Category Archives: Shareholders

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.

Application of the Oppressed Shareholder Provisions of the Business Corporations Act to Minority Oppression in other Business Organizations

By David White, Esq.
dwhite@pashmanstein.com

A developing trend toward applying minority shareholder oppression remedies under the Business Corporations Act (“BCA”), to owners of other business entities was curtailed by the Appellate Division.  Tutunikov v. Markov, A-1827-10T3 (August 1, 2013).

N.J.S.A. 14A:12-7, contained in the BCA,  provides a range of remedies to oppressed minority shareholders. “Oppression” is said to occur where the conduct of the majority owners frustrate the minority shareholder’s reasonable expectations in the venture. Where oppression is demonstrated, courts are authorized to order a forced buyout of the oppressed shareholder’s interests and fix the price at “fair value.”  “Fair value” is a judicial construct designed to avoid diminishing the value of an oppressed shareholder’s stock by valuation discounts, such as those for minority or non-marketable interests, which would inure to the benefit of the buyer.

The current Limited Liability Act (the “LLC Act”) does not contain a compulsory buyout remedy.  Instead N.J.S.A. 42: 2B-39 provides that an LLC member may resign and receive fair value for his shares “less all applicable valuation discounts.” Because of similarities in the predicaments of oppressed owners in the corporate and LLC settings, and in the absence of a specific, statutory remedy, Courts had begun to “import” oppression remedies from the BCA to minority members.

In Tutunikov, the Appellate Division flatly held that the BCA is not applicable to LLCs. Thus its oppression remedies were not portable. Nevertheless, the opinion did uphold a buyout at fair value, a concept generally seen in the setting of shareholder oppression.

New Jersey has adopted the Revised Uniform LLC Act (“RULLCA”), which includes an oppression remedy similar to that under the BCA. N.J.S.A. 42:2C-48.  The RULLCA will become effective for all New Jersey LLCs on March 1, 2014. In the short interval before RULLCA becomes effective, the application of the BCA to LLCs is unlikely to receive additional judicial attention.  However, the Tutunikov decision does not necessarily foreclose crafting oppressed owner remedies in the partnership setting by analogy to the BCA. Like the LLC Act, the Partnership Act, N.J.S.A. 42:1A-1, et seq. is silent on remedies for oppression. In precluding BCA remedies for LLC members, the Tutunikov Court relied in part on the fact that an oppression remedy under the RULLCA was imminent.   No such revision in the partnership statutes is pending, and accordingly, the Tutunikov decision does not completely preclude arguments along those lines.

New Act Will Apply to All Limited Liability Companies – Part Three

By Bruce Ackerman, Esq.
backerman@pashmanstein.com

New Jersey’s new law affecting every limited liability company (“LLC”) is the Revised Uniform Limited Liability Company Act (“RULLCA”), which took effect September 19, 2012.  RULLCA controls all LLC’s formed on or after March 18, 2013, and all LLC’s regardless of when formed as of March 19, 2014.  This final part of three parts explaining elements of RULLCA will address the following areas which have changed in the new Act — distributions, resignation and withdrawal, and the rights of members to information.

As to distributions, the old LLC law provides that, unless the operating agreement provides otherwise, distributions are to be made based on “the agreed value … of the contributions made by each member.”  Again highlighting the importance of the operating agreement, RULLCA provides that distributions prior to dissolution or winding up are to be “in equal shares among members and dissociated members.”  That is contrary to the ordinary agreement by members, which would provide for distributions by their percentage of ownership.  The parties must have their operating agreement set forth the terms of their agreement as to distributions.

As to resignation of a member and the right to any payment or “distribution” upon such withdrawal, the old LLC law provides for six months’ notice to withdraw and the payment of any distribution provided under the operating agreement or, if not provided, then payment of fair value for the interest held, less all applicable discounts.  In contrast, under RULLCA, a member may withdraw at any time, and there is no entitlement to any distribution upon withdrawal.  Of course, the members themselves may agree otherwise and set forth that entitlement within their operating agreement.

Finally, under the old LLC law in New Jersey, each member is entitled to receive information on the business and financial condition of the company, tax returns, member addresses, the operating agreement itself, and the value of cash and other assets held by the LLC.  The manager may maintain the information in confidence for such time as reasonably believed necessary to maintain trade secrets or other information the disclosure of which is believed not in the best interests of the LLC or required by a third party to keep confidential.

