Equitable Accounting vs. Access to Books and Records: Don’t Confuse Them
December 17, 2018
Raise your hand if you think that a lawsuit for an accounting by the managers of an LLC simply means they have to turn over financial records.
If you raised your hand, read on. If not, you can skip this post.
Soon it will be ten years since the Appellate Division, First Department, in the Gottlieb v Northriver Trading case, recognized the common-law right of an LLC member to seek an equitable accounting by the LLC’s managers. In my post about Gottlieb back then, by way of background I explained:
The “equitable action on account” has a rich legal history in early English and American law, reflecting a time when forms of pleading and the scope of judicial powers made sharp distinctions between actions “at law” and those “in equity.” In modern usage, the accounting action allows a trust beneficiary, partner, etc. to compel a fiduciary entrusted with property to render an account of his or her actions and for the recovery of any balance found to be due. The accounting involves more than simply turning over existing financial records. In New York practice, if the court grants an accounting, it may order the fiduciary to prepare a “long accounting” with detailed schedules of income and expenses over a defined period, followed by the filing of objections to the accounting, followed by proceedings before a court-appointed referee to hear and determine the accounting.
An equitable accounting indeed is more than simply turning over financial records, which was precisely what led to the appellate court’s ruling in Gottlieb. There, the lower court had dismissed the plaintiff’s complaint seeking an accounting because the defendant LLC managers already had turned over to the plaintiff copies of financial and business records allegedly constituting the entire universe of records in its possession or under its control.
The plaintiff, who protested that the managers had “not provided anything resembling an accounting,” ultimately triumphed before the appellate court which rejected the argument that the plaintiff was limited to her inspection rights and upheld the plaintiff’s right under common law to seek an equitable accounting.
Given the highly consequential substantive and procedural differences between, on the one hand, requiring the controllers to provide detailed schedules with back-up documentation of all income and expenses subject to objections by the party seeking the accounting in a formal proceeding in which the controllers as fiduciaries bear the initial burden of proof and, on the other hand, requiring the controllers merely to turn over financial records, why is it, ten years after Gottlieb, we still see cases conflating the two?
Take, for example, the recent decision in Atlantis Management Group II, LLC v Nabe, 2018 NY Slip Op 32460(U) [Sup Ct Oct. 1, 2018]. The case involves four LLCs, each of which operates a gasoline service station and all of which essentially have the same operating agreement naming the plaintiff as a non-managing member with specified rights to certain periodic reporting by the defendant managing members as well as rights to access and audit the LLCs’ financial records.
The plaintiff’s complaint (read here) includes a half dozen causes of action stemming primarily from the defendant managers’ alleged failure to distribute to the plaintiff its share of the profits. The complaint’s first cause of action, starting at ¶ 139, is labeled “Accounting” and alleges all the elements one would expect for an accounting claim, i.e., the existence of a fiduciary duty owed by the defendant managing members to the plaintiff, plaintiff’s pre-suit demand for an accounting, defendants’ failure or refusal to account, and the necessity for a judicially compelled accounting to determine the amounts due to the plaintiff. No mention of denial of access to books and records.
But when plaintiff subsequently moved for partial summary judgment on its accounting claim, it morphed into one seeking only access to books and records. The plaintiff’s supporting memorandum cited inspection rights under LLC Law § 1102 and under provisions of the operating agreements, to the point of defining defendants’ “accounting duties” as duties to “maintain books and records of account . . . and to allow [plaintiff’s] examination and audit of such books and records.” The same equivalency between an accounting and books-and-records access shows up in plaintiff’s argument that the requested “accounting” would avoid “prolonged discovery demands and discovery motions for an accounting that Defendants are already legally obligated to provide to Plaintiff.”
In opposing the motion, the defendants went along — wittingly or unwittingly I can’t say — with the plaintiff’s framing of its accounting claim as one merely seeking access to the LLCs’ books and records, arguing that the plaintiff’s course of conduct over an extended period evidenced the parties’ oral agreement to amend the operating agreements to eliminate its provisions requiring the defendants to provide financial records in exchange for a fixed monthly payment to the plaintiff.
Given the manner in which both sides framed the issue, it’s no surprise that the court’s decision likewise treated the accounting claim as one solely seeking access to the LLCs’ books and records. Here’s how it accurately summarized the plaintiff’s position:
Atlantis moves for partial summary judgment on its first cause of action, seeking an accounting of the LLC Defendants. Atlantis has demonstrated that it is an investor member of the LLC Defendants by submitting copies of the LLC Defendants’ Operating Agreements. Moreover, Atlantis submits evidence demonstrating that a demand for books and records was made, and Atlantis avers that defendants refuse to comply with the demand. Atlantis asserts that it is entitled to corporate records pursuant to its statutory right under Limited Liability Company Law 1102, its contractual right under LLC Defendants’ Operating Agreements, and its equitable right under common law.
The court’s opinion goes on to quote from LLC Law § 1102 and the operating agreements’ books-and-records provision before concluding that the supposed modification of the operating agreements as contended by the defendants
does not undermine Atlantis’s unconditional and distinct right to books and records. That defendants stopped providing Atlantis with financial information pursuant to section 13.3 of the Operating Agreements does not demonstrate Atlantis waived its right to books and records under section 13.1 of the Operating Agreements. Therefore, Atlantis is entitled to a copy of the books and records referred to in Limited Liability Company Law 1102 and Article 13 of the LLC Defendants’ Operating Agreements. [Citation omitted.]
The opinion winds up its discussion of the plaintiff’s accounting claim with a citation to Gottlieb and a finding that the defendants’ denial of plaintiff’s access to books and records “is inconsistent with their fiduciary duties,” leading to the court’s conclusion that “Atlantis is entitled to an equitable accounting.”
Nonetheless, the opinion’s decretal provision granting partial summary judgment in the plaintiff’s favor makes clear that, despite calling it an “equitable accounting,” the sole relief ordered is access to books and records:
ORDERED that defendants are directed to provide plaintiff Atlantis Management Group II LLC with copies and reasonable access to all books and records of: [the four Defendant LLCs], to the extent such books and records relate to plaintiff’s interest as a member, within 20 days of entry of this order; and it is further
ORDERED and ADJUDGED that defendants are required to provide a full accounting of: [the four Defendant LLCs] for the fiscal years 2014 – 2017, to the extent such books and records relate to plaintiff’s interest as a member, including, but not limited to, all records described in Limited Liability Company Law § 1102 (a), all records described in the operating agreement that governs the respective limited liability companies named herein as applied to each, and other information regarding the affairs of each limited liability company named herein, within 60 day of entry of this order.
Atlantis is just one of a number of instances I’ve seen over the years in which counsel and the courts treat accounting claims — which are practically de rigueur in complaints by non-control private business owners against controllers — as equivalent to claims to enforce statutory, common law, or contractual rights of access to books and records.
My point is simple: if you want access to books and records, plead and litigate your claim as such and not as an accounting claim. If you want an equitable accounting, plead and litigate your claim as such, taking care to explain to the court the difference between an accounting and enforcement of book-and-records inspection rights. It’s a needless source of confusion that adds to the risk of courts watering down Gottlieb by denying a true equitable accounting remedy to litigants who seek and deserve one under the guise that they have been given access to books and records.