The New Jersey Appellate Division affirms deference by the trial court to an unusual decision by a corporate board of directors, demonstrating the near-impenetrability of the business judgment rule. In Holiday Medical Center, Inc. v. Weisman, et al., Docket No. A-5198-08T2 (App. Div. November 17, 2010), the Appellate Division left untouched the finding of the trial court that the Holiday Medical Center, Inc. ("HMC") board of directors acted within their fiduciary duties in including a $2.9 million donation to the buyer in the sale of a medical facility. The Court's affirmation of this sale shows not only the strength of the business judgment rule, but also the heavy burden a shareholder carries in a derivative lawsuit.
To appreciate the gravity of this seemingly insignificant issue (the Court itself barely mentions it in the opinion), understanding the mechanics of the business judgment rule is important. A major hurdle a shareholder bringing a derivative lawsuit has to overcome is the business judgment rule - the very essence of corporate law that holds that officers and directors should be free to conduct the corporation's business without the burden of judicial interference. Judges, realizing their knowledge is better used in the courtroom than the boardroom, will generally not second-guess a decision of the board.
The business judgment rule cloaks the directors and officers in a presumption that favors the disputed decision. In order to strip this presumption, a shareholder must first show that the officers or directors engaged in "fraud, self-dealing, or unconscionable conduct." If the shareholder is successful in making this showing, the burden shifts to the directors and officers to show that the decision was fair to the corporation. In re PSE&G Shareholder Litigation, 173 N.J. 258, 276-277 (2002). Courts will analyze every decision that aggrieves a shareholder through the lens of the business judgment rule.
In Holiday Medical, HMC's board faced significant operation losses and decided to sell a nursing home facility it owned "while the assets retained some value." HMC ultimately sold the nursing home to a private school for $8 million: $3.3 million to pay off the existing mortgage on the facility, $2.9 million as a charitable donation back to the school, and $2 million to HMC. Arlene Markind, a five-percent shareholder of HMC, dissented from this sale and brought suit after the directors failed to offer her the value of her shares pursuant to her demand.
Holiday Medical is instructive to shareholders for two reasons - reasons barely touched upon by the Court in this latest opinion. First, this case shows reluctance of courts to undo a board's decision absent a clear showing of misconduct by the directors. Even in this unorthodox sale in which a significant portion of the proceeds was donated back to the buyer, presumably for preferable tax treatment, the business judgment rule barred the trial court from questioning this move with no evidence of "bad faith, self-dealing or fraud." If a shareholder seeks to upend a board decision, the evidence of some misconduct must be clear and convincing.
An additional lesson from Holiday Medical comes in the form of basic cost-benefit analysis. The amount that HMC was to pay Markind for her shares ranged from $80,000 to $100,000, depending on the valuation method accepted by the court. This most recent opinion is the second time this case went to appeal - only to be sent back to the trial court to for further proceedings. The litigation costs must have exceeded the amount Markind sought long before the second appeal and the court denied her application for attorney's fees. Shareholders must take heed to gather strong evidence when challenging a board decision and carefully determine if the litigation costs are likely to exceed what they hope to recover.
