New England Biz Law Update
A shareholder-derivative complaint that a plaintiff waited the required period to file, but did so before the corporation rejected his demand, could be dismissed under the so-called “business judgment rule,” the Supreme Judicial Court in Massachusetts has ruled.
The plaintiff argued that because the rule, G.L.c. 156D, §7.44, specifically references derivative proceedings “commenced after rejection of a demand,” it does not apply to complaints filed before an underlying demand is rejected.
The SJC, in response to a certified question from the 2nd U.S. Circuit Court of Appeals, disagreed.
“The language in various other provisions of the [Massachusetts Business Corporations Act], including language within §7.44 itself, clearly indicates that the Legislature intended that a corporation should be entitled to dismiss a derivative proceeding under the business judgment doctrine regardless whether the corporation’s rejection of the shareholder’s demand precedes or follows the filing of the derivative suit,” Justice Ralph D. Gants wrote for the court.
The 22-page decision is Halebian v. Berv, et al.
Broad implications?
Plaintiff’s counsel Joel C. Feffer of Harwood Feffer in New York criticized the ruling, calling it an example of courts “eviscerating derivative actions as a viable remedy” and, more broadly, engaging in the “deregulation of corporate governance.”
Feffer also asserted that the decision renders pointless the provision in §7.42 of the Business Corporations Act requiring that a plaintiff wait 90 days after filing a demand letter before filing a derivative complaint.
“The section has absolutely no purpose any longer,” he said. “Besides, under these facts [where the company is investigating itself], which is a bizarre concept to begin with, I can’t see how they’d need more time [before acting on a demand letter]. It should have taken them 90 minutes.”
John D. Donovan Jr. of Ropes & Gray in Boston, who submitted an amicus brief in the case on behalf of the co-chairs for the Task Force on the Revision of the Massachusetts Business Corporation Law, said the decision confirms the primacy of board power in Massachusetts.
“The SJC’s ruling ultimately is that [a corporate] board’s plenary authority isn’t trumped by mere chronology,” he said, adding that such a principle would extend beyond derivative suits to other types of business issues. “Shareholder attempts to usurp or assert corporate power won’t work.”
Donovan also noted that the business entity involved in the case was not actually a corporation, but a mutual fund organized as a Massachusetts business trust. Since most mutual funds in the United States are organized as Massachusetts business trusts, the SJC’s ruling should have far-reaching implications in the investment-management industry, he said.
“All across the country, directors of mutual funds will be looking at [Halebian] and confirming that their power is primary,” Donovan said.
Benjamin G. Robbins of the New England Legal Foundation, who also filed an amicus brief in the case, said that had the court answered the question the other way, a corporation’s right to determine in a reasonable manner whether a derivative suit is, in fact, serving its interests as a company would be lost.
“Whether it’s a decision about investing in new widgets or any other decision made on a routine basis that might be necessary for corporate growth, [directors] could be exposed to potential liability merely because of an arbitrary timing of events,” he said. “It’s day 91, and oops, you haven’t made a decision yet whether to reject a demand. You’d be out of luck and would now have to defend on traditional grounds, such as failure to state a claim, rather than
on business-judgment grounds.”
Robbins said that such a situation could have heralded an overly cautious corporate climate in which capable, talented risk-takers would feel stymied in making their decisions and become hesitant to serve on boards in Massachusetts because of potential liability exposure.
Additionally, companies that lost the figurative “race to the courthouse” in which a plaintiff filed suit before they had a chance to adequately assess the demand would face enormous pressure to settle questionable cases, similar to when a class action is certified.
“It would be a financial drain,” he said.
Defendants’ counsel James S. Dittmar of Goodwin Procter in Boston and plaintiff’s local counsel, Michelle H. Blauner of Shapiro, Haber & Urmy in Boston, could not be reached for comment prior to deadline.
Shareholder suit
Citifund Trust III is a Massachusetts business trust comprised of six separate mutual funds, each with a separate investment portfolio and separate shareholders.
An affiliate of Citigroup, Inc., served as investment advisor to each of the trust’s funds until June 2005, when Citigroup agreed to sell its asset-management business — including the affiliate that served as investment advisor to the funds under the trust — to Legg Mason, Inc.
Pursuant to the federal Investment Company Act of 1940, the investment advisory agreements between the funds and the Citigroup investment advisor were terminated. Any advisory agreement with a new entity would need to be approved by the trust’s board of trustees and its shareholders.