In contrast, RULLCA sets forth a procedure and time in which to secure LLC documents.  In general, RULLCA provides that the LLC shall furnish to each member any information concerning the company‘s activities, financial and other wise, that is material to the member pursuant to its operating agreement and, on demand, any other information.  Each member has that duty to provide information as well.  However, in a manager managed LLC, this information shall be provided by the manager if sought by the member for a “a purpose material to the member’s interest as a member,” and the member must make a written demand “describing with reasonable particularity the information sought and the purpose for seeking the information.”  The law provides a ten day period for the LLC to respond and inform the member when and where the LLC will provide the information and, if declined, the reasons why the information will not be provided.

As shown, a careful review of your current operating agreement should be made and appropriate changes and supplements to address those areas under RULLCA that leave to the members in their operating agreement to clarify and change what RULLCA provides.  With the March deadline looming for the RULLCA to apply to all LLC’s in New Jersey, it is important to make that review and update soon.

New Jersey Adopts Significant Changes Affecting Shareholder Derivative Lawsuits and Shareholder Rights

By Sean Mack, Esq.
smack@pashmanstein.com

On April 1, 2013, Governor Christie signed into law three bills designed to impose greater restrictions on shareholder derivative suits and to make New Jersey’s corporate governance law more business-friendly.

The new legislation permits companies to opt-in or out of certain provisions.   Company’s should therefore quickly review and understand these changes, and if desirable, adopt and file an appropriate amendment to their certificate of incorporation or bylaws.

The new legislation, which amends N.J.S.A. 14A:3-6, governs derivative lawsuits brought by minority shareholder(s) against the corporation, its directors and officers.

Under the new legislation, prior to the initiation of a derivative lawsuit, the complaining shareholder must make a written demand on the corporation for action.  Absent a demonstrable “irreparable injury to the corporation,” no lawsuit can be filed until the earlier of, the shareholder receiving a written rejection of the demand, or the passing of ninety days from the date of the written demand.  If the shareholder commences litigation after demand has been rejected, the complaint must meet a heightened pleading standard showing particular facts establishing that a majority of the board of directors, or all members of a committee, who determined the matter, did not consist of independent directors at the time the decision was made.

The new legislation provides additional grounds for moving to dismiss a derivative suit.  A court must dismiss a derivative lawsuit if the court finds that independent directors or a majority of independent shareholders have determined that the suit is not in the best interests of the corporation.  Specifically, the law permits the establishment of an independent committee of 1 or more directors, and a court shall dismiss a derivative complaint if the majority of the independent committee has determined in good faith, after reasonable inquiry, that the derivative proceeding is not in the best interests of the corporation.  A corporation also may request that the Court appoint an independent panel of one or more individuals to determine whether the maintenance of the lawsuit is in the best interests of the corporation, and provides that the plaintiff shall have the burden to demonstrate to the panel that the suit is in the best interests of the corporation.

To help ensure that the plaintiff shareholder fairly and adequately represents the interests of the corporation, in addition to being a shareholder at the time of the complained of conduct or having received the shares by operation of law from someone who held them at the time, the new legislation requires that a suing shareholder continue to be a shareholder during the course of the litigation.

The legislation also expressly mandates that the shareholder pay the corporation’s reasonable expenses if the court determines that the proceeding was brought without reasonable cause or for an improper purpose.  Also, for any shareholder holding less than 5% of the corporation’s stock, which is worth less than $250,000, the plaintiff shareholder must post a bond to cover the reasonable expenses of the corporation, including attorney’s fees.

For these new provisions to apply, existing corporations must amend their certificate of incorporation to adopt these provisions.

Another newly enacted piece of legislation amends the New Jersey Shareholder Protection Act, N.J.S.A. 14A:10A-1, et seq., which applies to all “resident domestic corporations.”  The new legislation revises the definition of “resident domestic corporations” to now include all corporations organized under New Jersey law.  However, a New Jersey corporation that does not have its principal executive offices located in New Jersey and does not have significant business operations in New Jersey as of April 1, 2013, may opt out of this new legislation by adopting an amendment to its bylaws opting out of this legislation before September 28, 2013.  Additional changes now permit a resident domestic corporation to engage in a business combination with an interested stockholder if the transaction that caused the holder to become an interested stockholder was approved by the corporation’s board of directors prior to the stock acquisition date.

