Lawmakers Looking To Change Shareholders’ Derivative Suits

Lawmakers Poised to Raise the Bar for New Jersey Shareholders’ Derivative Suits

Lawmakers in New Jersey are looking to create legislation that would make it more difficult to bring derivative suits by corporate shareholders could soon become a reality. The measure has been approved by the New Jersey Assembly and is quickly making its way its way through the Senate.

Below is a brief summary of the provisions of the legislation (S-2326/A-3123):

• A shareholder may not commence or maintain a derivative proceeding unless the shareholder: (1) was a shareholder of the corporation at the time of the act or omission complained of or became a shareholder through transfer by operation of law from one who was a shareholder at that time and remains a shareholder throughout the derivative proceeding; and (2) fairly and adequately represents the interests of the corporation in enforcing the right of the corporation.
• Prior to commencing a derivative proceeding, a shareholder must make a written demand upon the corporation to take suitable action. No action can taken until 90 days have expired from the date the demand was made unless the shareholder has been notified that the demand has been rejected by the corporation or unless “irreparable injury to the corporation” would result by waiting for the expiration of the 90-day period.
• A derivative proceeding may be dismissed if the maintenance of the derivative proceeding is “not in the best interests of the corporation.” This determination must be made in good faith by a majority vote of independent directors, a majority vote of a board-appointed committee, or a court-appointed panel.
• If a derivative proceeding is commenced after the demand is rejected, the plaintiff has the burden of proving that the decision makers were not “independent.”
• A director is considered independent if he or she has: (i) no economic interest in the challenged act or transaction material to him or her, other than an economic interest that is shared by all shareholders generally; and (ii) no material, personal, or business relationships with the defendant directors or officers who have a material interest in the act or transaction challenged.
• A derivative proceeding or a shareholder class action could not be discontinued or settled without the court’s approval.  If the court determines that a proposed discontinuance or settlement will substantially affect the interests of the corporation’s shareholders or a class of shareholders, the court must direct that notice be given to the shareholders affected.
• In any derivative proceeding or shareholder class action instituted by a shareholder or shareholders holding less than 5% of the outstanding shares of any class or series of the corporation, unless the shares have a market value in excess of $250,000, the corporation can require the plaintiff to give security for the reasonable expenses, including attorneys fees.

Under the bill, a New Jersey corporation must amend its certificate of incorporation to adopt the statutory standards. The bill in intended to bring New Jersey’s laws in line with those of neighboring states and is largely based on the Model Business Corporation Act. The New Jersey Corporate and Business Law Study Commission also supports the changes.