New Law Places Stricter Limits on Shareholder Derivative Suits

On April 2, 2013, Governor Christie signed  A-3123, which revises New Jersey’s law concerning shareholder derivative proceedings under N.J.S.A. § 14A:3-6. According to the New Jersey Corporate and Business Law Study Commission, the purpose of this new law is to preclude derivative lawsuits that impose excessive and unnecessary costs on New Jersey corporations. The law applies to both derivative proceedings brought on behalf of a single shareholder and shareholder class actions against a corporation or its directors that arise out of a breach of duty imposed by New Jersey statutory or common law. Highlights of the new law are described below.

Prior to this enactment, a shareholder could commence a derivative proceeding if the shareholder either held shares in the corporation at the time of the alleged adverse act or omission or succeeded to those shares from one who was a shareholder at that time. The new law, however, requires that a plaintiff remain a shareholder of the corporation for the duration of the proceedings; moreover, a derivative action can be maintained only if the suit “fairly and adequately” represents the interests of the corporation in enforcing its rights. The new law also increases from $25,000 to $250,000 the value of shares a plaintiff must hold in order to avoid having to post security against the possible award of litigation fees.

Additionally, the new law provides that, as a precondition to suit, a shareholder must make a written demand to the corporation to take suitable corrective action and allow the corporation 90 days to investigate and respond to the demand, “unless irreparable injury to the corporation would result by waiting.” A shareholder who commences an action after such demand is rejected must plead with particularity facts demonstrating that the decision was not made by “independent directors,” i.e., those who have no material interest in the challenged act beyond the economic interest common to all shareholders, as well as no “material, personal, or business relationships” with defendants who do. Importantly, the director’s status as a defendant, a defendant’s nominee, or the approver of the alleged adverse act does not automatically divest that director of his/her independence. Unless the independence of the directors is challenged successfully, the plaintiff has the burden to show bad faith.

The new law also provides that a derivative suit may be dismissed if “maintenance of the derivative proceeding is not in the best interests of the corporation.” This determination may be made by an independent director, a majority of independent directors, a board-appointed committee, or a court-appointed panel. A court can likewise base dismissal on a vote of the majority shareholders who did not benefit from the alleged adverse act or omission. The corporation itself can also move to dismiss by asserting the board’s independence and good faith, which motion the Court must grant unless it determines otherwise or the plaintiff is able to refute independence and good faith. Finally, a derivative suit cannot be “discontinued or settled” without the Court’s approval.

Corporations who want to avail themselves of the new law must amend their certificates of incorporation to do so.

Print