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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).

New Jersey Appellate Court Rules That Employers May Not Mandate Psychological Testing of Employees Based on Anonymous Tips

By Rachel Mills, Esq.
rmills@pashmanstein.com

The Americans with Disabilities Act (“ADA”) provides, in part, that an employer “shall not require a medical examination and shall not make inquiries of an employee as to whether such employee is an individual with a disability or as to the nature or severity of the disability, unless such examination or inquiry is shown to be job-related and consistent with business necessity.”[1]  A New Jersey appeals court recently interpreted this provision and ruled that an employer violated the ADA when it ordered its employee to undergo psychological testing based on anonymous and uncorroborated claims by the employee’s coworkers.[2]

Background

The Township Manager for the Township of Lakewood received an anonymous letter, purporting to be from a concerned employee of the Department of Public Works (“DPW”), relating to the Appellant, a truck driver for the DPW.  The letter claimed that “everyone knows he has some sort of mental issues” and that he puts other employees “at risk with his tirades and outbursts on a daily basis.”  It further described the Appellant as “a time bomb waiting to explode” and requested that something be done to ensure the safety of the other employees.

The Township took no action until eight months later when the Township advised the Appellant that he would be sent for a psychological examination to determine his fitness for duty.  Citing the ADA, the Appellant refused to submit to psychological testing.  The Township issued him a Preliminary Notice of Disciplinary Action and subsequently a Final Notice of Disciplinary Action, and ultimately, the Township terminated his employment based on his refusal to attend psychological testing contrary to the express directives of his superiors.

The Appellant appealed his termination to the Civil Service Commission, who transferred the matter to an Administrative Law Judge (“ALJ”) for a hearing.  At the hearing, only one witness testified for the Township, the director of the DPW.  The director testified that the DPW had some trouble with him over the years because he was “at times . . . confrontational, and at other times [he walked] away from someone who wished to speak with him.”  However, the director added that he was not afraid of the Appellant and that he was “no different than any other employee.”  The director further admitted that he had not investigated the allegations in the letter, and he was unsure what action, if any, the Township Manager had taken to verify its contents.

Based on the foregoing, the ALJ concluded that the Township’s demand that the Appellant undergo psychological testing was not reasonably “job-related and consistent with business necessity.”  The Civil Service Commission, however, reversed the ALJ and concluded that the Appellant was properly terminated for his insubordination.

The Appellate Division Decision

The Appellate Division reversed, concluding that the Township violated the ADA when it required the Appellant to submit to psychological testing based on the information in the anonymous letter.  His termination for refusing to submit to the psychological evaluation was therefore improper, and the panel remanded for his reinstatement.

The appellate panel reviewed the applicable regulations and interpretative guidance from the Equal Employment Opportunity Commission (“EEOC”) and summarized the governing standards as follows:

[T]he employer must reasonably believe, either through direct observation or through reliable information received from credible sources, that the employee’s perceived medical condition is affecting his or her work performance or that the employee poses a direct threat.  Then, and only then, may the employer lawfully require the employee to undergo a psychological fitness-for-duty examination.

With respect to the Appellant, the court explained that the Township failed to satisfy these standards because there was no evidence that he was unable to perform his essential job functions as a result of any suspected mental condition, that he had threatened other employees, or that he had a history of disciplinary infractions over his nine-year employment, aside from one incident wherein he was disciplined for refusing to help a coworker.  Notably, because the author of the anonymous letter was unknown, the letter did not provide the requisite reliable information from a credible source that the Township would have been justified in relying upon in ordering a psychological examination.  The panel explained that the information contained within the letter “was exactly the type of innuendo and rumor that the EEOC has advised employers is insufficient to support a mandatory evaluation.”  The appellate court advised that, had the Township wished to take action in response to the letter, the Township could have solicited information from the Appellant’s coworkers and supervisors concerning his job performance.

