In The Jayson Law Group LLC’s previous post, we focused on the requirements of the shareholder in commencing a derivatives commercial litigation suit. This post focuses on the involvement of the courts in a derivative suit under the new law, specifically N.J.S.A. 14A:3-6.4 and N.J.S.A. 14A:3-6.5.
The Court’s Involvement in the Derivative Suit under N.J.S.A. 14A:3-6.4
If the shareholder brings a derivative suit in court, the court may stay the proceeding if the corporation can show that it is making a good faith inquiry into the alleged misconduct. This keeps with the spirit of the new law in that it allows a corporation to remedy the situation on its own prior to incurring legal fees from the derivative suit.
How a Corporation Can Have the Court Dismiss the Derivative Suit under N.J.S.A. 14A:3-6.5
Subsection 5 of Assembly Bill A3123 discusses when and how a corporation can ask the court to dismiss the derivative suit. There are several ways that a corporation can accomplish this. The first way a corporation can dismiss the derivative suit is by a majority vote of Independent Directors present at a board meeting decide that maintaining the proceeding is not in the best interest of the corporation. The same result would occur if it was a majority vote of a special committee headed by an Independent Director who was appointed by a majority of independent directors. In both circumstances, the corporation must show that this conclusion by either body was reached after diligent inquiry.
The second way that a company can ask the court to dismiss the derivative suit is if a vote of the majority of disinterested shareholders decides that the derivative suit is not in the best interest of the corporation.
Under N.J.S.A. 14A:3-6.5(3) if a shareholder decides to proceed with a derivative suit after the corporation rejected the shareholder’s demand, the shareholder bringing the derivative suit’s complaint must plead “with particularity facts establishing that a majority of the board of directors, or all members of a committee, which in either case determined the matter, did not consist of independent directors at the time the determination was made.”
N.J.S.A. 14A:3-6.5(3) is why it is advisable for any corporation to proceed with a vote of independent directors or a committee including independent directors. By using such a tactic, the corporation places the burden on the shareholder alleging misconduct to prove that the corporation did not act above board.
N.J.S.A. 14A:3-6.5(4) also addresses this issue. If a majority of the board who voted to not proceed with the derivative suit was not independent the burden is then on the corporation to prove that their recommendation to not proceed with the derivative suit was the correct decision.
How the Corporation Can Move the Court to Dismiss the Derivative Suit
N.J.S.A. 14A:3-6.5(5) establishes the procedure by which a corporation can ask the court to dismiss the derivative suit brought by the shareholder. Among the things the corporation must show in the motion papers, are facts proving:
1) that a majority of the board of directors was independent at the time of their vote; and
2) that those independent directors acted in good faith in rejecting the shareholder’s claim in the derivative suit.
If a corporation can show those things, the court shall dismiss the shareholder’s derivative suit. The two exceptions to this are if the court finds that the court finds that the independent directors really were not independent or if the plaintiff in a pleading submitted to the court can prove with particularity that the independence of the board of directors who voted to dismiss the derivative suit was compromised.
But what happens if a corporation is unable to create a board of independent directors? Subsection 6 of the new law has a way for corporations to create a panel of independent directors. If a corporation is unable to create a board of independent directors it can make a motion to the court asking the court to appoint a panel to determine if the derivative suit should proceed.
How is a Director Independent?
Subsection 7 of Assembly Bill A3123 establishes how a director of the board can be independent. A director is independent if that director has “no economic interest in the act or transaction material to him or her, other than an economic interest that is shared by all shareholders generally; and no material personal, or business relationships with the defendant directors or officers who have a material interest in the act or transaction challenged.”
There are several instances where a director can appear to not be independent but the law views the director as independent for the purposes of the derivative suit. They are:
1) the nomination or election of the director by a person who is a defendant in the derivative proceeding or against whom action is demanded;
2) the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or
3) the approval by the director of the action being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director.
N.J.S.A. 14A:3-6.5(7)(b).
Conclusion – Part 2
These rules allow for a corporation’s board of directors to protect the corporation from litigious shareholders. The new law establishes clear ways that a corporation can show that the actions it took were in the best interest of the corporation prior to commencing an expensive law suit. If a corporation is accused by a shareholder of misconduct the corporation should contact a corporate attorney to make sure it is complying with Assembly Bill A3123 to protect itself moving forward against a potential shareholder derivative suit.
Check back for Part 3 of The Jayson Law Group LLC’s look at New Jersey’s Derivative Suit Law.