Illinois Appellate Court Provides Guidance on the Rights of Directors to Inspection of a Corporation’s Books and Records

In Munroe-Diamond v. Munroe¹, the Illinois Appellate Court recently addressed the issue of the rights of directors of a corporation to inspect the corporation’s books and records. Section 7.75 of the Illinois Business Corporation Act (BCA) provides shareholders with the right to examine certain corporate records provided that the examination is conducted for a proper purpose.² However, the BCA contains no corresponding provision regarding the inspection rights of directors. While there is a well-developed body of case law regarding shareholders’ rights to examine books and records, there are very few reported decisions addressing the inspection rights of directors.

Munroe-Diamond arose out of a common fact pattern, a dispute between siblings who comprised the shareholders and directors of a closely held corporation over the value of the corporation’s shares during buyout negotiations. In this particular shareholder dispute, the divide occurred along gender lines. The brothers owned the majority shares of a moving company and the sisters owned minority shares. The board of directors had hired a valuation firm to provide a fair market valuation of the corporation’s stock. That firm valued the controlling shares, all of which were held by the brothers, at nearly twice the value of the minority shares. The board of directors authorized the corporation to redeem the shares held by minority shareholders for slightly more than the appraised value. While other minority shareholders’ shares were redeemed, the sisters refused to sell their shares for the amount offered.³

Rather, the sisters made a demand upon the corporation to make available for inspection and copying any and all documents pertaining to twenty-four listed categories. The demand did not state a purpose for the inspection. The brothers refused to comply with the demand on the ground that no purpose was put forward as to why the sisters needed access to the documents and no explanation was provided as to how the documents related to the sisters’ duties as directors.⁴

The sisters then made a second demand and argued that the brothers’ refusal was inconsistent with Illinois law. The sisters’ position was that directors have an absolute and unqualified right to examine the corporation’s books and records, and, therefore, they were not required to identify a purpose for the requested examination or to justify their need for access to the records.⁵

Subsequent attempts to negotiate a buyout price for the sisters’ shares as well as to negotiate a partial inspection of the corporation’s books and records were unsuccessful. The sisters then filed a mandamus action. As an affirmative defense, the brothers alleged that the litigation was commenced for an improper purpose, namely, to force the brothers to either purchase the sisters’ stock for an excessive price or to force the corporation to liquidate.⁶

The sisters moved to strike the affirmative defense and for judgment on the pleadings. The trial court granted the sisters’ motions, struck the affirmative defense, and entered judgment on the pleadings in favor of the sisters. In so ruling, the trial court found that, as the sisters were directors, they had an absolute and unqualified right to examine the books and records of the corporation.⁷

The first issue before the appellate court were whether directors do have an unqualified right to inspect a corporation’s books and records or whether, like shareholders, directors’ rights are limited to inspections conducted for a proper purpose. A second issue before the court was, if directors’ inspection rights do require a proper purpose, whether the directors bear the burden of establishing the propriety of their purpose or whether the corporation bears the burden of establishing the impropriety of the purpose.

While noting that the case did not involve the rights of shareholders, the court began its analysis by discussing the history of shareholders’ rights to inspect a corporation’s books and records. At common law, shareholders had the right to inspect the books and records of the corporation, but were required to demonstrate a specific interest or proper purpose to justify the inspection.⁸ However, the General Incorporation Act of 1872, which provided shareholders with a right to examine the corporation’s books and records, did not include a requirement that the inspection be for a proper purpose and, thereby, abrogated the common law. Although courts interpreted that statute as not eliminating the consideration of a proper purpose, but instead shifting the burden to the corporation to establish an improper purpose.⁹

However, the Business Corporation Act of 1933 shifted the burden back to shareholders by placing certain limitations on a shareholder’s right to inspect books and records, including requiring that the inspection be for a proper purpose.¹⁰ Likewise, Section 7.75 of the Business Corporations Act of 1983¹¹, which remains in effect today, also provides shareholders with the right to inspect certain corporate books and records, “but only for a proper purpose.”¹²

The court then observed that, unlike the rights of shareholders, there is no corresponding statute addressing the rights of directors to inspect the corporation’s books and records.¹³ The court further noted that “court decisions construing the corporate director’s right to inspect records… are surprisingly few in number.”¹⁴

