A Shareholder derivative suit occurs when a shareholder of a corporation brings suit against that same corporation.  A shareholder brings a derivative suit when the shareholder or shareholders are attempting to prevent or remedy a perceived wrong committed by the corporation.  On April 1, 2013 New Jersey updated its Shareholder Derivative Statute when Governor Christie signed New Jersey Assembly Bill A3123, codified as N.J.S.A. 14A:3-6 et seq.  The Bill went into effect upon its signing.

Requirements of the Shareholder in Share Ownership

Under the new law, P.L. 2013, Chapter 42, a shareholder cannot proceed with derivative suit proceedings unless

1) The shareholder was a shareholder of the corporation when the alleged misconduct occurred, or if the shareholder alleging the misconduct had the shares transferred by operation of law from a shareholder who was a shareholder at the time of the misconduct; and

2) The shareholder is just in representing the interests of the corporation in proceeding with the action.

The shareholder must also maintain share ownership throughout the derivative suit.  The purpose of this section is to make sure that the shareholder bringing the derivative suit has the best interests of the corporation in bringing the action.

Requirements of the Shareholder in Bringing the Derivative Suit

Before a shareholder commences a derivative suit, the shareholder must write a formal demand letter to the corporation requesting that the corporation take action to right the alleged wrong.  The shareholder must then wait 90 days before taking further action to allow the corporation to right the alleged wrong.  There are two exceptions to the 90 day rule.  The first exception is if the corporation writes to the shareholder informing the shareholder that the corporation rejects the shareholder’s allegations.  The second exception is if irreparable injury would occur if the 90 day rule was observed.

The Purpose of These Requirements on the Shareholder

A derivative suit can be costly to a corporation.  If a shareholder brings derivative suit in court the corporation will have to spend money defending its actions.  By requiring that the shareholder be a shareholder at the time of the misconduct it means that litigious shareholders who look for potential derivative actions cannot come in after the fact and bring such a suit.  Furthermore, by instituting a 90 day rule the legislature allowed corporations time to address the alleged misconduct prior to trial and attempt to reach an amicable agreement with the shareholder.  By requiring that the shareholder maintain share ownership throughout the entire legal proceeding it ensures that the shareholder is not trying to extract a demand from the corporation by filing the derivative suit and truly believes that the corporation committed a wrong.

Check back for Part 2 of our look at the NJ Derivative Suit Law.