The Bottom Line

While anonymous complaint systems play a vital role in eradicating other forms of discrimination in the workplace, employers must be conscientious in ensuring that these systems themselves do not become a means of discrimination.  Thus, an employer should seek to corroborate and investigate any anonymous allegations of an employee’s mental health issues before requiring the employee to undergo psychological testing.

 

[1] 42 U.S.C. § 12112(d)(4)(A).

[2] In re Williams, — N.J. Super. —  (N.J. App. Div. Jan. 25, 2016).

 

Annual Review of Legal Documents

By Bruce Ackerman, Esq.

Published by the Meadowlands USA Newsletter

Everyone is attuned to addressing year-end tax and financial planning. However, most businesses do not give proper attention to reviewing their legal documents and the types of legal issues that should be looked at on an annual basis.

A yearly legal review should be a regular part of your company business planning. Even more importantly, by making the review of legal documents an annual concern you can often prevent legal issues from causing greater problems later on.

The following are some common areas that should be part of your annual legal business review.

Ownership & business entity documents

Take note of having your entity documents in order. If your business is a corporation, this should be a shareholder agreement, sometimes called your buy-sell agreement, and for a limited liability company you should have an updated, fully signed operating agreement. At least once a year, the company should be sure that these documents memorialize any changes in ownership and agreements between owners for future transfers.

For the rest of the article, click here.

When Smartphones Go to War, Patent Holders Seeking Injunctions against Infringement Win?

By Michael J. Zoller, Esq.
mzoller@pashmanstein.com

Prior to 2006, when a patent holder demonstrated that someone was infringing on its patent, it enjoyed a presumptive entitlement to an injunctive award permanently enjoining the infringement.  That all changed though when the Supreme Court handed down its decision in eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006).  In eBay, the Supreme Court held that instead of a general rule presumption in favor of injunction, the same equitable standard that applied for granting injunctions in non-patent cases should also apply to disputes arising under the Patent Act.  Consequently, following the decision in eBay, in order to obtain a permanent injunction against patent infringement, a patent holder had to pass a four-factor test by showing:

(1) that it has suffered an irreparable injury;

(2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury;

(3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and

(4) that the public interest would not be disserved by a permanent injunction.

Id. at 391.

This change was bad for patent holders because instead of the presumed injunction they used to receive upon a showing of infringement, in addition to proving infringement, the patent holders now had to prove that an injunction was warranted too.

In the wake of the Supreme Court’s eBay decision, the “Smartphone Wars” were launched.  The Smartphone Wars are a series of litigation between Apple and Samsung regarding Samsung’s infringement on some of Apple’s patents for cellphone and tablet technology.  The first decision (“Apple I,” 678 F.3d 1314) in the Wars was handed down in 2012 and the fourth and latest was just handed down in September 2015 (“Apple IV,” 801 F.3d 1352).

In Apple I, the Federal Circuit affirmed the District Court’s holding that to show an irreparable harm, a patent holder must make a showing of a “casual nexus” between the infringement and the alleged harm to the patent holder.  The Apple I decision further stated that “[s]ales lost to an infringing product cannot irreparably harm a patentee if consumers buy that product for reasons other than the patented feature.” Apple I, 678 F.3d  at 1324.  The decision in Apple I was another blew to patent holders.  To be able to obtain an injunction they now had to show that the technology being infringed on was the cause of their sales in the first place.  This can be very difficult to show when the actual item being sold, like a smartphone, contains many different features and pieces of technology.

Recently though, the Federal Circuit’s decision in Apple IV has swung the power back to the patent holders.  In Apple IV, the Federal Circuit took a closer look at the requirements of a casual nexus.  In its review, the Federal Circuit determined that the proper approach for finding a casual nexus was not a determination that the infringing features were the reason for consumers purchasing the smartphone, but rather a determination that the infringing features were important to consumers when making their purchasing decision.  When there are many reasons why a consumer chooses to purchase a particular smartphone, having to show that the features being infringed on are important to consumers versus having to that they are the specific reason the consumer chose the smartphone is a much lower standard to meet.  Consequently, in Apple IV, the Federal Circuit ended up granting Apple its injunction.

