On April 1, 2013, New Jersey’s provisions governing shareholder derivative proceedings were significantly revised in an effort to make the state more “businessfriendly.” The changes to the Business Corporation Act were made because the prior law placed few restrictions on shareholder derivative suits and offered little protection to corporations. For example, under the prior law shareholders at the time of an alleged wrong and their successors in interest could initiate an action without prior notice to the board of directors and without having any current share ownership. Thus, corporations and directors were at risk of being named in shareholder derivative suits without any real ability to evaluate the claims in advance and being exposed to suits from those with no real interest in the action. The new legislation has rectified this problem and established new requirements that should offer greater protections for corporations.
First, in order to have standing a derivative plaintiff must now satisfy three strict criteria: the plaintiff must have been a shareholder at the time of the alleged wrong; the plaintiff must remain a shareholder throughout the derivative action; and the plaintiff must fairly and adequately represent the interests of the corporation in enforcing the right of the corporation. The new amendments thus ensure that the plaintiff will have a direct interest in the proceeding at all relevant times and will be subject to potential exclusion in the event he or she is not deemed to be a fair and adequate representative.
Second, as a prerequisite to any derivative proceeding, a shareholder must make a written demand on the corporation to take action. Following the demand, a prospective plaintiff must then wait 90 days before filing a lawsuit unless the corporation rejects the demand sooner, or “unless irreparable injury to the corporation would result” by waiting. In the event that a corporation rejects a demand, a shareholder’s complaint must “allege with particularity facts establishing that a majority of the board of directors” that rejected the demand were not “independent directors.” In order to surmount that hurdle, it should no longer be enough to allege generally that the board cannot reach a truly independent, objective decision. Instead, a shareholder must plead that specific directors have a material economic interest or a close relationship with a specific director or officer who, in turn, has a material interest in the outcome.
Third, if the board determines after considering the demand that the action is not in the best interests of the corporation, a court must grant a motion to dismiss the lawsuit. The board’s determination can be made by one of four groups: (1) a majority of independent directors, where such directors constitute a quorum; (2) a majority vote of independent directors or a single independent director, where such directors do not constitute a quorum; (3) a majority vote of the shareholders, not including shareholders with a material interest or under improper influence; or (4) a court appointed panel. In the event that such determination is made by less than a quorum of independent directors, the corporation will bear the burden of proving the derivative action is not in the corporation’s best interests. In any other case, the plaintiff will have the burden of rebutting the board’s determination. An added benefit to defendants is the presumption that all discovery is stayed pending the filing of a motion to dismiss. While such a motion is pending, a plaintiff may only take limited discovery if, after a motion and hearing, the court finds that there is evidence of lack of independence or good faith on the part of the person or group that made the determination.
Finally, the new amendments empower the court to award any defendant – whether the corporation, a director or officer – litigation costs and attorneys’ fees if the plaintiff is found to have commenced or maintained the action without exercising reasonable diligence, without reasonable cause, or for an improper purpose. In connection with that provision, a corporation may demand that a plaintiff post a bond to cover the corporation’s costs and attorneys’ fees unless the plaintiff (or group of plaintiffs) holds more than 5 percent of the outstanding shares, or the market value of such shares exceeds $250,000. This is a significant increase from the prior law (unchanged since 1968), which only required the value to be $25,000.
In sum, these revisions to the New Jersey Business Corporation Act should be a positive development for corporations in New Jersey. The new provisions create a number of safeguards against frivolous or improper derivative actions and empower the courts to shortcircuit lawsuits deemed not to be in the best interests of a corporation with a minimum of time and expense.