The third piece of legislation also now permits shareholders to participate in shareholder meetings by means of remote communications.  What constitutes remote communications will be determined by guidelines and procedures established by the board, so long as each shareholder can participate in and have access to the same information and materials as those present for the meeting.

The New LLC Act Will Eventually Apply to All Limited Liability Companies – Part One

By Bruce Ackerman, Esq.
backerman@pashmanstein.com

The new law affecting every limited liability company (“LLC”) in New Jersey, dubbed the Revised Uniform Limited Liability Company Act (“RULLCA”), took effect September 19, 2012.  The prior law, generally known as the LLC Act, was largely unchanged since 1994.  This new Act is a major revision and brings changes to many aspects of forming and operating LLC’s in New Jersey.  This Part One will highlight a few of the first portions of the new Act, namely who the law affects and when, and the impact of the LLC Operating Agreement upon the members and managers.

The new Act, RULLCA, says that it applies to all LLC’s formed on or after March 18, 2013.  It will also apply to “all LLC’s”, regardless of the date of formation, eighteen months after its adoption on September 19, 2013.  Therefore, the critical date for all LLC managers and members in existing LLC’s is March 19, 2014.  At that time, all LLC’s in New Jersey will be governed by the new RULLCA.

Under the old law, the LLC’s “operating agreement” was defined as being a written agreement among the members as to how to conduct its business.  In contrast, the new law defines it as being an agreement that is “oral, in a record, implied, or in any combination thereof.”  This is a significant change, which now allows any writings, conversations, emails, verbal or other historical permissions or business practices to become, in effect, the operating agreement for the LLC.

Significantly, RULLCA now governs various parts of the operating agreement and even imposes rights and obligations where not otherwise specifically written by its members.  As an example, RULLCA provides that where the LLC operating agreement does not cover the listed items (relationship between members and the company, rights and duties for the manager, the company’s activities, and amending the agreement), RULLCA will control those items.  RULLCA also prohibits certain items from being altered, except within specified limits, such as changing a member’s duty of loyalty to the LLC, or the duty of good faith and fair dealing, or the vaguely stated “unreasonably restrict the duties and rights stated in section 40 [Right of Members, Managers, and Dissociated Members to Information]” or the right of a member to maintain a direct or a derivative action.

The initial provisions in RULLCA address the need to have LLC members that may operate other competitive businesses or deal with competitors.  Section 11(d) now permits the LLC operating agreement to specifically restrict or even eliminate the duty of loyalty of the members to the LLC and change the indemnification of the members and/or managers.

Just to make it less predictable, a catchall provision leaves it up to the court to decide whether the restriction or elimination of the duty of loyalty is “manifestly unreasonable”.

Lastly, RULLCA provides that any person that becomes a member of the LLC automatically agrees to the LLC operating agreement.  Look for Part Two to address the relationships between members and managers with the LLC and with each other.

Link to Part Two

Disassociation of LLC Member

By David White, Esq.
dwhite@pashmanstein.com

The Appellate Division recently construed the disassociation provisions of the LLC Act in a way that ostensibly eliminates the need for fault to expel a member.  In All Saints University of Medicine Aruba v. Chilana, 2012 N.J. Super. Unpub. LEXIS 2797  (2012), the Court held that judicial disassociation under N.J.S.A. 42:2B-24 b (3) may be granted, without more, where the member ‘s business conduct makes the prospect of continuing the LLC’s activities reasonably impractical.

In All Saints, plaintiffs and defendants formed a New Jersey LLC in connection with their operation of a medical school in Aruba.  Disputes arose among the members over financial issues and management of the company, including signing authority for checking accounts.  Plaintiffs’ complaints about the signatories resulted in the company’s  banks freezing its accounts.  Inability to access the accounts aggravated the already dire financial status of the medical school and threatened its operation.  The answering Defendant elicited capital contributions from the other members to continue the operation.  Plaintiffs declined to contribute and brought an order to show cause seeking relief for breaches of the Operating Agreement.  Defendant counterclaimed seeking authorization to operate the LLC unilaterally.  While the matter proceeded, defendant funded the company and sought to judicially disassociate plaintiffs from the LLC.

N.J.S.A. 42:2B-24(b) controls judicial disassociation of LLC members.  Sub section (3) (a) provides for expulsion where the member “engaged in wrongful conduct that adversely and materially affected the limited liability company’s business.”   Sub section (3)(c) permits expulsion where the member’s business related conduct “makes it not reasonably practicable to carry on the business with the member as a member of the limited liability company.”

