Given that New Jersey boasts some of the strongest protections for minority shareholders, it is generally assumed that the state provides a favorable forum for shareholders’ challenges to corporate actions. And, until recently, it was relatively easy for a shareholder to assert a derivative action against a New Jersey corporation. But a recent published decision of the Appellate Division, which follows an amendment to the New Jersey Business Corporation Act earlier this year, may be changing that. Is New Jersey really becoming more business friendly? As New Jersey is home to approximately 20 companies on the Fortune 500 list, some would argue it’s about time.
The Statutory Right to Inspect Corporations’ Books
Earlier this month, the New Jersey Superior Court Appellate Division made clear in a published decision that a shareholder’s right to inspect books and records under New Jersey law is not as broad as some have thought and certainly narrower than under Delaware law. When coupled with the amendment to N.J.S.A. 14A:3-6.9 earlier this year, the decision will make it more difficult for a shareholder to bring a derivative action against a New Jersey corporation.
Under Section 220 of the Delaware Corporation Code, a shareholder of a Delaware Corporation is entitled, upon making a written demand, to inspect and make copies of “a corporation’s stock ledger, a list of its stockholders” and, importantly, “its other books and records.” Thus, Section 220 provides a powerful tool to investigate potential wrongdoing of Delaware Corporations. In fact, the Delaware courts have made clear that a potential derivative plaintiff should utilize its inspection rights before filing a derivative action. See, e.g., King v. Verifone Holdings, 12 A. 3d 1140 (Del. 2011).
The New Jersey statute providing for inspection is different than Section 220. Under N.J.S.A. 14A:5-28, a shareholder has the right to inspect “the books and records of account, minutes, and record of shareholders of a corporation.” In Feuer v. Merck & Co., __ A.3d __, No. A-1262-16T3, 2018 WL 2450547 (June 1, 2018), the New Jersey Appellate Division held that the “book and records of account” is much narrower than a corporation’s books and records generally. Feuer involved the efforts of a shareholder to obtain access to the books and records of Merck & Co. in advance of filing a derivative action.
In Feuer, the shareholder was seeking evidence that Merck improperly rejected the shareholder’s demand that the Board of Directors commence suit against itself and senior management responsible for Merck’s acquisition of another pharmaceutical company. The shareholder claimed that the acquisition was ill-advised and reckless. In response to the demand, Merck’s board of directors appointed a “Working Group,” which ultimately rejected the demand. Thereafter, the shareholder made a demand on Merck seeking 12 broad categories of documents pursuant to N.J.S.A. 14A:5-28(4) and the common law. Merck’s board provided him some relevant minutes from the board and working group meetings, but otherwise refused the demand. The shareholder then filed an action seeking the production of the documents. In response, Merck filed a motion to dismiss. The trial court found that, while the shareholder had a proper purpose in seeking the documents, the requests fell outside the statutory and common law inspection right.
‘Feuer’ Holds the Statutory Right to Inspect Is Limited
On appeal, the Appellate Division first considered whether the shareholder had a statutory entitlement to the documents. The court held that N.J.S.A. 14A:5-28 does not “directly entitle any shareholder to inspect documents” but rather “preserves the court’s power to grant inspection to shareholders.” Id. at *3. The court noted, however, that “such inspection pertains only to ‘books and records of account, minutes and record of shareholders of a corporation.’” Id. (quoting N.J.S.A. 14A:5-28(4). Thus, the court held that this quoted language “authorizes inspection of a significantly narrower universe of corporate records than [the shareholder] demanded.” Id. at *4. The court stated that the “phrase ‘books and records of account’ does not encompass any and all records, books and documents of a corporation” and, further, that the phrase does not even “necessarily encompass all financial documents of a corporation.” Id. The Appellate Division acknowledged that its narrow construction of the term “books and records of account” was contrary to the construction from other jurisdictions, which have held the term is to be construed broadly to include all corporate records.
