Category Archives: Commercial Litigation

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).

Online Advertisers Beware

By Zachary Levy, Esq.
zlevy@pashmanstein.com

A lawsuit was filed in federal court earlier this month by an online advertising agency alleging a prevalent, yet seldom litigated form of e-commerce fraud, referred to in the industry as “click fraud.” Click fraud causes online advertisers to overpay for their ads in two main ways. First, the cost of placing an advertisement on a particular website is largely based on the amount of users who visit that website each day (the amount of “web traffic.”). The higher the web traffic on a particular website, the more they are able to charge to place an advertisement because there are more potential consumers. Second, rather than paying a flat-fee to place an advertisement on a website, other contracts may require that the advertiser pay a nominal amount each time their advertisement is clicked on. Clearly, it would be problematic for an advertiser to be paying for clicks even though those clicks are being generated by fraudulent users, or “bots.”

In the lawsuit, Congoo (a.k.a. Adiant), an online news and networking company, is alleging fraud with regard to a one-year advertising contract it signed with Sell It Social, who operates an e-commerce website known as Rebel Circus. Congoo agreed to pay $300,000 in fees to advertise on Rebel Circus based on the purported volume of web traffic on the website. Further analysis conducted by Congoo revealed, however, that a substantial amount of the web traffic on Rebel Circus is generated by “click farms,” or bots, which are programed to visit specific websites and create the illusion that several more human users are visiting the website than there actually are. According to the Complaint, Congoo suspected a high presence of artificially generated web traffic based on two different analyses. First, an empty advertisement placed on Rebel Circus, containing no content whatsoever, was still being clicked on several times by purported users. Second, the purchase rate stemming from clicks from Congoo’s advertisement on Rebel Circus was much lower than the statistical average, therefore evidencing the presence of bots, which obviously would not be purchasing anything. Congoo is seeking to rescind its contract with Sell It Social as a result of the suspected high amount of fraudulent web traffic.

While obtaining evidence of click fraud can be difficult, it is not impossible, and online advertisers should take steps to minimize their risk of being taken advantage of. First, advertisers can simply conduct online research to learn whether a website they are considering placing an ad on is known to have a high presence of bots or fraudulent users that inflate web traffic figures. Additionally, there is software available which gathers data from websites and advertisements and uses that information to monitor for signs of click fraud. For example, if an advertisement on Website A is generally clicked on by only 0.25% of visitors, but Advertiser X’s advertisement is clicked on by 2.5% of visitors, ten-times the statistical average, would likely be indicative of click fraud. One more way an online advertiser can protect themselves is to always include language in the advertising contract which provides for relief in the event click fraud is detected.

Fees on Fees for Corporate Indemnification: Who pays the bill when you have to sue your company to defend you?

As it appeared in the New Jersey Law Journal.

Schwartz, A.By Adam Schwartz, Esq.

So you are an officer or director of a company and you have been sued for some action (or inaction) you took in your corporate capacity. Does the company defend and indemnify you? In most instances, unless you are being sued for fraud, the company’s bylaws, and in some instances even New Jersey statutes, require the company to provide defense and indemnification. But what happens if the company refuses?

Under New Jersey’s corporate indemnification statute, you can sue to obtain the defense and indemnification to which you are entitled, but at what cost? Will you spend more suing the company than paying for your own defense in the underlying matter? Unless you can recover the attorney fees you incur in suing the company (often referred to as “fees on fees”), you will not be made whole. Moreover, if the company is not compelled to pay your legal fees, it creates an incentive to deny coverage in the first instance. Maybe you won’t bother suing. Maybe you won’t realize you can challenge the company’s decision to deny coverage.

There are no reported New Jersey cases addressing “fees on fees” in the corporate indemnification context. However, a New Jersey court will inevitably face this issue. How will it be resolved? On issues of first impression, New Jersey courts often look to other jurisdictions for guidance, such as Delaware and New York, which have similar corporate indemnification statutes. However, those states have reached opposite conclusions—Delaware allows an officer to recover “fees on fees” while New York does not. Thus, New Jersey courts facing this issue will likely follow the state—Delaware or New York—with the most persuasive reasoning.

