Give the Corporate Director a Serpent Deflector: Reinforcing an Absolute Right to Inspection under the California Corporations Code

By: Ethan J. Birnberg, Esq., Porter Simon, P.C., Truckee, California

[Article originally published in the Vol. 45, No. 3 of The Writ (Washoe County Bar Association)] 

            California is no stranger to litigation between corporations and their board of directors. Directors are provided the tools and ability to meaningfully participate in management, and an absolute right to certain information under Section 1602 of the California Corporations Code:

            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 and also of its subsidiary corporations, domestic or foreign.[1]

            There are exceptions to a director’s “absolute” access, which was the subject of Fowler v. Golden Pacific Bancorp, Inc (“Fowler”).[2] This case is not only important for corporations to recognize that suing a director is unlikely to provide the basis to deny an inspection request—but is equally important for sitting directors to understand their rights, power, and California’s general rule of unfettered access to corporate records absent a narrow exception.

A Bank, a Law Firm, and a Director

            Fowler was a founder of Golden Pacific Bancorp and its largest shareholder holding almost 19% of the issued stock. Fowler was also the CEO of a law firm that represented Bancorp. Bancorp commenced a malpractice action against the law firm related to prior defense representation and added Fowler as a defendant, alleging Fowler breached his fiduciary duty and was negligent when convincing Bancorp to hire the law firm.

            Two months later Fowler sent a written inspection request under Corporations Code 1600 et seq., demanding to copy and inspect books and records, including items related to legal fees, loan files, and accounting records. Bancorp denied the request on grounds that Fowler had a conflict of interest and sought to undermine Bancorp’s claims in the pending malpractice action. Fowler then made the same request through an alternative method: propounding a discovery request in the state court action. Once again, Bancorp refused to produce the documentation or otherwise adhere to Fowler’s demands. Fowler thereafter filed a motion to compel, arguing that the requested documents were relevant to Bancorp’s claims and his defenses in the malpractice lawsuit. The Sacramento Superior Court denied the motion to compel and concluded that the document requests were overbroad, invaded third party privacy rights, and sought information that was not relevant.

            Fowler was not done. He promptly filed a preemptory writ of mandate to enforce his inspection rights. His petition alleged an “absolute right” as a director and shareholder to inspect and copy Bancorp records, supported by his declaration that “he requested the inspection to protect his interests as Bancorp’s single largest shareholder and to fulfill his fiduciary duty as a director to stay informed about Bancorp’s financial condition and operations.”[3] The parties exchanged their respective declarations refuting and contesting factual and legal positions prior to a hearing. The trial court conducted the hearing and granted the writ petition. Its opinion reinforced the “absolute right” held by directors and the strong public policy to allow inspections absent “extreme circumstances,” which requires a corporation to establish the director’s intent to commit an irremediable tort against the corporation by a preponderance of the evidence.[4] Bancorp appealed.

Enforcing the Absolute Right Must Produce an Absurd Result

            California’s Third District Court of Appeal affirmed the trial court. Highlighting the general rule of a director’s unfettered access, the court stated that “mere possibility that information could be used adversely to the corporation is not by itself sufficient to defeat a director’s inspection rights.”[5] An exception to the general rule should only occur if the absolute right of inspection would produce an absurd result—which would only happen in extreme cases. As an example, the Court noted “such as when the evidence establishes the director’s clear intent to use the information to breach fiduciary duties or otherwise commit a tort against the corporation.”[6]

            To reach its decision the Court of Appeal analyzed several similar cases that provided additional examples of the exception to the general rule. In Havlicek v. Coast-to-Coast Analytical Services, Inc.,[7] the Court of Appeal guided the trial court on remand with the following hypothetical:

            A disgruntled director unambiguously announces his or her intention to violate his or her fiduciary duties to the corporation and the shareholders by using inspection rights to learn trade secrets, gain access to confidential customer lists, and compete with the corporation. In this situation, does the Legislature want the judiciary to come to the aid of the disgruntled director, enforce the ‘absolute right’ to inspect and help the director commit a tort against the corporation? No.”[8]

            The Court of Appeal also reviewed Saline v. Superior Court to instruct that a director’s right to inspection cannot be denied solely because the director has a conflict of interest or is embroiled in litigation with the corporation.[9] In Saline, the court refused to limit the inspection rights of a director despite evidence that the director had a conflict of interest, breached fiduciary duties, breached a confidentiality agreement, and publicly defamed management, because there was no evidence to show the director intended to use the documents obtained to “disclose trade secrets, compete with or otherwise harm” the corporation.[10]

