“Every director shall have the absolute right at any reasonable time to inspect and copy all books, records and documents of every kind and to inspect the physical properties of the corporation of which such person is a director.”
– Corporations Code Section 8334
An HOA Board Member’s Right to Inspect Is Not Absolute
Is a corporate director’s right of access to all of a corporation’s records and documents really so ironclad? Although the law’s policy favoring broad access to corporate records by a director is strong, both statutory law and appellate decisions show that a director’s “absolute” right to inspect and copy records is not always so absolute.
The Corporations Code includes provisions that authorize a court to impose conditions in appropriate circumstances when a director seeks judicial enforcement of his or her absolute right of record access. Also, as discussed in this article, California appellate courts have upheld balancing of a director’s rights to inspect corporate records against important interests of the corporation and its members or shareholders. These interests include protecting the members’ privacy rights in the voting decisions and the corporation’s right to preserve its attorney-client privilege.
Limitations Within the Corporations Code
The General Corporation Law which governs “for profit” corporations includes a provision (Corporations Code § 1602) that is substantially the same as Section 8334 of the Nonprofit Mutual Benefit Corporation Law. In related provisions, both the Nonprofit Corporation Law (§ 8336) and the General Corporation Law (§ 1603) provide that when a director’s lawful demand for inspection of corporate records is denied, the superior court may enforce the director’s right of inspection with just and proper conditions.
The fact that the Code provides for superior court authority to enforce a director’s inspection rights “with just and proper conditions” gives a hint that in using the word “absolute” the Legislature didn’t mean absolutely absolute.
Appellate Decisions Limiting Inspection Rights
California courts have held that a director’s statutory right to have access to all corporate documents represents a legislative judgment that directors are better able to discharge their fiduciary duties to the corporation and its shareholders or members if they have free access to information concerning the corporation. However, in the three appellate opinions discussed below, the courts have held that, in certain particular situations, a director’s “absolute” right of access to corporate records must be weighed against other important legal considerations.
In a 1995 opinion, Chantiles v. Lake Forest II Master Homeowners Association, the California Court of Appeal held that, notwithstanding a director’s “absolute” right of access to all association records, that right must yield to the constitutional privacy rights of association members in their voting decisions.
In Chantiles a director, who believed that his slate of candidates for election to the association’s board of directors had been “shortchanged,” sought to inspect and copy all of the ballots cast in the association’s recent director election. When the association refused to allow him to have access to those ballots, citing its concern for preserving the privacy rights of individual voting members, director Chantiles sued to compel the association to honor his absolute right to inspect and copy the ballots. The trial court ruled against his unrestricted right of access to the ballots. Instead, the court established a procedure whereby Chantiles’ attorney could inspect the ballots on his behalf. The court’s procedure included guarantees of each member’s anonymity so that it would not be possible to determine how an individual member had voted. Chantiles rejected this procedure and appealed the trial court’s decision, claiming that the trial court could not lawfully place any limits on his “absolute” right of record inspection.
The appellate court upheld the trial court, holding that the trial court had correctly concluded that homeowners association voting constituted a class of information in which members have a reasonable expectation of privacy. The court explicitly rejected Chantiles’ claim that, because Corporations Code section 8334 expressly gives him an “absolute” right to inspect “all” association records, “this right need not yield to any other right, not even a constitutional right.” The court concluded to the contrary:
“We hold that homeowners association members have a constitutional privacy right in their voting decisions . . . A homeowners association director’s statutory right to inspect the records of the association must be balanced against this privacy right.”
Three months after the Chantiles opinion was issued, another district of the Court of Appeal came to a similar conclusion as to a director of a “for profit” corporation. In Havilcek v. Coast-To-Coast Analytical Services, Inc. two of the five directors of a corporation who opposed a corporate merger appealed a trial court order denying their request for an order permitting them to inspect the books and records of the corporation. On appeal they contended that they had an absolute right to inspect all the corporation’s records and that the trial court erred by refusing them the right to inspect the records, at least subject to just and proper conditions as provided in Corporations Code Section 1603.) The Court of Appeal agreed with them and reversed the trial court’s decision. The appellate court first ruled that the trial court had erred in finding that the law of Delaware rather than that of California applied to the dispute because the California statutes governing a director’s right to inspect and copy corporate records constituted a strong California public policy favoring broad inspection rights for corporate directors. Even though the trial court should have applied California law, it “is not obligated to grant appellants [the requesting directors] unfettered access to every document ever created by [the corporation].” Instead, the court said, the trial court may impose ‘just and proper conditions’ upon the appellant directors’ otherwise absolute inspection rights. Sections 1602 and 1603 of the Corporations Code must be read together. Although a director’s “absolute right” to inspect corporate documents is the general rule in California, according to the Court of Appeal “absolute” does not always mean “absolute.” As the court explained, “The literal meaning of the words of a statute may be disregarded to avoid absurd result.”