As an initial matter, all three states follow what is called the “American Rule,” which provides that each litigant must bear his own legal costs unless a statute, court rule or contract specifically provides that a successful plaintiff can recover attorney fees. See Porreca v. City of Mellville, 419 N.J. Super. 212, 224 (App. Div. 2010); see also Goodrich v. E.F. Hutton Group, 681 A.2d 1039, 1043 (Del. Sup. Ct. 1996); Baker v. Health Management Systems, 98 N.Y. 2d 80, 88 (2002). Thus, the ability to recover “fees on fees” will be determined by corporate indemnification statutes and/or the company’s bylaws. As bylaws frequently provide for coverage “to the fullest extent” allowed under the law, the corporate statutes will be the focal point for any analysis.

The applicable Delaware Statute, 8 Del. C. 145(a), provides as follows:

A corporation shall have the power to indemnify any person who was or is a party or is threatened to be made a party to any … suit or proceeding … by reason of the fact that the person is or was a director, officer, employee or agent of the corporation … against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonablyincurred by the person in connection with such action, suit or proceeding.

In Stifel Fin. Corp. v. Cochran, 809 AD.2d 555 (Del. Sup. Ct. 2003), the Delaware Supreme Court noted that § 145(a) permits indemnification “in any action,” may extend to the indemnification action itself. It further noted that § 145(a) is remedial in nature and “should be broadly interpreted to further the goals it was enacted to achieve.” Those goals include (i) assisting corporate officials resist what they consider to be unjustified suits, and (ii) encouraging “capable men to serve as corporate directors, secure in the knowledge that expenses incurred by them in upholding their honesty and integrity as directors will be borne by the corporation they serve.”

In light of those objectives, the Stifel court held that “without an award of attorneys’ fees for the indemnification suit itself, indemnification would be incomplete.” Thus, it concluded that, while § 145(a) does not expressly state that “fees on fees” are recoverable, the language provides that “fees on fees” are “permissible” and therefore “authorized”—although not required. As the company’s bylaws provided for indemnification to the fullest extent of the law, and “fees on fees” are permissible under the law, the officer was reimbursed for the fees he incurred in seeking indemnification. Moreover, the Stifel court observed that allowing “fees on fees” under these circumstances would prevent a company with “deep pockets” from wearing down a former director, “with a valid claim to indemnification, through expensive litigation.”

In essence, Stifel subordinated the American Rule and looked to the purposes behind § 145(a) to determine that “fees on fees” supported the statute’s remedial purpose. It did not believe corporations would be unduly punished by this result because they can tailor their bylaws to exclude “fees on fees” if so desired.

On the other hand, New York’s highest court has held that New York’s corporate indemnification statute does not permit “fees on fees.” Baker, 98 N.Y.2d at 88. The corporate indemnification statute in New York, McKinney’s Business Corporation Law § 722, provides that:

A corporation may indemnify any person made, or threatened to be made, a party to an action or proceeding … by reason of the fact that he … was a director or officer of the corporation … against judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees actually and necessarily incurred as a result of such action or proceeding, or any appeal therein.

In Baker, a corporate officer who successfully obtained indemnification argued that he was entitled to “fees on fees” because the attorney fees he incurred by suing to obtain indemnification were “necessarily incurred as a result” of his being sued in his corporate capacity for securities fraud. The Baker court rejected the officer’s argument, holding that the fees he incurred in the indemnification lawsuit were caused by the company’s refusal to indemnify; they were not incurred as a result of the officer being sued in the underlying securities fraud action.

