspection right to simply assess the state of the business. Typically, the following reasons are considered valid reasons for a stockholder inquiry: requests for the purpose of preparing a stockholder derivative suit, communication with other stockholders to influence corporate policies, to gain the list of stockholders to communicate with them regarding dissent from a merger and seeking appraisal rights, and suspicion of mismanagement, fraud, or other wrongdoing by corporate officers.
Enforcement of Inspection Rights
If the corporation denies access to the stockholder, the stockholder does have the right to bring a lawsuit in the company’s’ state of incorporation to demand that the stockholder be granted access to the books and records that will satisfy their request for information. States vary in how the approach the burden of proving the validity and necessity of the request. In Delaware, if the request seeks only a list of stockholders, or a stock ledge, the Company bears the burden of proving that the request is for an improper purpose, but for all other requests, the stockholders must prove that a valid reason exist for review. In Ohio, the burden on the company to show that the stockholder is not entitled to inspect the books and records.
Is there any way I can protect my corporation’s information?
Most if not all corporate responses to requests to inspect the books and records of a corporation are accompanied with a confidentiality agreement. Any confidentiality agreement should respect both the right of the corporation to reasonably protect the confidentiality of the books and records, but also the right of the stockholder to discuss the documents with their advisors, attorneys, and like-minded stockholders.
You may allow the stockholder to inspect the books and records of your corporation in the business offices, but the stockholder does have a right to copy those books and records, subject to the terms of any confidentiality agreement.
Who pays for this?
It depends—it’s one of many factors that can be negotiated between the corporation and the stockholder, including where the inspection of books and records will take place, at what time the inspection will take place, and what the nature the documents will take (paper copies or digital copies). Because the investor is making the request, the investor almost always pays for the expense of producing the documents, as well as the cost of making any copies. However, this cost may be shared between the corporation and the stockholder. The corporation may even decline some or all of an inspection request because the production of documents would be too time-consuming or expensive.
This post is provided for general information purposes and is not legal advice. As always, if you have any questions about this post or how it might impact your business, contact one of our attorneys.