The books and records demand often is the opening act in business divorce litigation.  The relatively low burden that an owner must meet in order to obtain access to a company’s books and records (discussed here), and the availability of an accelerated special proceeding in New York courts makes the demand a logical opening salvo in many intra-company disputes.  It is a relatively speedy and cost-effective tool for a minority owner investigating misconduct or otherwise contemplating litigation against the majority. 

But there still is plenty of strategy to consider.  If ownership of the company is in dispute, asserting a books and records demand may bring that question to the forefront before it is truly ripe for litigation.  Likewise, a books and records demand may implicate not only the records of the company itself, but also the records of related companies and affiliates.  Finally, depending on the obligations set forth in the owners’ agreement, a demand for books and records may be a two-way street, imposing obligations on the owners themselves.

Each of these considerations plays strongly in a series of recent decisions from New York State and Federal Courts:

Merger Clause Bars Assertion of Membership Interest, Requiring Dismissal of Books and Records Claim.

If ownership of a corporation is disputed, a books and records demand in which the plaintiff’s right to the demanded documents hinges on his ownership status is an effective way to bring that issue to the forefront. Depending on the evidence required to establish ownership, that may or may not be a good thing. That’s the lesson that the plaintiff learned in Spiegler v Mish Mish Inc., where the Court’s resolution of the books and records demand put the brakes on the plaintiff’s claimed ownership altogether (22-CV-8774 [SD NY Oct 11, 2023] [report and recommendation adopted SD NY Nov 3, 2023]).

In Spiegler, the plaintiff alleged that the sole owner of the defendant corporation Mishelle Weinerman, offered to give plaintiff a 35% equity stake in Mish Mish, Inc.—a corporation in the business of “transforming job descriptions from textual to visual”—in exchange for his agreement to become the corporation’s Chief Technology Officer.  Plaintiff agreed, and some nine months later the plaintiff and the Corporation negotiated and signed an employment agreement.  The employment agreement specified plaintiff’s title, responsibilities, and salary, but it made no mention of awarding plaintiff the allegedly agreed-to equity stake.  It also contained a merger clause, to wit:

This Agreement contains the entire agreement of the parties hereto relating to the subject matter hereof and supersedes all prior agreements and understandings with respect to such subject matter, and the parties hereto have made no agreements, representation or warranties relating to the subject matter of this Agreement that are not set forth herein.”

Approximately two years later, Alvarez and Marsal paid the corporation $1 million for its design services.  But when that influx did not result in a distribution to the plaintiff, he grew suspicious.  Eventually, plaintiff sued in federal court seeking, among other relief, access to the books and records of the Corporation.

The Corporation opposed the books and records demand on the grounds that plaintiff’s claim to be a 35% shareholder is “highly implausible.”  Citing the merger clause in the employment agreement, United States Magistrate Judge Gabriel W. Gorenstein agreed:

Here, there is a merger clause, which states: “This Agreement … supersedes all prior agreements and understandings with respect to [the] subject matter” and that it “contains the entire agreement of the parties.”  The Agreement undoubtedly has the “same general purpose” as the alleged oral offer, since both concerned Mish Mish’s retention and compensation of Spiegler as CTO.  Finally, the two provisions cannot coexist.”

Thus, held the Court, “because [plaintiff] has failed to plead facts that demonstrate his status as a shareholder in Mish Mish, his claims for an accounting and for access to records should be dismissed.”

Shareholder’s Access to Records of Related LLC and the Blurred Lines Between Entities.

The inspection rights of a shareholder of a New York corporation are set forth in section 624 of the Business Corporation Law; the inspection rights of a member of a New York LLC are set forth in section 1102 of the Limited Liability Company Law.  While both the BCL and the LLC law can be supplemented with common law rights or additional inspection rights set forth in the owners agreement, it is important to not confuse the two.

