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Morano v. Hicks

A-0379-97T5 (N.J. Super. App. Div. 1999) (Unpublished)

CORPORATIONS; DERIVATIVE ACTIONS—Even though a particular action should have been brought as a derivative action, a judgment obtained on a direct claim will not be set aside if the resulting distribution would be the same.

Various investors worked together and organized a group of corporate entities to manage their business of developing “cogeneration” projects. One such project was sold for a payment partly in cash and partly to be paid over time. Litigation arose over the deferred payments. When the company was formed, two of the shareholders became its directors. After the sale, one director improperly removed the other and appointed his own son as a replacement. Thereafter, the father and his son pledged the company’s deferred payment to a banking institution for a loan to a corporation controlled solely by the father. When the deferred payments were received, the funds were used to repay the loan and to pay other personal obligations. None of the deferred payments were made to the corporation’s other shareholders.

The lower court found that the director’s removal was invalid and that the transfer of assets by the new board was also invalid. It also found that the original two shareholder-directors were “deadlocked.” The Appellate Division was disturbed that the litigation should have been, but was not, commenced as a derivative suit on behalf of the corporation. This was because the primary injury caused by the misappropriation of the deferred payments was to the corporation. An action by the shareholders that did not receive any funds from the corporation should have resulted in a judgment in favor of the corporation, which would then have distributed the funds in accordance with the shareholders’ ownership interests. Nonetheless, the Appellate Division refused to disturb the lower court’s judgment on that basis, as urged by the defalcating director, because the resulting distribution would have been no different. In addition, the defalcating director argued that the business judgment rule protected his decision to pay for his personal obligations. The Court was not persuaded because the business judgment rule “protects a board of directors from being questioned or second-guessed on conduct of corporate affairs except in instances of fraud, self-dealing, or unconscionable conduct.”


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