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New Law Limits Viability of Shareholder Derivative Suits in New Jersey

New Law Significantly Limits Viability of Certain Shareholder Derivative Suits in New Jersey

On April 2nd, New Jersey Governor Chris Christie signed bill A-3123 into law and in doing so, significantly revised the law in New Jersey regarding shareholder derivative proceedings under N.J.S.A. §14A:3-6, etseq. The stated purpose of the new law is to temper derivative lawsuits brought by shareholders against a corporation, its directors or majority shareholders and to make efforts to curb excessive and unnecessary litigation costs on New Jersey corporations.  Beyond this succinct goal, an ancillary intent of the law is to encourage corporations to continue to incorporate in New Jersey by making the state more corporate friendly.

Notable changes  include the following:

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.”  This 90 day waiting period is a akin to a tort claims notice and is intended to give corporations adequate time to remedy potentially minor issues before dealing with the costs and expense of litigation.

In the event that a plaintiff challenges a company’s actions in suit after the demands made in the 90 day letter are rejected, he/she/it must allege with particularity that the decision was improper and show any rejection was in bad faith or not made by “independent directors.”   A status as a litigant does not divest a director of independence and unless the independence of the directors is challenged successfully, the plaintiff must show bad faith on the part of the entity.

The law increases the interest requirement that a plaintiff must hold an entity to avoid the posting of security against the possible award of attorney’s fees and costs. If litigant a holds 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 attorney’s fees.  This will hopefully dissuade minority shareholders from filing suits with questionable merit.

The law requires that a plaintiff remain a shareholder throughout any initiated litigation so that it can adequately and fairly represent the corporation’s interests.  Prior to this change, the shareholder merely had to be a shareholder at the time suit was filed.

The law applies to both derivative proceedings brought on behalf of single shareholders as well as class actions.

A corporation can move for dismissal of a suit, after a good faith investigation, and assert that the derivative proceeding is not in the best interest of the corporation on the grounds that its board is independent and acted in good faith.  Such a motion will be granted unless the court finds otherwise or the shareholders rebut the corporation’s supporting facts.

The court must stay discovery until ruling on the motion to dismiss, but can order limited discovery if the plaintiff shows a lack of independence or good faith.

The court must approve any settlement or dismissal.

The court can award expenses to the plaintiff if the proceedings result in a substantial benefit to the corporation, or to the defendant if the case was commenced or maintained without reasonable diligence or reasonable cause or for an improper purpose.

For these new provisions to apply, existing corporations must amend their certificate of incorporation and explicitly adopt these provisions.

For more information about this new law and how it may impact your business please contact Olender Feldman LLP, or review our additional  business legal resources here.