Arizona Rule of Civil Procedure 23.1 governs certain pleading requirements for a shareholder derivative action. In a recent Superior Court decision, the judge found that a minority shareholder could sue both derivatively and directly where the shareholder alleged that the two man closely, held corporation operated in practice as a partnership. The court relied upon Johnson v. Gilbert, 127 Ariz. 410, 412, 621 P.2d 916, 918 (App. 1980) in which it is stated that where a closely held corporation “operated more as partners than in strict compliance with the corporate form,” standing existed to sue both directly and derivatively. The court did not require the shareholder to follow the formal requirements of 23.1.
The owners of a partnership, limited liability company or corporation are entitled to inspect the books and records of the company as long as they are not doing so for an improper purpose. Restrictions on inspection will and should arise where for example confidential and proprietary information is being publicly disclosed or the information disclosed is being used to damage the company. But what do you do when as an owner you are having a difficult time requiring management produce such records?
If there are persistent problems with the production of company records to its owners I suggest the company appoint a person independent of management to handle corporate records production. While this person must be independent of the management who is reluctant to produce records, the person should have full access to company electronic and hard copy financial information. If litigation has commenced, apply to the Court under Rule 53 and have a Corporate Records Master appointed.
The Court has a broad range of powers to appoint a Master to aid the Court or the parties in litigation. Not only should such a Corporate Records Master have full access to records, but also to management to insure proper records are being produced. The Manager should have the ability to recommend to the Court sanctions for failure to produce records and on the other hand, control owners who are abusing their inspection rights. The Corporate Records Master may be a buffer and liaison to insure reasonableness yet protection in the production.
Before receiving protection, a director or officer most likely has to establish the challenged conduct arises “by reason of the fact” or “because” he is or was a director or officer of the corporation, which can be difficult. If a formal complaint is on file, this critical determination can often be resolved by reviewing the claims and allegations within the pleading(s). If the allegations in the pleading(s) challenge the conduct in an “official” capacity, as opposed to an “individual” capacity, the test is often satisfied and the director or officer may qualify for protection.
Prior to seeking protection, a director or officer must comply with Arizona’s statutory requirements. First, if the corporation’s articles of incorporation eliminate liability for the challenged conduct, then a director or officer needs to provide the corporation with only a “written undertaking. “The written undertaking must affirm that the director or officer will repay the advanced and reimbursed fees if he is ultimately required to do so after final disposition. Arizona law does not require the undertaking to be secured.
Second, if the proceeding involves conduct for which liability has not been eliminated under a provision of the articles of incorporation, then the director or officer must take an additional step. In addition to providing the corporation with a “written undertaking” as described above, the director or officer must furnish a “written affirmation. “In this document, the director or officer must affirm his good faith belief that such conduct was made in good faith and that he reasonably believed: (i) in the case of conduct in an official capacity with the corporation, the conduct was in the corporation’s best interests; or (ii) in all other cases, the conduct was at least not opposed to the corporation’s best interests. If the challenged conduct is criminal in nature, the director or officer also must affirm he had no reasonable cause to believe the conduct was unlawful.
If litigation is on the horizon, savvy directors and officers know to consult an attorney and specifically inquire whether they are eligible for advancement or reimbursement of legal costs. Tiffany & Bosco has several attorneys knowledgeable in the area of officer and director liability who can aid in sorting out the issues.
Arizona law provides several significant protections to directors and officers. Their ability to receive reimbursements and advances for legal expenses is one such protection. This often overlooked protection can dramatically affect the feasibility, outcome, and cost of litigation.
Arizona law permits both directors and officers to receive reimbursements and advances for legal expenses. Importantly, Arizona law does not limit their ability to qualify for these protections to those directors and officers currently serving a corporation. In fact, former directors and officers are entitled to receive the same protections.
The right to qualify for this unique protection is frequently triggered long before formal litigation is instituted. Directors and officers may be able to receive advances when an action is merely threatened. Moreover, this protection is not limited to civil cases; rather it may apply to pending actions or suits, formal or informal, and whether civil, criminal, administrative, or investigative.