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Corporate Accountability to Shareholders - the Accounting Remedy

Maintaining corporate accountability to shareholders. Can a shareholder audit the corporate books? The shareholder accounting remedy.

Corporate Accountability and Shareholder Accounting Remedy

Enforcing Corporate Accountability: The Shareholder's Remedy of an Accounting 

In Ritchie v. Rupe the Texas Supreme Court specifically that denial of access to corporate books and records is among the various “squeeze-out” or “freeze-out” tactics that  that controlling shareholders commonly use “to deprive minority shareholders of benefits, to misappropriate those benefits for themselves, or to induce minority shareholders to relinquish their ownership for less than it is otherwise worth.” Shareholders do have the right to inspect corporate books and records, but the inspection statute only gives the shareholder the right to inspect existing records. Inspection rights do little good when the financial records are missing, inadequate, or false. Texas shareholder rights are not limited to looking at whatever the corporation decides to record, but also include the legal power to enforce corporate accountability.

Corporate Accountability Duties

The Business Organizations Code requires that “[e]ach filing entity shall keep: (1) books and records of accounts.”  These records are to be made available to shareholders  and directors,  and the corporation must provide annual statements for the last fiscal year “that contain in reasonable detail the corporation’s assets and liabilities and the results of the corporation’s operations” to a shareholder upon written request.  Unlike the duty to allow shareholder inspection, there is no statutory penalty for the failure to keep records and no express requirement to keep complete and accurate records. While not addressed specifically by the Code or in any Texas case, logic would dictate that the duty to keep records of account and provide them to owners and directors necessarily implies a duty to maintain financial records that are accurate, complete, and meaningful.  How else would the corporation be able to comply with its statutory duty to provide annual statements “that contain in reasonable detail the corporation’s assets and liabilities and the results of the corporation’s operations?"  Although logically implied by the corporation’s statutory obligation, these duties are expressly imposed by trust law. Texas courts have held that a corporation functions as a trustee to its shareholders with respect to their share ownership. A fundamental duty of every trustee is to “maintain a complete and accurate accounting of the administration of the trust.”  One Texas court has noted that the president and general manager of a corporation, “in control of the business and books of the corporation,” acts as “trustee for the corporation and for the other stockholders.”  Courts in other jurisdictions have held that the accounting duties of a trustee, by analogy, impose a duty on corporate officers and directors to account for corporate finances.  The Texas Supreme Court in Yeaman v. Galveston City Co., expressly recognized the shareholder’s right to the common-law remedy of an accounting based on the corporation’s trustee duties.

The Accounting Remedy

A suit for an accounting is founded in equity.  The granting of an accounting is within the discretion of the trial court.  To be entitled to an accounting, the plaintiff must show a fiduciary relationship with the defendant  and the need for the procedure—typically that the failure to keep accurate and complete records will render the task of uncovering the defendant’s wrongdoing so complex that adequate relief cannot be obtained at law.  However, the remedy of an accounting is to create accurate financial records where none exists, not merely to grant the plaintiff access to existing records. If the minority shareholder can obtain the needed information through a statutory inspection demand or through ordinary discovery in a lawsuit, then the court will not order an accounting.

The accounting remedy will be useful to minority shareholders in cases where the corporation has either failed to keep adequate accounting records or where the books have been “juggled” to hide theft. In situations where the controlling sharenholder, through his control of the books, has prepared to defend his gross misappropriation of funds and disportionate distributions by making the misconduct difficult to prove, an accounting remedy might be particularly helpful as a step preceding a derivative suit for damages. An order requiring the corporation and the controlling shareholder to prepare and present accurate financial records, properly accounting for all corporate receipts, expenditures, assets, and liabilities can shift some of the enormous burden of unscrambling the financial eggs onto the corporation and majority shareholder, rather than on the plaintiff minority shareholder. An accounting is flexible remedy that may apply in various scenarios.  Also useful is the trial court’s ability under Rule 172 of the Texas Rules of Civil Procedure to appoint an independent auditor to oversee or perform the accounting.  The audit procedure provides the court the power to appoint an auditor “[w]hen an investigation of accounts . . . appears necessary for the purpose of justice between the parties to any suit,” and requires the auditor to prepare a report, verified by affidavit “that he has carefully examined the state of the account between the parties, and that his report contains a true statement thereof, so far as the same has come within his knowledge.”  The parties are given a 30-day deadline to file exceptions to the report, and the court reasonable compensation to such auditor to be taxed as costs of suit.

Direct or Derivative?

The duty of corporate accountability is a duty that the corporation, as trustee, owes to each shareholder and
should be available as an individual remedy against the corporation, as was the case in Yeaman. However, similar to Ritchie’s treatment of the Patton v. Nicholas claim for suppression of dividends, there may be policy reasons for requiring the claim be brought in a derivative action, because the benefit would be conferred on all shareholders equally and the responsibility for complying with the order to perform the accounting will fall on the corporation’s management. Therefore, in most cases, we would expect that shareholder would bring a derivative claim to assert the accounting remedy. Because the claim would be brought under the derivative litigation statute, successful shareholders would be entitled to attorneys fees.

Houston Business Lawyer Eric Fryar About the author: Houston Business Lawyer Eric Fryar is a published author and recognized expert in the field of shareholder oppression and the rights of small business owners. Eric has devoted his practice almost exclusively to the protection of shareholder rights over the last 25 years. Learn more

 

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This post represents our opinion regarding the relevant shareholder oppression and minority ownership rights law. However, not everyone agrees with us, and the law is changing quickly in this area. This page may not be up to date. Be sure to consult with qualified counsel before relying on any information of this page. See Terms and Conditions.

 

 

 

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