The decision in Apple IV is a positive turn for patent holders after their rights had been limited in the earlier litigations.  That said, while patent holders may have won this battle, the war is not yet over.  Samsung has petitioned the Federal Circuit to rehear the case en banc.  Should the Federal Circuit grant the petition and reverse then patent holders may be telling a different story.  As they say, history is written by the victors…

Who Should be Protected the Attorney or the Client?

By Michael Zoller, Esq.
mzoller@pashmanstein.com

The New Jersey Supreme Court recently granted certification in the case of Mortgage Grader Inc. v. Ward & Olivo LLP, John Olivo and John Ward to address the question of who should bear responsibility for a legal malpractice claim when a law firm allows its insurance coverage to lapse during dissolution.  The Trial Court held that when the law firm fails to maintain the malpractice insurance required by Court Rule 1:21-1 it reverts to being a general partnership and individual partners of the law firm can all be personally liable for the malpractice committed by one partner.  On appeal, the Appellate Court reversed the Trial Court by holding that the law firm organized as a limited liability partnership does not revert to a general partnership when it fails to maintain its legal malpractice insurance.  Now the Supreme Court will settle the issue.

The question presented by Mortgage Grader is one of importance to both clients and attorneys.  Court Rules allow attorneys to practice in corporations, companies and partnerships that all provide limit personal liability protection.  If an attorney commits malpractice only the individual attorney and the firm itself may be held financially responsible.  The aggrieved client cannot personally pursue other attorneys in the firm.  The tradeoff for this limited liability protection is that the firm must maintain at least a specified amount of malpractice insurance so that there is a pool of money for the client to potentially collect against.  The circumstances of Mortgage Grader appear to have highlighted a loophole in the insurance coverage in return for limited liability protection paradigm.

In Mortgage Grader, the plaintiff retained the law firm of Ward & Olivo, LLP to represent it in several patent infringement suits.  John Olivo was responsible for handling the cases on behalf of Mortgage Grader.  When Mortgage Grader realized that it had entered into unfavorable settlements due to advice from Olivo it sued the firm and its two named partners for malpractice.  Normally, the firm’s malpractice insurance would provide a pool for Mortgage Grader to potentially recover from, but in this case no insurance was available because prior to the claim being made, Ward & Olivo had dissolved and instead of purchasing a tail policy to provide coverage for claims filed after dissolution, the firm had allowed its insurance policy to lapse.

It is Mortgage Grader and the Trial Court’s opinion that since Ward & Olivo chose to not purchase a tail policy while it was still winding up its affairs, Mortgage Grader should be able to recover against whatever assets of the firm still exist and both Olivo and Ward individually.  This approach provides more protection to Mortgage Grader because it creates a bigger pool of money for it to potentially recover from.  It is Ward and the Appellate Court’s opinion that even though Ward & Olivo did not purchase a tail policy to maintain insurance coverage, Ward should still be afforded liability protection and Mortgage Grader should only be allowed to potentially recover against whatever assets of the firm still exist and Olivo individually.  This approach provides protection to Ward because Mortgage Grader will not be able to potentially recover from his personal assets.

The question before the Supreme Court boils down to who should be protected: the client who engages a law firm under the assumption that malpractice insurance is in place to protect it should something go wrong or the attorney who chose to not purchase tail insurance when he dissolved his firm?  The answer the Supreme Court provides has the potential to affect all attorney-client relations going forward so it bears watching from both sides of the aisle.

Court Holds that State Worker Classification Law Is Pre-Empted by Federal Law

Mack, S.By Sean Mack, Esq.
smack@pashmanstein.com

On February 5, 2015, a federal judge in Massachusetts dismissed two lawsuits against JB Hunt and FedEx, which had alleged that those carriers violated a Massachusetts labor law by classifying their drivers as independent contractors rather than as employees.  The Federal judge concluded that the Massachusetts law was preempted by the Federal Aviation Administration Authorization Act and therefore could not be enforced.  The FAAA expressly provides that federal statutes will preempt or supersede state laws if they could affect “prices, routes and services” of motor carriers and interstate freight movement.