For controlling precedent, the Munroe-Diamond court looked back to an 1896 decision of the Illinois Supreme Court, Stone v. Kellogg¹⁵. Stone involved a petition for mandamus brought by Kellogg, a director and minority shareholder of the Central Union Telephone Company (“Central Union”) against Stone, the president of Central Union and others. Kellogg suspected that conflicts of interest existed between Central Union and its majority shareholder, the American Bell Telephone Company (“American Bell”). Kellogg sought to examine documents including contracts entered into between Central Union and American Bell. When the company refused to provide access to the documents, Kellogg filed a petition for mandamus.¹⁶ Stone, Central Union’s president, filed an answer in which he alleged that Kellogg was searching for grounds to attack the company and its management for his private advantage.¹⁷ The trial court sustained Kellogg’s demurrer to Stone’s answer and granted the petition for mandamus, a decision which was affirmed by the Illinois Supreme Court.¹⁸

Stone had brought his petition in his capacities as both a shareholder and director. Most of the Stone court’s discussion focused on the statutory rights of shareholders to inspect corporate records. As discussed, the law in effect at the time that governed the rights of shareholders to inspect a corporation’s books and records was the General Incorporation Act of 1872. In analyzing that statute, the Stone court explained that:

[t]he shareholder is not required to show any reason or occasion rendering an examination opportune and proper, or a definite or legitimate purpose. The custodian of the books and papers cannot question or inquire into his motive and purposes. If he has reason to believe that they are improper or illegitimate, and refuse the inspection on this ground, he assumes the burden to prove them as such.¹⁹

Thus, the Stone court held that, under the statute in effect at the time, shareholders were presumptively entitled to inspect the books and records of the corporation unless the corporation could prove that the demand was made for an improper purpose. The court then held that, applying that standard, Stone’s answer failed to meet the burden of establishing an improper purpose. Therefore, Kellogg was entitled to an inspection of the books and records that he sought as both a shareholder and director.²⁰

In its discussion of Stone, the Munroe-Diamond court noted that the Stone court applied the same standard to demands for inspections by directors as it held the statute required be applied to demands of shareholders. That standard was that demands were presumptively proper and that the burden rested on the custodian of records to prove an improper purpose.²¹ The court then observed that “[a]s of [the Stone] decision in 1896, corporate directors had the same rights of inspection as shareholders—no more, no less.” The court further explained that:

[s]o that means that, as of 1896 at least, both shareholders and corporate directors had the presumptive right to inspect any and all corporate records, “unless it [could] be said that the answer show[ed] sufficient reason for refusing the writ.” That is, the right was not unqualified, but presumptive—the burden was on the corporation to demonstrate a “sufficient reason” for refusing the writ, namely that the “object and purpose” of the inspection “was not legitimate” or was “to injure the corporation.”²²

The court then noted that, with regard to the inspection rights of shareholders, the Business Corporation Act of 1933 shifted the burden to shareholders to establish a proper purpose. Section 7.75 of the Business Corporation Act of 1983, which remains in effect today, continues to place the burden of establishing a proper purpose on shareholders who seek to inspect the corporation’s books and records of account.²³ However, no statute ever shifted the burden for demands for inspections of books and records by directors from the corporation to directors and the supreme court never overruled its decision in Stone. Thus, the Munroe-Diamond court held that the Stone court’s rule that directors have a presumptive right to inspection of a corporation’s books and records and that the burden is on the corporation to establish an improper purpose if it wishes to deny the director’s demand for inspection remains in effect today.²⁴

In discussing the different standards to be applied to inspection demands by directors and shareholders, the court noted the different purposes for which directors and shareholders need access to a corporation’s books and records. The court observed that directors have fiduciary duties to their corporations and shareholders, which require them to review the books and records.²⁵ This duty justifies the rule that directors have a presumptive right to access to the corporation’s books and records.

