Books and Records Case Illustrates Crucial Importance of Pre-Suit Demand
July 31, 2017
The third time definitely wasn’t a charm for the plaintiff in Austin v Gould, 2017 NY Slip Op 31494(U) [Sup Ct NY County July 13, 2017], in which the court dismissed ill-pleaded claims for “unfettered and unlimited access to all books and records” of a series of Delaware limited liability companies and their wholly-owned real estate subsidiaries.
The decision by Manhattan Commercial Division Justice O. Peter Sherwood is the latest in a series of trial and appellate court rulings, spread over seven years and three separate lawsuits, rejecting claims by the LLCs’ non-managing one-third owner against the managing two-thirds owner allegedly for failing to distribute millions in management and acquisition fees.
The plaintiff’s two prior lawsuits — the first filed in 2010 and, after its dismissal, the second filed in 2013 — hit dead ends for various reasons including untimeliness and pleading deficiencies. The third lawsuit, filed in 2016, asserted claims for access to the LLCs’ books and records along with damages claims for breach of fiduciary duty and conversion.
The third lawsuit’s complaint identically alleged as to each of the six managing LLCs and each of the six real estate LLCs that plaintiff “has demanded in writing access to the books and records of [entity name], as required by law, but has been denied access.” Nothing more. No copies of the alleged pre-suit demands attached to the complaint. No copies of the alleged pre-suit demands submitted in opposition to the defendant’s dismissal motion.
The defendant’s dismissal motion highlighted the complaint’s allegations seeking to justify access to books and records for the purpose of determining how much money is owed in connection with the management and acquisition fees that were the subject of the prior unsuccessful lawsuits, arguing that since the claims for fees were barred under principles of res judicata, the plaintiff could not demonstrate a “proper purpose” for inspection of records under § 18-305 of the Delaware LLC Act. The defendant further argued:
- the plaintiff’s demand for access to “all books and records” of each LLC was not sufficiently specific to permit the LLCs and the court to evaluate their propriety, citing Norfolk County Retirement Sys. v Jos. A. Banks Clothiers, Inc., 2009 WL 353746 [Del Ch Feb. 12, 2009], aff’d 977 A2d 899 [Del 2009];
- each of the operating agreements provides for inspection of books and records by a member “following reasonable advance notice to the company for valid business purposes as determined in the sole discretion of the Managing Member” (italics added); and
- the plaintiff, as a non-managing member of the managing LLCs, lacked standing and authority on behalf of the managing LLCs to demand access to the books and records of the wholly-owned real estate LLCs.
Plaintiff’s opposition served up additional “valid purposes” to inspect books and records, including verifying the accuracy of K-1s reflecting deficits in plaintiff’s capital accounts, determining the value of his membership interests, and investigating a suspect sale transaction involving one of the real estate LLCs. Plaintiff cited DFG Wine Co. v Eight Estates Wine Holdings, LLC, 2011 WL 4056371 [Del Ch Aug. 31, 2011], which I wrote about here, in support of his standing to demand access to books and records of the wholly owned real estate LLCs.
Justice Sherwood’s decision agreed with the defendant and dismissed the plaintiff’s claims demanding inspection of books and records of both the managing and real estate LLCs, for a number of reasons:
- While the complaint alleged that plaintiff made a pre-suit written demand as required by § 18-305, “the complaint does not state the purpose for the demand, nor that the written demand stated such a purpose.”
- The complaint’s stated purpose for inspection relating to previously dismissed claims for management and acquisition fees “does not constitute a proper purpose.”
- Plaintiff’s additional purposes for inspection articulated in his opposition to the motion, while “arguably” constituting a proper purpose under Delaware law, “at best establish an ex post facto justification” absent evidence they were given with plaintiff’s written pre-suit demand.
- Even assuming valid purposes included in a written demand, “they would not justify plaintiff’s demand for ‘unfettered and unlimited access to all books and records.’”
- Because plaintiff is neither a member of the real estate LLCs nor authorized to act on behalf of the managing LLCs, plaintiff is not entitled to inspect books and records of the real estate LLCs and, in any event, failed to establish valid demand under Delaware law.
Justice Sherwood also examined the right to inspect LLC books and records under New York law as to one of the managing LLCs whose operating agreement includes a New York choice-of-law provision. While pointing out that the New York statute (LLC Law § 1102), unlike its Delaware counterpart, does not contain a written demand requirement, Justice Sherwood nonetheless threw out the claim based on the absence of a valid purpose for inspection.
The decision temporarily at least left unresolved plaintiff’s inspection claims as to one of the managing LLCs and its subsidiary due to the defendant’s failure to submit a copy of the managing LLC’s operating agreement and plaintiff’s alleged belief that it was formed under New York law, thus making it “unclear what states’ laws apply to this entity.” Justice Sherwood therefore denied dismissal as to those two entities “without prejudice to defendant bringing a renewed motion that includes a copy of the relevant operating agreement or agreements.”
Not surprisingly, last week the defendant filed a renewed motion attaching copies of the LLC’s operating agreement and certificate of formation in Delaware.
The Takeaway. Counsel for non-controlling owners should think of the written pre-suit demand not as a hurdle to clear, but as a helpful tool to fix the parameters of inspection and to put the controlling faction on the defensive by articulating valid purposes for the demand and identifying books and records relating to the inspection’s purposes. Preparing the demand is not a particularly onerous or time-consuming task. The penalty for not doing so, or doing so in a slap-dash manner, can be high, as the Austin case starkly illustrates.