The Connecticut Supreme Court’s Decision in Benjamin v. Island Management, LLC, and an Examination of the Rights of Members to Inspect an LLC’s Books

On November 2, 2021, the Connecticut Supreme Court issued its decision in Benjamin v. Island Management, LLC,[1] ruling that Connecticut General Statute § 34-255i of the Connecticut Uniform Limited Liability Company Act (CULLCA) does not require members of an LLC to present “credible proof” of mismanagement in order to inspect the LLC’s books and records. 

Background

The defendant is a manager-managed LLC created to oversee and manage a sizable family estate.  The LLC’s members are six separate trusts each created for the benefit of six children of William Ziegler III.  Two of the children, Bill and Cynthia, were both co-managers and co-presidents of the defendant.  After the death of the children’s father, a dispute arose over the amount of annual distributions the children were receiving.  Due to this dispute, one of the children, Helen, was approached by the other members of the LLC about a potential buyout offer.  Helen thereafter made an informal request for financial and related information about the defendant which the LLC denied.  Helen followed that request up with a series of written demands for inspection of the defendant’s books and records, citing § 34-255i.  Section 34-255i (b) (2) provides in relevant part:

“[A] member may inspect and copy full information regarding the activities, affairs, financial condition and other circumstances of the company as is just and reasonable if: (A) The member seeks the information for a purpose reasonably related to the member's interest as a member; (B) the member makes a demand in a record received by the company, describing with reasonable particularity the information sought and the purpose for seeking the information; and (C) the information sought is directly connected to the member’s purpose.” (Emphasis added by the Court.)

The defendant produced many records in response, but it refused to produce others.  Helen’s final demand requested twenty-seven categories of information for the stated purpose of (1) determining the value of her trust’s interest in the defendant; and (2) ascertaining the condition and affairs of such entities so that the trust for her benefit may exercise its rights as a member of the defendant in an informed manner.  After she was again rebuffed, Helen, in her capacity as trustee of her trust, commenced suit seeking to compel the defendant to comply with her inspection demand, alleging the defendant violated § 34-255i by failing to produce the requested records.  The trial court ruled for the plaintiffs (co-trustees of Helen’s Trust) finding that a member’s desire to value shares or to determine whether improper transactions occurred are proper inspection purposes.  After the defendant appealed to the Appellate Court, the Connecticut Supreme Court transferred the case to itself. 

The Court’s Decision

The Court begins its analysis by acknowledging the paucity of caselaw on the ULLCA, but notes that courts often rely on corporation and partnership jurisprudence when analyzing LLC law.  The chief issue the Court sets to resolve is determining what standard applies to the rights of LLC members to inspect records for mismanagement.  One standard, practiced most notably by Delaware courts, contends that a requirement of “credible proof” of mismanagement is necessary to ascertain whether the information sought is directly connected to a proper purpose.[2]  Under the credible proof standard, a shareholder seeking to inspect corporate records to investigate mismanagement must come forward with facts that demonstrate a reasonable basis to suspect mismanagement.  The goal of the standard is to prevent “fishing expeditions” and is a recognition that “the primary purpose of the inspection must not be one that is adverse to the best interests of the corporation.” Abdalla v. Qadorh-Zidan, 913 N.E.2d 280, 287 (Ind. App. 2009).[3] 

Other jurisdictions practice a more lenient standard that relies on three principles.  The first is that “[t]he right of inspection rests on the proposition that those in charge of the corporation are merely the agents of the shareholders who are the real owners of the property.”  Guthrie v. Harkness, supra, 199 U.S. 148, 155 (1905);[4] second, to require shareholders to prove mismanagement without access to a corporation’s records is to practically deny the right of inspection in the majority of cases;[5] and third, in the absence of a clear statutory directive placing the shareholder to prove his or her purpose, it is sufficient for the shareholder to allege a proper purpose to make a prima facie case in support of inspection, and if the corporation disputes the allegation, require the corporation to come forward with evidence to support its position.[6]   

Weighing the competing standards, the Court finds the arguments against the “credible proof” standard to be more persuasive.  Notwithstanding the Court’s position that LLC jurisprudence can be deduced from corporation and partnership caselaw, the Court reaches its holding due, in part, to differences in the CULLCA and the Connecticut Business Corporation Act (CBCA).  The CBCA permits inspection if the shareholder's demand “is made in good faith and for a proper purpose.” C.G.S § 33-946.  The CULLCA does not impose such a condition which “cuts strongly against imposing a credible proof requirement…”[7]

The Court goes on to find that the absence of credible proof requirement would not lead to a mere allegation of mismanagement leading to “unfettered and burdensome” inspection.  Historically, one seeking inspection of records to investigate mismanagement will provide facts evidencing a basis to support inspection, as the plaintiffs did.  When one seeking inspection does not provide such evidence, the CULLCA provides mechanisms for preventing improper inspection requests.  The CULLCA states that the purpose for inspection must be “reasonably related to the member’s interest as a member”; for information “directly connected to the member’s purpose”; and only to the extent it is “just and reasonable.”  Furthermore, an LLC fighting inspection can produce evidence that the member has not met the statutory conditions.[8]    Lastly, in its operating agreement, an LLC is free to “impose reasonable restrictions on the availability and use of information provided for under § 34-255i.”[9]   

The Court concludes that there is neither a statutory, nor policy basis to justify a credible proof standard for the inspection of an LLC records.  Instead, a trial court may “consider the absence of facts demonstrating a basis to suspect mismanagement, in combination with other factors, in determining whether an improper purpose is the true reason for the demand and the extent to which disclosure is just and reasonable under the circumstances.”[10]

Andrew W. O’Sullivan is an associate at the firm’s Hartford office, where he practices in the areas of commercial litigation, and creditors’ rights and bankruptcy.  He can be reached at aosullivan@uks.com or at (860) 548-2671.

Kevin J. McEleney is a Shareholder in UKS’ Hartford office, practicing in the areas of creditor’s rights, bankruptcy and commercial litigation.  He can be reached at kmceleney@uks.com or (860) 548-2622.

Disclaimer: The information contained in this material is not intended to be considered legal advice and should not be acted upon as such. Because of the generality of this material, the information provided may not be applicable in all situations and should not be acted upon without legal advice based on the specific factual circumstances.

[1] Benjamin v. Island Mgmt., LLC, No. 20501, 2021 WL 5098658 (Conn. Nov. 2, 2021)
[2] Id. at *10.
[3] Id. at *11.
[4] Id. at *12.
[5] Id.
[6] Id. at *13.
[7] Id.
[8] Id. at *14. 
[9] Id.
[10] Id. at *15.