In Ryoo v Five Senses Korean Bbq, Inc., a 26.7% shareholder sought under BCL 624 to compel production of a broad swath of financial records maintained by the Corporation ([Sup Ct, NY County 2023]).  In support of that petition, the shareholder submitted his previous letter demand made on a different company, Five Senses Korean BBQ, LLC.  A strange pre-suit demand indeed.

The Corporation failed to timely respond to the BCL petition, and its late-filed opposition did not draw the distinction between Five Senses Inc. and Five Senses LLC.   

Presumably frustrated with the Corporation’s untimely opposition, the Court not only granted the Petitioner’s request to compel the Corporation to produce its records, but it also ordered the disclosure of the records of the non-party LLC.  The Court observed:

The petitioner alleged facts sufficient to establish that he wishes to inspect the respondent’s books and records to ascertain the financial state of the respondent’s business as a closely held corporation, the relationship of the LLC to the respondent, including the extent of any shares that the LLC may own, the propriety of the tax returns, the amount of any dividend or distribution to which he might have been entitled, and the identities of the other shareholders and members, which may have changed since he entered into the Operating Agreement.”

The end result, therefore, is a strange bootstrapping of Petitioner’s demand for the LLC’s books and records onto Petitioner’s BCL 624 demand for the Corporation’s records based on the Court’s finding that the LLC is “related.” Going forward, the Corporation will face an uphill climb limiting any further discovery into the non-party LLC. A poignant reminder of the importance of not only corporate separateness, but also timely filing of opposition papers.

Two-Way Street: Removed Manager Must Turn Over Books and Records.

While litigation over books and records typically focuses on the owner’s request to the company, operating agreements and shareholders agreements can also impose an affirmative obligation on the owners.  In ERI/SNL 2015 Holdings LLC v SNL Dev. Group LLC, New York County Commercial Division Justice Andrea Masley considered a company’s emergency request for an injunction requiring its former managing member to turn over the company’s records to allow for the continued management of the company (2023 N.Y. Slip Op. 33951[U] [Sup Ct, New York County 2023]).

ERI/SNL concerns a dispute over the construction and sale of 22 self-storage facilities across New York state.  Plaintiff ERI was to provide the financing and defendant SNL was to oversee the construction of the facilities.  The parties formed several LLCs in furtherance of that joint venture, each subject to an operating agreement deeming defendant SNL and its affiliated entities “managing members.”  SNL could be removed as a managing member of the LLCs at plaintiff ERI’s direction upon the occurrence of a “Removal Event.” 

Moreover, Section 4.3(b) of the Operating Agreements requires an outgoing Managing Member to “promptly turnover all Company books, records and other items required by the Manager so appointed to facilitate its future management of the Company and its assets.”

Apparently finding misconduct warranting removal of SNL, on July 27, 2023, plaintiff sent notice that it was removing defendant as a managing member of the LLCs.  While SNL initially challenged the removal, by September it had withdrawn its challenge.

But the dispute lingered.  By October, SNL had failed to turn over the documents or tools necessary for ERI to continue to operate the LLCs toward completion of the storage centers.  As a result, ERI sought an injunction enforcing the turnover requirements of the Operating Agreement.  Justice Masley granted an injunction immediately requiring SNL to turn over virtually every document in SNL’s possession, finding:

Defendants have admittedly failed to transfer any documents or tools necessary to operate the platforms and ventures even though plaintiffs have had control of the ventures and platforms since September. Rather, all of plaintiffs’ information has come from subpoenas and others — not defendants. It appears that a cause of action exists in favor of plaintiffs and against defendants and that plaintiffs are entitled to a preliminary injunction on the ground that defendants threaten or are about to do or are doing or procuring or suffering to be done, an act in violation of plaintiffs’ rights respecting the subject of the action and tending to render the judgment ineffectual.”

The relative simplicity of a books and records demand can be disarming. But sometimes those demands raise critical questions that can have a potentially dispositive effect on future proceedings, as these cases illustrate.

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