Drivers have previously had success challenging their classification as independent contractors instead of employees in various state and federal courts in obtaining rulings that they were improperly classified as independent contractors.    For example, the Ninth Circuit Court of Appeals, which covers California and other Western States, has twice overturned rulings by lower courts that had concluded that drivers were independent contractors, not employees.  A federal court in Indian also ruled against FedEx in a class action concluding that it had misclassified its workers in various states.

Following those rulings, several states have enacted legislation creating a presumption that drivers are employees, not independent contractors.  New Jersey currently has bills pending in the legislature that would create a presumption that drivers of motor carriers are employees.  In 2013, the NJ Assembly passed the Truck Operator Independent Contractor Act  (A1578) that would establish a presumption that port and parcel delivery truck drivers are employees unless companies can prove otherwise.  The NJ Senate labor committee has cleared similar legislation (S1450), but the law has not yet been adopted in NJ.

The ruling in Massachusetts most likely will be appealed, but if upheld, is significant as it would provide precedent to invalidate similar worker classification laws in other states, and may dissuade states like NJ from  adopting a classification law that will be subject to preemption.

Best Practices for Verifying Employee Work Eligibility While Avoiding Discrimination Issues

By Eleanor Lipsky, Esq.
elipsky@pashmanstein.com

When hiring new employees, employers should be careful to comply with laws prohibiting the hiring of undocumented immigrants, while also ensuring that no discrimination on the basis of national origin or citizenship occurs.

The Immigration and Nationality Act (INA) is a federal law that makes it illegal for employers to knowingly hire persons who are not authorized to work in the United States.  Under the INA, an employer must check documents to confirm the identity and work eligibility of all persons they hire and complete a Form I-9, the Employment Eligibility Verification form, for every new employee, whether they are a citizen or not.  Failure to comply with the Form I-9 can result in sanctions against employers.  Further, the INA makes it unlawful for an employer to continue to employ an undocumented worker or one who loses their authorization to work at a later point.

However, the INA also prohibits discrimination when hiring and firing on the basis of one’s national origin or citizenship status.  The U.S. Department of Justice’s Office of Special Council for Immigration-Related Unfair Employment Practices offers suggestions for how an employer can avoid committing any immigration-related discrimination.[1]  For instance, an employer should allow an employee to choose which documents to present for the Form I-9, as long as it satisfies the requirements of the Form.   An employee would have a case against an employer who demanded to see a certain type of document, such as a green card, if the employee already provided appropriate documents otherwise.

Most importantly, an employer should treat all applicants the same and not make any assumptions when interviewing, offering a job, and when verifying work eligibility.  Any type of “citizens only” hiring policy or requirement that applicants have a particular immigration status is usually illegal.  The same guideline applies to a firing decision — for example, an employer cannot choose to fire or lay off someone solely because they only have a temporary work permit in favor of someone with legal permanent residency.

Keep in mind that an employee or prospective employee is protected under the INA if he or she is a U.S. citizen, national, permanent resident, temporary resident, refugee, or asylee.   Remember that U.S. citizenship or nationality belongs to any individual born of a U.S. citizen, along with all persons born in Puerto Rico, Guam, the Virgin Islands, Northern Mariana Islands, American Samoa, and Swains Island. Further, employers should recognize that refugees or those with recently granted asylum may not yet have Social Security numbers.   This could become a particular concern if an employer uses an on-line application system requiring such information because it could create an unnecessary hurdle for individuals who are in fact authorized to work in the United States, and thus should be avoided.

Employers should review their hiring and work eligibility verification policies in order to ensure compliance and avoid any potential fines and penalties imposed by the INA.

[1] See http://www.justice.gov/crt/about/osc/.