In August 2006, the board of trustees voted to enter into new advisory agreements with the same investment advisor, which was now an affiliate of Legg Mason, under essentially the same terms as before. A proxy statement was sent to the shareholders recommending approval of the new agreements, and the shareholders voted to approve.
On Feb. 8, 2006, the plaintiff wrote a demand letter to the board that it bring suit against
eight individual trustees for breach of fiduciary duty. According to the plaintiff, by failing either to solicit competing bids or to seek better terms than those in the prior agreements, the board had placed Citigroup’s interests in completing its transaction above those of the funds themselves.
The board acknowledged receiving the letter and advised the plaintiff that it had created a committee of special trustees to consider his demand.
On May 30, 2006, more than 90 days after the date of his demand letter, the plaintiff, who had not yet received a definitive response from the board, filed a derivative complaint alleging breach of fiduciary duty against eight individual trustees in U.S. District Court.
Six weeks later, the board formally rejected the plaintiff’s demand and moved to dismiss his claim pursuant to Massachusetts’s business judgment rule, found in §7.44 of the Business Corporations Act.
According to the statute, a derivative proceeding “commenced after rejection of a demand” shall be dismissed if the court finds that the defendants have acted in good faith that “maintenance of the derivative proceeding” is not in the corporation’s best interests.
The defendants argued that because the corporation had decided to reject the plaintiff’s claim by a vote of the independent directors after a good-faith inquiry, it was entitled to dismissal under the rule.
But the plaintiff maintained that, according to its explicit terms, the statute provides for dismissal only when a suit is “commenced after rejection of a demand” and thus the business judgment rule was inapplicable.
The judge dismissed the claim, and the plaintiff appealed to the 2nd Circuit, where the panel reserved judgment on the merits pending a response from the SJC to its certified question as to whether the business judgment rule could be applied to a derivative complaint filed timely but prior to a corporation’s rejection of the underlying demand.
Legislative intent
The court acknowledged that the Legislature’s inclusion of the phrase “commenced after rejection of a demand” in §7.44 invited a “negative implication” that a proceeding could not be dismissed under the business judgment rule if a corporation failed to reject a plaintiff’s demand before the plaintiff filed suit.
However, the SJC cautioned, the notion of a negative implication — where the express inclusion of one concept should necessarily imply the exclusion of another — should be applied with great care and certainly should not be used to override legislative intent.
The Legislature did not intend for the business judgment rule to apply only to derivative complaints filed after the underlying demand was rejected, the court found.
First, §7.44 states clearly that a derivative proceeding shall be dismissed if the corporation has made a good-faith determination, after a reasonable inquiry, that the “‘maintenance of
the derivative proceeding’” is not in its best interests, Gants said.
The term “maintain” has a different meaning from “institute” or “begin,” implying that an action needs to be begun before it can be maintained, the justice continued.
“By speaking of the maintenance, rather than the initiation, of a derivative proceeding, the Legislature recognized that a corporation may reject a shareholder’s demand after the derivative complaint has been filed in court, and that rejection of the demand may require dismissal of the complaint,” Gants said.
Similarly, §7.44 requires that a derivative action be dismissed if a panel of independent individuals appointed by the court on the corporation’s motion determines that maintaining the derivative proceeding is not in the corporation’s best interest, he said.
“A corporation, however, cannot file the motion contemplated under [§7.44] with a court unless the derivative proceeding has already commenced,” Gants said. “It would therefore be impossible for the panel appointed by the court to reach a determination that the plaintiff’s demand for suit should be rejected before commencement of the suit.”
Accordingly, the plaintiff’s reading of the statute would strip the provision enabling the appointment of an independent panel of any purpose, creating an absurd result that the court can presume was unintended by the Legislature, he said.
Other sections of the Business Corporations Act also demonstrate that the Legislature did not intend for the business judgment rule to apply only to complaints filed before a rejection of a demand, the court observed.
For example, §7.43 states that if a corporation starts an inquiry into allegations made in a demand or complaint, the court can stay any derivative proceeding for as long as it considers appropriate, Gants said.
But “a court cannot stay a proceeding that has yet to commence and a derivative proceeding commences only when suit is filed,” he said, adding that the plaintiff’s reading of the statute would render the provision superfluous as well.
Thus, Gants said, “despite the statute’s unfortunate inclusion of a phrase that, when read in isolation, would suggest that §7.44(a) was intended to limit dismissals under the business judgment doctrine to derivative proceedings ‘commenced after rejection of a demand,’ we conclude that the Legislature did not intend such a limitation.”
Attorney Eric T. Berkman is a freelance writer.
