Monthly Archives: May 2016

NJ Boards of Directors May Not Alter Shareholder Quorum Requirements Via Amendment to Corporate Bylaws

By Rachel Mills, Esq.
rmills@pashmanstein.com

It is not unusual for shareholders in closely held companies to overlook the shareholder quorum requirements.  But such quorum requirements can be either an Achilles’ heel or powerful tool in the event of a shareholder dispute on the direction and operations of the company.  In a recent appellate decision, a New Jersey court ruled that a corporation’s board of directors could not deal with an obstructionist shareholder by modifying the company’s shareholder-quorum requirement through a bylaw amendment.[1]  Instead, any deviation from the New Jersey Business Corporation Act’s default rule on shareholder quorum—that a majority of a corporation’s shares must be represented in person or by proxy at a shareholder meeting in order to constitute quorum—must be provided for in the corporation’s certificate of incorporation.  Companies and shareholders looking to either prevent corporate changes or overcome obstructionist shareholders should carefully consider their options.

Background

The Board of Directors of Laurel Gardens Co-Op, Inc. (“the Co-Op”), a New Jersey corporation, attempted to alter the definition of quorum for purposes of shareholder meetings by amending the Co-Op’s bylaws.  Those bylaws required the majority of the Co-Op’s shares, sold or unsold, to appear in person or by proxy to constitute quorum.

Prior to the Board’s attempt to alter the shareholder-quorum requirement, the Board, in 2012, twice called a shareholder meeting wherein the Board intended to vote on a proposed amendment to the bylaws regarding the Co-Op’s subleasing rules and requirements.   Specifically, the sublease amendment would alter the bylaws to require, as a pre-condition for subleasing an apartment, that the owner wait at least one year after acquiring an apartment before the owner can apply to sublease the apartment.  This amendment would essentially reduce the ratio of rental units to owner-occupied units, which would make it easier for prospective purchasers to obtain financing to purchase Co-Op shares.  The plaintiffs, who included the Co-Op’s sponsor at the time the Co-Op converted to a cooperative from of ownership, raised objections to the sublease amendment, asserting that the amendment would violate the sponsor-protection provision.  That provision provided that the bylaws could not be amended in any manner that would affect the sponsor’s rights/interests.  While the proposed sublease amendment exempted the sponsor from its restrictions, the plaintiffs claimed that the sublease amendment nonetheless ran afoul of the sponsor-protection provision because the amendment had the potential to harm the sponsor’s future attempts to sell its shares to prospective purchasers who may wish to sublease the units rather than occupying the units themselves.

At the two shareholder meetings called by the Board to put the sublease amendment to a vote, an insufficient number of shareholders attended the meetings to establish a quorum.  The Board then called a third shareholders’ meeting, immediately following the Board’s monthly meeting.  At the Board meeting prior to the shareholder meeting, all of the Board members who were present unanimously approved the sublease amendment and also an amendment to the bylaws’ shareholder-quorum requirement.  The shareholder-quorum amendment reduced the necessary quorum from a majority of the Co-Op’s shares to 20% of the shares.

The plaintiffs—the Co-Op’s sponsor and one of the Co-Op’s directors—filed suit, individually and derivatively, against Co-Op and the directors who approved the challenged amendments.  The plaintiffs claimed shareholder oppression, breach of contract, and tortious interference based, in large part, on the bylaws’ sponsor-protection provision.  The plaintiffs argued that the sublease and shareholder-quorum amendments ran afoul of that sponsor-protection provision because they had the capacity to limit the value of the sponsor’s shares to prospective purchasers.

The trial court granted summary judgment in favor of the defendant Co-Op and directors and dismissed the complaint with prejudice.

The Appellate Division Decision

The Appellate Division reversed, concluding that, under the unambiguous text of the New Jersey Business Corporation Act, N.J.S.A. 14A:1-1 to 17-18 (“the Act”), the Board could not unilaterally reduce the shareholder-quorum requirement by bylaw amendment.  N.J.S.A. 14A:15-9 states in relevant part: “Unless otherwise provided in the certificate of incorporation or this act, the holders of shares entitled to cast a majority of the votes at a meeting shall constitute quorum at such meeting.”  The court interpreted this “to mean that, in order to hold a vote amongst the Co-Op’s shareholders, a majority of all shares of the Co-Op must be represented at the meeting.”

The court explained that the only manner to modify the shareholder-quorum requirement under the Act is by amendment to the certificate of incorporation, which can only be approved by a vote of the shareholders under N.J.S.A. 14A:9-2(4).  The Co-Op’s certificate of incorporation did not address quorum for shareholder meetings, and, as a result, the Act’s default majority requirement for shareholder quorum controls.  Under the plain language of N.J.S.A. 14A:15-9, an amendment to the corporation’s bylaws was insufficient to modify the Act’s default quorum requirement.

The appellate court was not persuaded by the defendants’ argument that some shareholders, particularly the sponsor who held a substantial percentage of shares, were preventing the Board from conducting meaningful business by boycotting shareholder meetings.  The court noted that the Board had alternatives to address the perceived obstructive behavior, including by persuading shareholders to attend the annual meeting to amend the certificate of incorporation or by initiating General Equity Litigation under N.J.S.A. 14A:5-2 to obtain a court-ordered shareholder meeting wherein “the majority quorum requirement would have been waived by operation of law.”

The Bottom Line

Quorum requirements are critical to a company’s operations because they determine how many shares must approve material changes to the business and how it functions.  Smaller quorum requirements can empower minority interests to exert significant control.

On the one hand, this case is a powerful example of the ability of a shareholder owning a substantial portion of an entity’s shares to slow and obstruct the business of the corporation to its advantage by merely absenting itself, and other shareholders under its influence, from attendance at shareholder meetings.  Going forward, those forming corporations in New Jersey could consider altering the Business Corporation Act’s default rules in the certificate of incorporation at the time of the corporation’s inception to give the Board of Directors the necessary flexibility to take corporate action in the face of shareholder obstruction, apathy, or inaction.

On the other hand, managers and shareholders may wish to implement and maintain the default majority quorum requirements to prevent a minority group from taking action that affects the entire business without a majority present.  Businesses can deal with obstructionist shareholders in other ways, including, as described in the Appellate Division decision, by instituting General Equity Litigation.

Board members or shareholders considering modifications the default quorum requirements can contact me for further discussion and evaluation of strategies for dealing with individual situations.

 

 

[1] Sterling Laurel Realty, LLC, et al. v. Laurel Gardens Co-Op, Inc., No. A-0696-14T4 (N.J. App. Div. April 5, 2016) (approved for publication).