In Havilcek, the court said that where a corporation determines that an unfettered inspection will result in harm to the corporation, it may decline a director’s request for inspection. And when a court is asked to intervene where a corporation has refused to permit a record inspection by a director, the court may exercise its broad discretion to fashion a protective order imposing just and proper conditions on a director’s record inspection.
Most recently, in January of this year, another panel of Justices of the Court of Appeal reaffirmed the idea that a director’s “absolute” right of access to corporate records is subject to certain limitations. Like the Havilcek case discussed above, Tritek Telecom v. Superior Court involved a “for profit” corporation formed under the California General Corporation Law rather than a nonprofit corporation. Tritek Telecom, Inc. originally had three directors, but one resigned leaving the corporation with only two. Conflicts arose between the two directors resulting in a lawsuit by one of the directors against the corporation and the other director. Ultimately, the director who filed the lawsuit filed a petition under Corporations Code §1603 to enforce his absolute right to inspect the corporation’s books and records. Over the corporation’s objection that the records to be inspected constituted privileged and confidential attorney-client communications, the trial court granted the director’s petition. The corporation sought appellate review of that ruling.
The Court of Appeal reversed the trial court’s decision granting the director access to the requested records. The court stated that “a corporate director does not have the right to access documents that are covered by the attorney-client privilege and were generated in defense of a suit for damages that the director filed against the corporation.”
The court noted that the petitioning director had filed his action to enforce his director’s inspection rights after he filed his shareholder action against the corporation. Thus, the court said, he was not a disinterested director and the presumption of good faith usually given to a director did not apply to him. Although he is still a director of the corporation, the court stated,
“his filing of the shareholder action makes him [the corporation’s] adversary. [He] cannot take off his ‘shareholder’s hat’ and swap it for his ‘director’s hat’ and claim an absolute right to access all corporate documents.”
The court held that a court may properly limit a director’s inspection rights when the director’s loyalties are divided and documents he might obtain in his capacity as a director could be used to advance his personal interest in obtaining damages against the corporation in his lawsuit.
These three cases clearly show that a director’s “absolute” right to inspect and copy all association records is not absolute in an ironclad sense. Even though California has a strong public policy favoring corporate directors’ broad inspection rights, that policy is subject to reasonable limits in proper cases. Limits may include a limited, rather than absolute, access to certain records with restrictions designed to protect the corporation’s or its member or shareholder’s rights, as in Chantiles and Havilcek, or an outright denial of access, when necessary, such as in Tritek Telecom.
When Should Boards Limit a Director’s Inspection Rights?
There may be times, though infrequent, when an association is faced with a demand by one of the members of its board of directors for access to certain records of the association where the demand raises a legitimate concern about possible adverse consequences to the association or its members if the access demand is granted. In these circumstances, the board of directors, not including the interested director, must decide whether to permit the requested access. In making that decision, the board must, as in all its decisions, adhere to the strictures of the prudent business judgment rule which is codified in Corporations Code section 7231. Under that rule, the board members are required to make decisions that they believe are in the best interests of the association and its members and with reasonable care.
California’s strong public policy of allowing a corporate director to have broad access to corporate records should not be taken lightly. But when an association is faced with a demand for access of certain association records, even by a current director of the association, and there is a legitimate concern whether granting the requested access might be in conflict with the interests of the association or its members, the board of directors must make a decision as to the individual director’s demand for record access in good faith, in a manner the other directors believe is in the best interests of the association and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. The duty of inquiry which is a part of the business judgment rule may mean that, before deciding to grant or deny a director’s request for access to certain association records, the board should seek the advice of legal counsel. When a director performs his or her duties as a director in accordance with the requirements of the prudent business judgment rule, including its duty of inquiry, that director is protected from personal liability for the good faith decisions he or she makes on behalf of the association.
James Devereaux is a partner at Berding & Weil. He has been a frequent contributor to the ECHO Journal and a regular speaker at ECHO seminars.