The Baker court then examined the legislative history of §722 and discerned no evidence suggesting an intention to allow “fees on fees.” It further held that even if the officer’s argument had merit, it would be preempted by the American Rule. In essence, the Baker court held that, since “fees on fees” were not expressly authorized in §722, they are not available. It did not believe its holding would unduly punish corporate officers because they “remain free to provide indemnification of fees on fees in bylaws, employment contracts or through insurance.”

New Jersey’s corporate indemnification statute provides that: “Any corporation … shall have the power to indemnify a corporate agent against his expenses and liabilities in connection with any proceeding involving the corporate agent.” N.J.S.A. 14A:3-5(2). As with the Delaware and New York statutes, it is silent on the issue of fees on fees. The reasoning of Delaware and New York, provide credible arguments for and against “fees on fees.” However, New Jersey is more likely to follow the logic of Stifel.

The New Jersey Supreme Court has noted that Delaware’s corporate indemnification statute is similar to and in fact, constitutes “the very genesis of New Jersey’s Indemnification Statute.” Vergopia v. Shaker, 191 N.J. 217, 220, fn. 1 (2007). Thus, it will likely look to Delaware courts for guidance as it has previously done for corporate law issues. Moreover, New Jersey courts have recognized the remedial nature of the corporate indemnification statute and the goals it seeks to achieve—goals identical to those identified in Stifel. SeeCohn v. Southbridge Park, 369 N.J. Super. 156, 160 (App. Div. 2004) (noting that the statute (i) helps corporate officials resist what they consider to be unjustified suits and claims, and (ii) encouragescapablemen to serve as corporate directors.)

Moreover, one of the primary differences between New York and Delaware is who the courts believe are responsible for protecting themselves against an unfavorable result. Delaware believes that it is incumbent upon the company to amend its bylaws to exclude “fees on fees”; while New York places that burden for ensuring the availability of “fees on fees” on the individual officer.

Faced with this dichotomy, New Jersey will likely place the burden on the company to exclude coverage. In other instances, New Jersey courts have looked to the relative bargaining power of the respective parties to determine the viability of a claim. SeeMohammed v. Count Bank of Rehoboth Beach, Delaware, 189 N.J. 1, 15 (2006) (contracts of adhesion); see also Alloway v. General Marine Industries, 149 N.J. 620, 628 (1997) (whether tort or contract principles apply to transaction). In this instance, the relative bargaining power clearly rests with the company, which has already approved the bylaws and has deeper pockets that the individual.

Thus, notwithstanding New Jersey’s adherence to the American Rule, a New Jersey court will likely find that “fees on fees” are permitted under N.J.S.A. 14A:3-5(2).•

Reprinted with permission from the February 9, 2015 issue of The New Jersey Law Journal. © 2014 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

Unconscionable Commercial Practice

By Suzanne M. Bradley, Esq.
sbradley@pashmanstein.com

In an opinion analyzing what constitutes an “unconscionable commercial practice” under the New Jersey Consumer Fraud Act (“NJCFA”), the United States District Court for the District of New Jersey recently dismissed a putative class action brought under the Act and New Jersey common law regarding defendant Novartis AG’s pricing of its Excedrin Migraine product.  In Yingst v. Novartis AG, 2-13-cv-07919, District Judge Claire Cecchi determined that Novartis’ pricing of the product, while strategic, was not illegal under the NJFCA, and therefore dismissed Plaintiff’s claims.

Plaintiff Kerri Yingst alleged that Novartis sells Excedrin Migraine and a pharmacologically equivalent product, Excedrin Extra Strength, at different wholesale prices which in turn caused Yingst and other consumers to pay a premium for Excedrin Migraine, despite the fact that the two products consisted of “identical ingredients in identical quantities.”  Compl. ¶21.  Yingst alleged that at the time she purchased Excedrin Migraine, she believed that because Excedrin Migraine was sold at a higher price, it was a more effective product for migraine relief.  Novartis moved to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6), and the court granted the motion.