            Turning to the question of fact at issue, the trial court held that Bancorp failed to produce sufficient evidence to curtail Fowler’s absolute right to inspection. It was not persuaded that Fowler’s inspection was motived by an improper purpose or intended to breach fiduciary duties or commit a tort.[11] After failing to meet its burden at trial, well-settled appellate standards of review did not bode well for Bancorp. A court of appeal does not reexamine the preponderance of the evidence—it is bound by the fundamental rule that a lower court judgment is presumed correct and “all intendments and presumptions will be indulged in favor of its correctness.”[12] The question for the appellate court was whether the evidence compelled a finding in favor of the appellant as a matter of law, and Bancorp fell short of that standard because its “evidence” was in the form of largely unsupported allegations that had little persuasive value. Bancorp also failed to persuade the trial court that Fowler had an ulterior motive and intended to harm Bancorp while continuing his duties as a member of the Board. The Court of Appeal deferred to the trial court’s determination of credibility, which it must, but added that even if it found an ulterior motive the trial court already ruled that the documents Fowler sought were irrelevant to the litigation.[13] Thus, there was no support for Bancorp’s assertion that providing Fowler access to records would somehow “severely undermine” Bancorp’s lawsuit.

Mootness Did Not Override a Substantial Public Interest

            When an issue or case is no longer ripe for a decision, it is moot. By the time the appellate court could rule Bancorp was acquired by a new entity and Fowler was removed from the Board. Without director status, Fowler’s inspection rights must be analyzed under Corporations Code 1600 and not afforded an “absolute right” under Corporations Code 1602. The court could have punted on this case, rendered the appeal moot, and left the Sacramento Superior Court opinion intact. It refused because the case “present[ed] an issue of substantial and continuing public interest: whether a director’s ‘absolute’ right of inspection under section 1602 may be curtailed because the director and corporation are involved in litigation and there is a possibility the documents could be used to harm the corporation.”[14]

Major Takeaways under California Law

            Fowler further cements California’s strong policy of allowing a director an absolute right to inspect books and records unless an exception exists. The importance of the issue is shown by the Court of Appeal’s discretionary decision to issue an opinion when the appellate issue was moot. Concerning the burden of proof, the California statutory scheme does not impose a “proper purpose” requirement like Nevada and many other states.[15] Fowler only needed to demonstrate that he was a director and made a demand for inspection that was refused. Once that showing was made, the burden of proof shifted to Bancorp to show why the inspection should be curtailed by “just and proper conditions.”[16] Even when a corporation commences an action and alleges its director committed negligence, breach of fiduciary duty, concealment, and fraud, a director is still entitled to inspect records because a fear that the documents may be misused is not enough to legally refuse the inspection demand. Fowler reinforces that corporations must understand the inevitable uphill battle when contesting a director’s right of inspection under the California Corporations Code. When faced with a director’s inspection demand, corporations must assess their limited options wisely.

Ethan Birnberg is a business attorney licensed in Nevada, California, Colorado, and Wyoming. He regularly assists clients with corporate/business issues, homeowner association governance and disputes, asset sales and acquisitions, and real estate issues including land use matters, landlord/tenant disputes, lease formation, and development/construction projects. He holds dual certifications as a business bankruptcy and consumer bankruptcy specialist from the American Board of Certification and has extensive insolvency experience assisting entities seeking to restructure under chapter 11 of the U.S. Bankruptcy Code, borrowers and lenders seeking out-of-court workouts, creditor enforcement, and representing chapter 7 trustees. He can be reached at birnberg@portersimon.com.

[1] Cal. Corp. Code § 1602.

[2] Fowler v. Golden Pacific Bancorp, Inc. (2022) 80 Cal.App.5th 205.

[3] See id. at 213.

[4] Id. at 214-15.

[5] Id. at 211.

[6] Id.

[7] Havlicek v. Coast-to-Coast Analytical Services, Inc. (1995) 39 Cal.App.4th 1844, 1851.

[8] Id. at pp. 1855-1856.

[9] Saline v. Superior Court (2002) 100 Cal.App.4th 909.

[10] Id. at 914.

[11] See Fowler, 80 Cal.App.5th at 225.

[12] Id. (citing In re Marriage of Arceneaux (1990) 51 Cal.3d 1130, 1133).

[13] Id. at 225.

[14] Id. at 211.

[15] An affidavit concerning the purpose of the inspection must be submitted under NRS 78.257(2) (Private corporations) and NRS 82.186 (Nonprofit corporations).

[16] See Cal. Corp. Code § 1603.