California limited liability company (and partnership) disputes | Courtroom war stories and lessons learned

Why LLC Managers Should Take Member “Books and Records” Requests Seriously

Under California’s Revised Limited Liability Company Act (“RULLCA”), LLC participants have substantial freedom to structure their relationship in a customized manner under their governing operating agreement.  But one of the statutory rights that is so fundamental that it cannot be altered by an operating agreement is a member’s right to inspect and copy the LLC’s books and records.

Access to books and records — a statutory right that can’t be eliminated

Under section 17704.10(b) of RULLCA, any LLC member, manager, or holder of a transferable (economic) interest has the right, upon reasonable request, to “inspect and copy during normal business hours any of the records required to be maintained pursuant to section 17701.13.”

And under section 17701.10(d)(2), the LLC’s operating agreement cannot “vary a member’s rights under section 17704.10.”

What are the “books and records?”

According to section 17701.13(d), the LLC is required to maintain:

  1. Current names and contact information for members and transferees, with information regarding contributions and share of profits/losses.
  2. Name and contact information of each manager (if manager-managed).
  3. A copy of the articles of organization and all amendments thereto.
  4. Copies of the LLC’s federal, state, and local income tax returns and reports for the past six years.
  5. A copy of the LLC’s operating agreement and any amendments thereto.
  6. Copies of the LLC’s financial statements, if any, for the past six years.
  7. The books and records of the LLC “as they relate to the internal affairs” of the LLC for the past four years.

While most managers are aware of their obligation to furnish membership lists and contact information to members upon request, many are hesitant to provide more sensitive information, such as the LLC’s financial statements, tax returns, and the books and records relating to the LLC’s “internal affairs.”  When LLC members suspect LLC managers of breaching fiduciary duties, the conduct in question often relates to the manager’s handling of the financial aspects of the business, and the internal financial and management records can become “ground zero” in the hunt for incriminating evidence.

Only if “reasonably related to the interest…”

Depending on the facts, some managers may attempt to take cover behind some qualifying language in section 17704.10, providing that the request for information must be “reasonable,” and must be “reasonably related to the interest of [the requesting] person as a member, manager, or transferee.”  The manager will often assert that the member requesting the information was doing so to “further their witch-hunt” or to “bolster their potential claims,” not for “legitimate LLC purposes.”

But that can be a very dangerous position to take.  There aren’t many published Court of Appeal opinions addressing what “reasonably related” means within the context of section 17704.10, but as a general proposition California courts tend to be very protective of membership interests.  Further, it is not inconsistent for a member’s records request to be both reasonably related to their membership interests and an effective evidence-gathering tool for a potential claim against the manager.

There are times, of course, when taking a hard line against a books and records request makes sense.  Take, for example, the recent Delaware Court of Chancery opinion in Durham v. Grapetree, LLC, in which the court confirmed that the LLC was not required to create new documents outside the normal course of business to answer a member’s demand for information; only existing records sought for a proper purpose need be produced.

The attorney fee sledgehammer

But the cautious and risk-averse LLC manager will almost always err on the side of disclosure.  That’s because under section 17704.10, refusing to provide access to books and records upon a proper request can lead to an award of attorney fees against the LLC for wrongfully refusing access.

Under section 17704.10(g), in any action brought to enforce the right of access to books and records, “if the court finds the failure of the limited liability company to comply with the requirements of this section is without justification, the court may award an amount sufficient to reimburse the person bringing the action for the reasonable expenses incurred by that person, including attorney’s fees, in connection with the action or proceeding.”

That means even if the operating agreement was drafted in a very manager-friendly way, with fiduciary duties minimized to the greatest extent possible and no general “prevailing party” attorney fee provision, a member who has wrongfully been denied access to the LLC’s books and records might still have a right to recover attorney fees expended on the effort to get those books and records.

The “what would a jury think” factor

If the risk of attorney fee liability isn’t enough to provoke most managers to err on the side of disclosing books and records, managers should also consider one final wild card.

If a manager is defending serious claims for breach of fiduciary duty, is it really wise to also give the member a separate claim to present to the jury based on withholding books and records?  Even if the claim for breach of fiduciary duty is weak, many jurors will sympathize with the “passive investor left in the dark” theme of most books and records access claims.

Withholding access to books and records without good cause just makes it look like the manager has something to hide.  And sometimes that’s all it takes to tip the scales of justice in a plaintiff’s favor.