As Judge Cecchi explains, New Jersey’s strong Consumer Fraud Act provides that a plaintiff is entitled to treble damages, reasonable attorneys’ fees, and reasonable costs if she proves that the defendant engaged in an unlawful practice that caused an ascertainable loss.  In this case, Plaintiff did not argue that Novartis committed any affirmative act of deception, fraud, false pretense, false promise, or misrepresentation, and did not argue that Novartis knowingly concealed, suppressed or omitted any material fact with intent to induce reliance.  Instead, Plaintiff contended that Novartis engaged in an “unconscionable commercial practice” within the meaning of the NJFCA by using the U.S. Food & Drug Administration (“FDA”)’s requirement that Excedrin Migraine and Excedrin Extra Strength have separate packaging as a means to extract a premium from consumers while providing no extra benefits.  The New Jersey Consumer Fraud Act does not define the phrase “unconscionable commercial practice.”  However, Judge Cecchi noted that the New Jersey Supreme Court has defined the term as an act lacking good faith, honesty in fact and observance of fair dealing.  Turf Lawnmower Repair, Inc. v. Bergen Record Corp., 655 A.2d 417, 429 (N.J. 1995) (citing Meshinsky v. Nichols Yacht Sales, Inc., 541 A.2d 1063, 1066 (N.J. 1988)).  As with the broader Act, New Jersey case law provides that the phrase “unconscionable commercial practice” should be interpreted liberally to effectuate the Act’s public purpose.

In the case at hand, Judge Cecchi noted that there was no dispute that both Excedrin Migraine and Excedrin Extra Strength were properly labeled and contained no misinformation regarding the medications.  Therefore, because Plaintiff had conceded that there was no dishonesty by Novartis, Judge Cecchi determined that its pricing of Excedrin Migraine was not an act that lacked good faith or honesty in fact.  Further, Judge Cecchi found that Plaintiff could  not establish that Novartis’ pricing of Excedrin Migraine lacked fair dealing; Plaintiff did not cite any cases, and the Court was aware of none, in which an “unconscionable commercial practice” was found under the Act based solely upon disparate pricing of substantively identical products manufactured by the same defendant.  Although the dearth of case law was not itself fatal to Plaintiff’s claim, the fact that Plaintiff paid, at most, $1.05 more for a 300-count package of Excedrin Migraine than for a 300-count package of Excedrin Extra Strength was a “minor detriment” that did not “rise to the level of unfair dealing.”  While Novartis’ creation of a pricing structure in which migraine sufferers paid a higher price for pills pharmacologically identical to Excedrin Extra Strength in order to obtain the directions and warnings mandated by the FDA was “strategic,” Judge Cecchi held that such behavior was not proscribed by the NJCFA and dismissed Plaintiff’s NJFCA claim.[1]  As Judge Cecchi’s opinion demonstrates, slight price differentials in otherwise identical products, absent any evidence of misrepresentation or misinformation, are “within the bounds of reasonableness and concomitantly outside the ambit of the NJCFA.”

[1] Judge Cecchi also dismissed Plaintiff’s unjust enrichment claim.  In New Jersey, a constructive or quasi-contract is a vehicle by which a plaintiff may enforce a public duty to prevent unjust enrichment or unconscionable benefit.  To state a claim for unjust enrichment, the plaintiff must allege (1) at plaintiff’s expense (2) the defendant received benefit (3) under circumstances that would make it unjust for the defendant to retain the benefit without paying for it.  Judge Cecchi again noted that Plaintiff did not allege any misrepresentation or misinformation by Novartis, and also did not allege that Excedrin Migraine failed to relieve her ailment or that Excedrin Extra Strength performed better than Excedrin Migraine; Plaintiff “deliberately purchased the higher-priced product and received exactly what she paid for.”  See Def.’s Reply p. 6.  Therefore, the Court found nothing “unjust” about Plaintiff’s transaction, and granted Novartis’ motion to dismiss with respect to Plaintiff’s unjust enrichment claim.