If you invest in ownership in a Texas corporation, limited liability company (“LLC”) or Texas limited partnership (“LP”), and get shut out or suspect some act of mismanagement, the right under the Texas Business Organizations Code to ask for documents is an essential protection.
But until the 2017 Texas legislative session, if the business refused an owner’s demand for documents, only a shareholder in a corporation could seek recovery of attorney’s fees and other expenses for having to go to Court to force the entity to turn over documents, while LLC and LP investors had no right to attorney’s fees.
In 2017, the Texas legislature leveled the playing field by amending the Texas Business Organizations Code to allow both LLC members and limited partners to recover attorney’s fees when the business refused to give them documents. Given the increasing use of LLC and LPs for newly formed private companies, this is a much-needed protection.
A little background . . .
If you invest in a large publicly traded company, federal law and the SEC require public companies to submit reports to the SEC that are published and freely available to the public. But investments in private Texas businesses are a different story. While a private business might prepare audited financials and circulate regular financial reports to its owners, it is not required to do so. Investors in private businesses, particularly investors that lack majority control, have to rely on the business entity’s voluntary preparation of reports about the status of the company.
Unfortunately, when a minority owner gets crosswise with the majority owner, access to information about the business is usually the first thing to stop. Frequently, this is an unfortunate event because nothing sparks concern about bad acts like a refusal to share information. The most commonly refused document requests are for financial statements, followed closely by deals with related parties, and compensation information for the majority owner—particularly if the majority owner is also a key officer and employee.
The Texas legislature has long had provisions requiring private Texas businesses to maintain certain minimal records and to make those records available to an owner on request. (I use the term “owner” generically here rather than shareholder for a corporation, member for an LLC, and limited partner for a LP).
For corporations, the Texas legislature also incentivized corporations to cooperate with owner requests for information by making any corporation that refused an inspection request liable for attorney’s fees and expenses. This was an essential protection for investors because the costs of a legal fight to obtain documents could easily become uneconomic, if not unaffordable, particularly for those with small-dollar investments.
While owners of LLCs and LPs had similar rights under the LLC code and the LP code to request information from the entity they invested in, the LLC code and the LP code did not impose attorney’s fees and costs liability on an LLC or LP that refused to permit inspection and copying of documents.
In the 2017 regular legislative session, the Texas legislature equalized the rights of LLC and LP owners by enacting new statutory sessions making LLCs and LPs liable for attorney’s fees and costs if they refused to permit inspection and copying of requested documents.
So what’s the point?
When a business is confronted with a disgruntled minority investor (who may also be a former employee), a common response is to shut off all information. This often forces the minority owner to file claims for breach of fiduciary duty or make other allegations based on incomplete facts—allegations bolstered by the business’s very refusal to provide information in the first place. The business now faces a claim for breach of fiduciary duty, will incur legal fees in defense, and ends up turning over the same information in discovery. Meanwhile, the minority investor seeks out every wrongful act to support damages large enough to justify the lawsuit in the first place. The refusal to turn over records results in a spiral of escalation that causes both sides to spend more and makes it difficult to resolve the situation. The new LLC and LP statutes awarding an owner attorney’s fees should provide an incentive to cooperate before litigation and if the minority does have to go to Court to get documents, enable the minority owner to file a simpler pleading on their demand for documents rather than throwing the kitchen sink at the majority and the business.
But what about situations where the business or majority owner knows that the minority investor seeks documents for a personal benefit, for example to benefit a competing business they just opened or disparage the business to its customers? The legislature addressed this concern as well. The newly added LLC and LP statutes give the business a defense to an award of attorney’s fees and costs if the person suing to inspect records “has improperly used information obtained through a prior examination of the records” or “was not acting in good faith or for a proper purpose in making the person’s request for examination.”
Fights over access to information aren’t going to disappear because of these statutes. But the right of investors in LLCs and LPs to receive attorney’s fees should the business entity refuse to provide records reflects the increasing use of these corporate forms by Texas businesses and investors. It also recognizes that the refusal to provide information about the business deprives the investor in a private company of a key protection and would harm the business climate in Texas. If you are a majority or minority owner in Texas dealing with a request for records or a refusal to provide them, speaking with an attorney can be an important step in understanding your rights.
Texas Business Organizations Code (“BOC”) Section 3.151 and 3.152 – obligating all Texas entities to keep and permit inspection of certain records.
BOC 21.218 and 21.222 – obligating Texas corporations to permit inspection and imposing liability for attorney’s fees and costs if they refuse.
BOC 101.502 and 101.503* – obligating Texas LLCs to permit inspection and imposing liability for attorney’s fees and costs if they refuse.
BOC 153.552 and 153.5521* – obligating Texas LPs to permit inspection and imposing liability for attorney’s fees and costs if they refuse.
*newly enacted in 2017 by the 85th Leg., R.S., Ch. 74 (S.B. 1517), effective September 1, 2017.