Preview:

Original MSWord Version
This case can also be found at 173 N.J. 258, 801 A.2d 295.


SYLLABUS
(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).
In re P.S.E. & G. Shareholder Litigation (A-41/42-01)
Argued February 26, 2002 -- Decided July 23, 2002
Verniero, J., writing for a unanimous Court.
In this appeal, the Court considers the proper standard of review to be applied in evaluating whether a corporation's board of directors responded properly in rejecting a shareholder's demand to commence legal action on the corporation's behalf, and whether the lower court correctly applied that standard in this case.
This appeal stems from four derivative actions brought by shareholders of Public Service Enterprise Group, Incorporation (Enterprise), a public utility holding company, and its wholly-owned subsidiary, Public Service Electric & Gas Company (PSE&G)(collectively, the company). Defendants are certain directors of both entities and include current and former PSE&G officers (collectively, the Board). PSE&G operates the Salem and Hope Creek nuclear power plants (power plants) located in southern New Jersey. Based on events that took place over a period of many years, plaintiffs allege that defendants recklessly mismanaged both power plants to the company's financial detriment.
On October 4, 1995, following the closing of one of the power plants, plaintiff G.E. Stricklin sent a formal demand letter to the Board asking it to institute suit against each of its officers for mismanagement of the nuclear operations. In response, the Board adopted a resolution on October 17, 1995, retaining the law firm of Kasowitz, Benson,Torres & Friedman (the Kasowitz firm) to investigate the allegations raised in the demand letter. On December 27, 1995, before the Kasowitz firm's investigation was complete, Stricklin filed a shareholder derivative complaint that raised the same allegations as the demand letter and contended that Board members should be held personally liable for the company's financial losses. Stricklin also contended that her demand on the Board had been rejected wrongfully because the Board had not acted on it. On February 28 and March 5, 1996, additional shareholders filed two more derivative actions, but they did not make a demand on the company prior to instituting suit. Instead, they assert that such demand would have been futile.
Meanwhile, the Kasowitz firm reviewed over 43,000 pages of documents and conducted over thirty interviews with company personnel. After completing its investigation, the firm issued a 124-page report on February 8, 1996, and a supplemental report on March 14, 1996, concluding that there was no basis on which to institute legal action against any employee, officer, or director of Enterprise or PSE&G. On March 19, 1996, the Board adopted a resolution accepting the Kasowitz firm's recommendations. Later, in depositions or certifications, the Board members gave their reasons for rejecting the litigation, including 1) the memorandum and reports presented by counsel; 2) the inquisitiveness and preparedness of Board members at meetings during the relevant time period; 3) the open lines of communication and information in respect of the company's nuclear operations; 4) the depth of the information presented to the Board on a regular basis and its vigorous action in response to that information; and 5) the excessive cost of such litigation.
On July 3, 1996, a fourth shareholder filed a complaint. The trial court consolidated the four actions and defendants moved to dismiss the complaints. In December 1996, the trial court found that all four plaintiffs had alleged sufficient facts to withstand dismissal. The trial court further excused the failure to make a demand by some of the plaintiffs because it found that they had alleged sufficient facts to create a reasonable doubt that the directors were disinterested or independent. The Appellate Division and this Court denied leave to appeal.
After the consolidated cases were transferred to another judge, the cases were bifurcated according to whether a demand had been made by the plaintiffs (demand-made cases), or whether a demand had not been made by the plaintiffs (demand-futile cases). Defendants moved for summary judgment in the demand-made cases in December 1997 and in the demand-futile actions in May 1998. In deciding the motions, the judge adopted a modified version of the business judgment rule and ordered discovery on issues that included the disinterestedness of the Board and the reasonableness of its decision to terminate litigation. The trial court granted defendants' motions for summary judgment at the conclusion of discovery. The Appellate Division affirmed.
HELD : The Court adopts the modified business judgment rule as the standard for evaluating whether a corporation's board of directors responded properly in rejecting a shareholder's demand or in deciding to terminate legal action on the corporation's behalf. The modified business judgment rule places an initial burden on directors to demonstrate that they acted reasonably, in good faith, and in a disinterested fashion in arriving at their decision. The lower courts properly applied that standard when dismissing the derivative litigation in this case.
1.
A shareholder derivative action permits a shareholder to bring suit on behalf of the corporation and, if successful, it forces the wrongdoers to compensate the corporation for the injury they caused. Shareholder derivative litigation is an infringement on director autonomy and may have a negative effect on corporate governance if, for example, it is initiated by opportunistic shareholders. Therefore, as a prerequisite to derivative litigation, most jurisdictions require that shareholders make a demand on the corporation's board of directors to act. New Jersey's procedure is codified under Rule 4:32-5. Like most jurisdictions, New Jersey will excuse the demand requirement if the shareholder can establish that it would be futile. For shareholder plaintiffs in New Jersey to withstand a motion to dismiss for failure to make a demand, they must plead with particularity facts creating a reasonable doubt that: 1) the directors are disinterested and independent; or 2) the challenged transaction was the product of a valid exercise of business judgment. (Pp. 18 to 29).

2.
The Court agrees with those jurisdictions that apply a single standard of review in both demand-made case and in cases in which the demand was excused, and adopts a modified business judgment rule that imposes an initial burden on a corporation to demonstrate that in deciding to reject or terminate a shareholder's suit the members of the board 1) were independent and disinterested; 2) acted in good faith and with due care in their investigation of the shareholder's allegations, and that 3) the board's decision was reasonable. Shareholders must be permitted access to corporate documents and other discovery limited to the narrow issue of what steps the directors took to inform themselves of the shareholder demand and the reasonableness of their decision. (Pp. 29 to 33).

