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In Re Johnson & Johnson Derivative Litigation

2011 WL 4526040 (U.S. Dist. Ct. D. N.J. 2011)

CORPORATIONS; FIDUCIARY DUTY — To infer that the majority of a corporation’s board of directors acted in bad faith by failing to properly oversee a company, the shareholders need to show that the directors knew or should have known that violations were taking place and that the directors took no steps to prevent or remedy the situation, not merely that the directors did not respond appropriately to “red flags.”

In their shareholder derivative action, the plaintiffs accused certain former and current officers and directors of breaching their fiduciary duties by permitting and fostering a culture of systematic, calculated, and widespread legal violations. They claimed that the board members knowingly took no action even though there were “red flags” that should have put them on notice as to illegal activities taking place. The corporation moved to dismiss the complaint for failure to state a claim.

The shareholders claimed that once the board members acquired knowledge of bad acts, in the form of Federal Drug Administration (FDA) warning letters, FDA reports, subpoenas from state attorneys general, and plea agreements with the United States Department of Justice, they should have taken proper steps to correct the deficiencies and protect shareholder value. They argued that the board members who served on the audit committee, public policy advisory committee, and science and technology committee had substantial knowledge regarding the allegations of kickbacks and faulty products and should have prevented those activities from continuing instead of allowing them to continue.

The Court disagreed, finding that the “red flags” were insufficient to infer that a majority of the board of directors acted in bad faith by failing to properly oversee the company. To the Court, the allegations, taken as a whole, did not demonstrate a systemic failure by the board of director. It noted that the shareholders needed to show: (1) that the directors knew or should have known that violations were taking place; and (2) the directors took no steps to prevent or remedy the situation. Just because the company may not have responded appropriately to “red flags” did not mean that its board of directors acted in bad faith or failed to properly discharge their duties as directors.

The Court dismissed the complaint, but allowed the shareholders an opportunity to file an amended complaint. In doing so, it noted that the Appellate Division in New Jersey Superior Court had acknowledged that a shareholder may seek to inspect a corporation’s books and records relating to a pending suit. A court would then determine the scope or limitations of such an inspection. Therefore, in light of the possibility that the shareholders could seek an inspection of the corporation’s books which could lead to additional information sufficient to establish a case, dismissal with prejudice was inappropriate. So, the Court gave the shareholders thirty days to notify the Court if they intended to amend their complaint.


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