The court also rejected the shareholder’s claim that the statute should be construed broadly to allow a shareholder to determine “whether he has a well-founded derivative claim.” Id. at *5. While the Appellate Division recognized that a plaintiff pursuing a derivative action needs to satisfy particularized pleading requirements, the court held a shareholder “is not entitled to broad-ranging inspection under the statute just because it would be useful, or because he prefers it to discovery within a derivative action.” Id. at *6. Rather, the court held “[w]e are bound by the plain language of the statute.” Id.
Does N.J.S.A. 14A:5-28 Abrogate the Common Law Right to Inspect Books and Records?
After finding that there was no statutory right to inspect the requested books and records, the Appellate Division considered whether the common law provided a basis for the inspection. The court recognized that, under the common law, shareholders had a qualified right to examine the books and records of a corporation so long as the request was made in good faith and the shareholder had a proper purpose.
Merck argued that the adoption of N.J.S.A. 14A:5-28 abrogated the common law. The Appellate Division noted that other states had split on this issue. The court added that “there would be no apparent reason for the statute to preserve common law rights” and found that “[h]ad the Legislature intended to preserve the entire body of common law rights, it could have expressly said so.” Id. at *8. For example, the court noted that in the Open Public Records Act, that legislature provided: “’[N]othing contained in P.L.1963, c.73 (C.47:1A–1 et seq.), as amended and supplemented, shall be construed as affecting in any way the common law right of access to any record …’ N.J.S.A. 47:1A–1.” Id. (alteration in original).
While certainly suggesting in dicta that the common law was abrogated by N.J.S.A. 14A:5-28, the Appellate Division decided to leave that question unanswered, stating: “In the final analysis, however, we need not decide whether the residual common law is abrogated by N.J.S.A. 14A:5–28.” Id. Instead, the court held that “assuming for argument’s sake that the common law survives alongside the statutory rights, it provides no relief under the facts and circumstances of this case.” Id.
In reaching this conclusion, the Appellate Division cited to earlier cases as authoritative and instructive on the issue of a shareholder’s right to inspection. Those cases held that: (a) a claim that a company overpaid for an acquisition “was not enough to justify a common law inspection,” id. at *9, and (b) the amount of stock owned by the shareholder was a relevant factor for a court to consider when deciding whether to allow the inspection.
Ultimately, the court held that there is “no basis in the common law cases for the kind of specific inspection [the shareholder] generally seeks” because it was the shareholder himself who “effectively forced the creation of documents upon his or her allegation of mismanagement.” Id. at *9-10. As the court concluded, “[i]t is not for us to expand the common law—to the extent it applies at all—to recognize a right to inspect documents that did not exist, but for the requester’s initial demands.” Id. at 10. Thus, the court rejected the shareholder’s efforts to inspect Merck’s books and records.
Recent Statutory Amendment Also Makes It Harder to Assert a Derivative Action
This decision follows a recent amendment to N.J.S.A. 14A:3-6.9, which now provides that, unless a corporation expressly opts out of the statutory scheme, a shareholder, before commencing a derivative action, must make written demand on the company and then must wait until either the company rejects the demand or 90 days (whichever is sooner) before commencing a derivative the action. A shareholder can no longer rely on a claim that demand would be futile.
Together, the Appellate Division’s limited construction of N.J.S.A. 14A:5-28 and the legislature’s amendment to N.J.S.A 14A:3-6.9 will make it much more difficult for a shareholder to assert a derivative action in New Jersey. Time will tell what effect these decisions will have on New Jersey corporations. New Jersey might just be on a path to becoming more business friendly. If New Jersey is going to remain the headquarters of some of the country’s largest pharmaceutical, financial, retail and energy companies, some may argue New Jersey must continue to make changes to become more business friendly. These changes appear to be a step in the right direction.
Frederick W. Alworth and Jonathan S. Liss are directors in the Commercial & Criminal Litigation Department of Gibbons P.C. in Newark.