3.
The main difference between the test for determining demand-futility and the modified business judgment rule is that a plaintiff has the burden of demonstrating demand-futility, whereas a defendant has the burden of satisfying the elements of the modified business judgment rule. If the court relieves a shareholder of the demand requirement, a defendant may later renew its motion to dismiss the litigation. At that juncture, the court would evaluate the motion by applying the burden-shifting and other aspects of the modified business judgment rule. Although the demand-futility test and the modified business judgment rule both implicate whether directors are disinterested and independent, a court applying the modified business judgment rule is not bound by any finding associated with an earlier court's decision to excuse demand. The court should consider the board's decision under the modified business judgment rule only after the parties have completed adequate discovery to enable the court to render a fully-informed decision. (Pp. 33 to 37).

4.
The thrust of plaintiffs' allegations is that defendants mismanaged the company and breached their duty of care. The Court reserves for another day what the appropriate standard might be for allegations such as self -dealing, fraud, or similar bad acts. (Pp. 37 to 38).

5.
The Court finds that defendants presented undisputed evidence proving that they were disinterested and independent

when they decided to reject the demand and terminate the litigation. Moreover, nothing in the record demonstrated that the directors had divided loyalties, stood to receive any improper personal gain or were unduly influenced by any improper motive. Therefore, defendants satisfied the first element of the modified business judgment rule. (Pp. 38 to 41).

6.
The second element of the modified business judgment rule, whether defendants acted in good faith and with due care in investigating the merits of the litigation, was met through the extensive investigation and resulting report by the Kasowitz firm, which was experienced in nuclear power matters and in shareholder litigation. (Pp. 41 to 46).

7.
Finally, defendants satisfied the final element of the test by demonstrating that their decision to terminate the litigation was reasonable. By virtue of the procedures that they employed, defendants informed themselves of the substance of the shareholders' allegations and weighed those allegations against the likelihood that the litigation would succeed. The Board acted consistent with the principles articulated in the Court's opinion when relying on the Kasowitz investigation to guide its decision. (Pp. 47 to 51).


The judgment of the Appellate Division is AFFIRMED.
JUSTICE STEIN , concurring in the Court's opinion, agrees that the Board satisfied the legal standard for independence in this matter, but emphasizes that the de novo review undertaken by trial and appellate courts should include a scrupulous and painstaking examination of the record to ensure that the board's discretion has been exercised reasonably and responsibly. Further, Justice Stein is of the view that the Kasowitz firm's dual role as the Board's independent investigator and its brief role as the Board's litigation counsel was inappropriate, but he believes that the dual role did not render unreasonable the Board's reliance on the investigative report.

CHIEF JUSTICE PORITZ and JUSTICES COLEMAN, LONG, and LaVECCHIA join in JUSTICE VERNIERO's opinion. JUSTICE STEIN filed a separate concurring opinion. JUSTICE ZAZZALI did not participate.

SUPREME COURT OF NEW JERSEY A-41/ 42 September Term 2001
IN RE: PSE&G SHAREHOLDER LITIGATION
DR. STEVEN FINK AND DR. DAVID FRIEDMAN, P.C. PROFIT SHARING PLAN, derivatively on behalf of and for the benefit of Public Service Enterprise Group, Incorporated and Public Service Electric & Gas Company,
    Plaintiffs-Appellants,
v.
LAWRENCE R. CODEY; E. JAMES FERLAND; LEON R. ELIASON; STEVEN E. MILTENBERGER; JOSEPH J. HAGAN; AND STANLEY LaBRUNA,    Defendants-Respondents,
and PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED and PUBLIC SERVICE ELECTRIC & GAS COMPANY,
Nominal Defendants-Respondents.
A. HAROLD DATZ PENSION AND
PROFIT SHARING PLAN

        Plaintiff-Appellant,
and

GAIL DORFF, derivatively on behalf of and for the benefit of Public Service Enterprise Group, Incorporated and
Public Service Electric & Gas Company,

Plaintiff,
v. LAWRENCE R. CODEY; E. JAMES FERLAND; LEON R. ELIASON; STEVEN E. MILTENBERGER; JOSEPH J. HAGAN; and STANLEY LaBRUNA,        Defendants-Respondents, and
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED and PUBLIC SERVICE ELECTRIC & GAS
COMPANY,
Nominal Defendants-Respondents.
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED BY G. E. STRICKLIN derivatively in her capacity as

a shareholder,
    Plaintiff-Appellant,

v.
E. JAMES FERLAND; IRWIN LERNER; MARILYN M. PFALTZ; RICHARD J. SWIFT; LAWRENCE R. CODEY; ERNEST H. DREW; JAMES C. PITNEY; T. J. DERMOT DUNPHY; RAYMOND V. GILMARTIN; JOSH S. WESTON and STEVEN E. MILTENBERGER,
    Defendants-Respondents,
and
SHIRLEY A. JACKSON,
Defendant,

and
PUBLIC SERVICE ENTERPRISE GROUP INCORPORATED,
Nominal Defendant- Respondent.
Argued February 26, 2002

Download a-41-01.opn.pdf

New Jersey Law