Brown v. Brown

323 N.J. Super. 30, 731 A.2d 1212 (App. Div. 1999)
  • Opinion Date: July 7, 1999

CORPORATIONS; DERIVATIVE ACTIONS—Where there was no risk to a corporation’s creditors and no unfairness to the remaining shareholders, a former shareholder was allowed to continue a derivative action even though the recovery would go directly to that shareholder.

The issue in this matter was whether a former 50% shareholder in a closely-held corporation who transferred all of her shares to the other 50% shareholder as part of a divorce settlement can continue a suit in the nature of a shareholders’ derivative action against a third-party, when the action arose out of events that occurred during the shareholder’s ownership. Here, a roofing company was owned in equal parts by a husband and wife. At the time when the husband sought to retire out of state and the wife was ill, their adult daughter became chief operating officer of the company. During the pendency of a divorce action brought by the husband, the wife filed a third party complaint in the nature of a shareholder’s derivative action against the daughter and a business owned by the daughter. The gist of that action was that the daughter had diverted corporate opportunities from the roofing business to her own business. During the course of a trial on the derivative action claim, the husband and wife settled their divorce action. That settlement included a transfer of the wife’s shares to the husband. The judgment of divorce recognized the wife’s “right” to continue her third-party complaint. The husband, acting on behalf of the company, assigned the corporation’s claims against the third-party defendants to his wife. A few years after the divorce settlement, on the trial date of the law suit against the third-parties, those parties sought to have the case dismissed. The lower court dismissed the case because it found that the wife’s claims constituted a shareholder derivative action, and not a private or direct action of her own. The statute authorizing derivative actions requires that a plaintiff suffer an injury distinct from that suffered by other shareholders or the corporation as a whole and that the shareholder in such an action hold his or her shares “at the time of the transaction of which he complains.” A similar provision is included within the Rules of the Court. On the other hand, although both the statute and rule require a plaintiff to have been a shareholder at the time of the action complained of, neither of them required ownership throughout the litigation. This issue was a case of first impression in New Jersey. Some states, including Delaware, make continuing ownership a requirement. The Court, while noting that New Jersey frequently follows Delaware law in corporate matters, found no compelling policy reason to do so in the unique circumstances presented in this case. Here, part of the settlement between the husband and wife was that the wife surrender her shares in exchange for valuable consideration, including the opportunity to pursue her suit against third party defendants. The Court found no prejudice to the third party defendants, who gave no consideration for the divorce settlement or for the transfer of the shares. Further, under the American Law Institute’s Principles of Corporate Governance: Analysis and Recommendations (1992), it was stated that “[i]n the case of a closely held corporation ... the court in its discretion may treat an action raising derivative claims as a direct action… .” A comment to that statement stated that “the normal policy reasons for requiring a plaintiff to employ the form of the derivative action may not be present or will be less weighty, even though the action alleges in substance a corporate injury.” There was no suggestion in the record that there was a risk of multiple suits if the former shareholder continued the action and there was no suggestion that the company had been left with insufficient assets to meet its obligations to creditors, who would therefore be prejudiced if the ex-wife were permitted to recover damages that otherwise were due to the corporation. Also, there was no risk of an unfair distribution of any recovery, since the only remaining shareholder had clearly consented to continuation of the action. Finally, the Court did not find this case to be a “strike suit.” Consequently, the Court permitted the suit to continue even though it was in the nature of a derivative action and the complaining shareholder no longer held shares in the corporation.