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Kahn v. Rusckowski

A-2181-08T2 (N.J. Super. App. Div. 2010) (Unpublished)

CORPORATIONS; SHAREHOLDERS — A majority shareholder owes the minority shareholders a fiduciary duty to act fairly and board members have a fiduciary duty to minority shareholders and cannot use their powers for their own personal advantage and to the detriment of minority shareholders.

A publicly traded New Jersey corporation, providing medical transcription technology and services, had approximately 70% of its common stock owned by an electronics conglomerate. A governance agreement between the two required, in part, that the corporation’s board of directors would have eleven members. The agreement also established a supervisory committee whose responsibilities included the general oversight, administration, amendment, and enforcement of any other agreements between the parties which would be required to be disclosed to the Securities and Exchange Commission (SEC).

Likely in response to the corporation’s delisting because of its failure to timely file a yearly annual report with the SEC, the electronics conglomerate publicly announced that it viewed its ownership interest as a non-core holding and that it was examining its options. It subsequently announced that it hired an advisor to advise it on strategic alternatives, and later its decision to sell its entire interest in the corporation if a satisfactory price could be realized. It intended to pursue a transaction in which price the corporation’s other shareholders would be offered the same consideration as the conglomerate, subject to any necessary approval of the board.

That same day, the company publicly announced it would examine whether a sale of the corporation was in its and the minority shareholders’ best interests. By that time, an amendment to the governance agreement had reduced the board to seven members consisting of four conglomerate directors and three independent directors. The three independent directors subsequently resigned and were replaced by three other individuals. The company received a firm proposal in which the minority shareholders would benefit from the same consideration (price per share) offered to the conglomerate, which price allegedly exceeded the stock market price. The corporation rejected the proposal; however the conglomerate sold its shares to the same bidder at the same higher share price.

A minority shareholder alleged the sale of the corporation was not in the minority shareholders’ best interests and filed a complaint individually and on behalf of the minority shareholders against the conglomerate directors, the conglomerate, and the corporation alleging breach of the fiduciary duties of good faith, fair dealing, loyalty, and due care. The shareholder also sued the independent directors, alleging that they breached their duties of undivided loyalty by rejecting the proposal, and that this prevented the minority shareholders from accepting the premium for their shares.

The defendants filed a motion to dismiss for failure to state a claim upon which relief could be granted, alleging that the shareholder’s breach of fiduciary duty claim was derivative, and that the shareholder failed to plead either that he made a demand on the board, or that such demand would have been futile. Alternately, they contended that the shareholder failed to allege facts supporting his breach of fiduciary duty claim, and that they were, in any event, shielded from liability by the company’s certificate of incorporation which limited the board member’s personal liability for damages for breach of any fiduciary duty, and by the business judgment rule based on their reliance on their advisor.

The lower court granted the motion to dismiss, concluding the lawsuit was a derivative action because the shareholder failed to alleged that he suffered either a special injury not suffered by all shareholders or a wrong involving his contractual rights as a shareholder. The lower court found the shareholder failed to make a demand on the board to bring suit on the company’s behalf or that the board refused to do so, and that he failed to allege facts that such demand would have been futile. The lower court concluded that the shareholder could only proceed with a derivative action if he presented specific and compelling facts to rebut the presumption of the business judgment rule, which the court found the shareholder failed to do. It found the shareholder made no allegations regarding either a fiduciary duty owed by the company to its shareholders or a breach of such duty. The shareholder appealed.

On appeal, the Appellate Division reversed, holding that the lower court improperly found the matter to be a derivative action. Under the New Jersey Business Corporation Act’s “special injury” exception, a shareholder may bring an individual action where there is a wrong suffered by the shareholder that was not suffered by all shareholders generally or where the wrong involves a contractual right of the shareholders, such as a right to vote. The Court found the shareholder in this case alleged a “special injury because” the proposal of a share price purchase greater than market value allegedly caused injury to all of the shareholders but the conglomerate, specifically the minority shareholders. Therefore, not all shareholders were allegedly affected.

The Court reversed the lower court’s dismissal as to the conglomerate, the conglomerate directors, and the two independent directors, finding that a majority shareholder owes the minority shareholders a fiduciary duty to act fairly, and board members have a fiduciary duty to minority shareholders and cannot use their powers for their own personal advantage and to the detriment of minority shareholders. The minority shareholder had alleged that the conglomerate and the conglomerate directors breached their fiduciary duty by rejecting a proposal to sell the whole corporation in order to advance the conglomerate’s interest in receiving quick payment from the same bidder for its own shares. The shareholder also alleged that two of the independent directors rejected the proposal in order to protect shares they controlled through other entities they managed. Lastly, the Court held that the issue of whether the business judgment rule or an exculpatory clause shielded the individual defendants from liability required the completion of discovery and could not be decided on motion.


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