Applying that standard to the facts before it, the court held that the brothers, who had pled as an affirmative defense that the sisters were using the inspection as a cudgel to negotiate a higher price for their shares, had sufficiently pled an improper purpose. Without taking any position on the merits of the defense, the court held that an issue of fact as to the propriety of the sisters’ purpose existed and, therefore, the trial court’s entry of judgment on the pleadings in favor of the sisters was error.²⁶ Notably, the court distinguished the affirmative defense pled by the Munroe brothers from the answer pled by Stone. The affirmative defense pled by the Munroe brothers contained “factually specific allegations” regarding the sisters’ allegedly improper purpose in using the “rather ambitious inspection demand” to negotiate a higher purchase price for their shares. In contrast, Stone had pled only the conclusory allegation that the director was just trying to find a way to hurt the company.²⁷ The Munroe-Diamond court’s reference to the sisters’ “rather ambitious inspection demand” is noteworthy and suggests that, had the demand been more circumscribed, the court may have been less receptive to the argument that the brothers’ affirmative defense raised a genuine factual dispute.

The court also addressed its earlier opinion in the case of Semande v. Estes²⁸, in which it had stated that “directors have an absolute and unqualified right to examine a corporation’s books and records . .”²⁹ The Munroe-Diamond court observed that the Semande court’s statement “bordered on dicta”.³⁰ The issue in Semande was whether a director could pierce the corporate veil to pursue a shareholder individually. The Semande court held that a director could not pierce the corporate veil, in part, because directors have access to corporate records and, therefore, do no need equitable remedies to inform themselves about the corporation’s financial condition.³¹ The Munroe-Diamond court further found that, regardless of whether the Semande court’s statement that directors have an unqualified right to inspect corporate books and records was essential to the holding of that case, as the statement cannot be reconciled with the Illinois Supreme Court’s Stone decision, the Semande court’s finding was incorrect.³²

Thus, the Illinois Appellate Court’s recent decision in Munroe-Diamond v. Munroe provides guidance regarding an issue that is not addressed by statute and has not received much attention by Illinois courts – the rights of directors to inspect a corporation’s books and records. The court clarified that directors have a presumptive right to inspect books and records and do not need to set forth a proper purpose for the inspection in their demand. However, that presumptive right can be rebutted by demonstrating that the inspection demand was made for an improper purpose. In such a situation, the corporation that wishes to avoid providing the director with access to the corporation’s books and records has the burden of proving that the purpose was improper.

Samuel Neschis is a member of Neschis & Tolitano, LLC.

¹ Munroe-Diamond v. Munroe,2019 IL App (1st) 172966

² 805 ILCS 5/7.75

³ Munroe-Diamond, 2019 IL App (1st) 172966, ¶¶ 4-5.

⁴ Id.,¶ 6.

⁵ Id.,¶ 7.

⁶ Id.,¶ 8.

⁷ Id.,¶ 9.

⁸ Id.,¶ 14 citing Morris v. Broadview, Inc., 385 Ill. 228, 232 (1944).

⁹ Id.,¶ 14 citing Morris, 385 Ill. at 23; Stone v. Kellogg, 165 Ill. 192 (1896).

¹⁰ Id.,citing Morris, 385 Ill. at 233.

¹¹ 805 ILCS 5/7.75.

¹² Munroe-Diamond, 2019 IL App (1st) 172966, ¶ 14 quoting 805 ILCS 5/7.75 (West 2016) and citing ICD Publications, Inc. v. Gittlitz, 2014 IL App (1st) 133277.

¹³ Id., ¶ 15.

¹⁴ Id.

¹⁵ 165 Ill. 192 (1896).

¹⁶ Id., at 195-196.

¹⁷ Id., at 198.

¹⁸ Id., at 207.

¹⁹ Id., at 205.

²⁰ Id.

²¹ Munroe-Diamond v. Munroe, 2019 IL App (1st) 172966, ¶¶ 22-23.

²² Id., quoting Stone, 165 Ill. at 206.

²³ Section 7.75(c) of the BC, 805 ILCS 5/7.75(c), provides that “if a shareholder seeks to examine books or records of account the burden of proof is upon the shareholder to establish a proper purpose. If the purpose is to examine minutes or the record of shareholders or a voting trust agreement, the burden of proof is upon the corporation to establish that the shareholder does not have a proper purpose.”

²⁴ Id., ¶ 27.

²⁵ Id., ¶ 39.

²⁶ Id., ¶¶ 46-49.

²⁷ Id., ¶¶ 47-48.

²⁸ 374 Ill. App.3d 568 (3d Dist. 2007).

²⁹ Munroe-Diamond, 2019 IL App (1st) 172966, ¶ 33 quoting Semande, 374 Ill. Ap.3d at 472.

³⁰ Id., ¶ 34.

³¹ Id.

³² Id., ¶ 35.