The trial court determined that plaintiffs’ conduct met both tests, finding that it was wrongful under sub section (3)(a) and, under sub section (3)(c ), that it made impractical carrying on the business together.

On appeal, the Appellate Division observed that the statutory grounds were expressed disjunctively.  It further noted that N.J.S.A. 42:2B-24 uses the generally mandatory verb, “shall,” in providing for disassociation on the occurrence of one of the specified bases.  Accordingly, it found that either basis would suffice, calling them “equally dispositive.”

While the decision sidesteps whether the fault alleged against plaintiffs was “wrongful,” it carefully notes “the reality” of the adverse consequences.  The court limited its holding “to the facts of this rather unusual case.”  Notwithstanding the apparent equation of the wrongfulness and impracticality grounds for disassociation here, the sub-text of the Appellate decision suggests that in general, fault remains at least a background factor.

The Revised Limited Liability Company Act Creates a Statutory Remedy for Oppression of Minority Members

By David White, Esq.
dwhite@pashmanstein.com

The Revised Uniform Limited Liability Company Act (“RULLCA”), enacted on September 19, 2012, creates a statutory remedy for oppression of minority members in New Jersey limited liability companies. P.L. 2012, c. 50. The remedy parallels the relief provided to shareholders in close corporations under the Oppressed Shareholder Act (the “OSA”), N.J.S.A. 14A:12-7(1)(c),  with two slight textual differences requiring harm from oppression and an enhanced standard for an award of attorneys’ fees.

The Limited Liability Act (the “LLCA”) was silent on minority oppression.  N.J.S.A. 42:2B-1 et seq. Under the LLCA, any member of an LLC could resign and have his interest bought out.  N.J.S.A. 42:2B-24.  The LLCA provides that the resigning member’s interest is to be valued at “fair value less all applicable valuation discounts…” N.J.S.A. 42:2B-39.  The standard of valuation for an oppressed shareholder’s interest under the OSA, in contrast, is fair value without discounts.  Balsamedes v. Protameen Chems., Inc., 160 N.J. 352, 368 (1999); but see, Denike v. Cupo, 394  N.J. Super. 357 (App. Div. 2007) (disassociated member’s interests in an LLC valued without marketability or minority discounts).

As a result, courts addressing oppression of LLC members previously fashioned remedies by analogy to the OSA.  See, eg. Denike v. Cupo, 394 N.J. 357.  Without an explicit statutory remedy, however, some courts were reluctant to craft minority-oppression relief in LLCs. See, Hopkins v. Duckett, 2012 N.J. Super. Unpub. LEXIS 93, at *33.

RULLCA provides that Courts may grant various forms of relief where the managers or those in control of the company “have acted or are acting in a manner that is oppressive and was, is, or will be directly harmful to the applicant.” 2012 Bill text N.J.A.B. 1543, Art. 7, Section. 48(5) (b) (Dissolution and Winding Up).  Oppression provides grounds for ordering the sale of a member’s interests to the company or another member, as well as  dissolution of the company or appointment of a custodian or provisional managers. Id. at Article 7, Section 48 (b)

The Oppressed Shareholder Act, N.J.S.A. 14A:12-7(1) (c) provides:

The Superior Court, in an action brought under this section, may appoint a custodian, appoint a provisional director, order a sale of the corporation’s stock as provided below, or enter a judgment dissolving the corporation, upon proof that [,in] the case of a corporation having 25 or less shareholders, the directors or those in control have acted fraudulently or illegally, mismanaged the corporation, or abused their authority as officers or directors or have acted oppressively or unfairly toward one or more minority shareholders in their capacities as shareholders, directors, officers, or employees.

The definitions of oppression in RULLCA and OSA differ slightly.  Under the OSA, oppression is a per se violation that exists, even without damages.  RULLCA, however, requires a showing of direct harm, in addition to oppressive conduct by the controlling members.

The two acts also differ with respect to awarding counsel fees.  Under the OSA, a court may award attorneys’ fees in its discretion where the award “would be fair and equitable to all parties under all the circumstances of the case.” Id.  Awarding attorney’s fees under RULLCA remains discretionary but also requires a finding that the losing party acted “vexaciously, or otherwise in not good faith.” RULLCA  Art. 7,,Section 48(c).

RULLCA takes effect six months after enactment but does not generally apply to existing LLCs until eighteen months after its effective date. RULLCA , Art.11, Sections 96 and 91.