Alert August 31, 2010

Massachusetts High Court Holds That Timing of Derivative Proceeding’s Commencement Relative to Board’s Rejection of Shareholder Demand Does Not Affect Board’s Ability to Pursue Dismissal Based on Business Judgment Rule

Last week, the Supreme Judicial Court of Massachusetts (the “SJC”) resolved an unsettled question of Massachusetts law regarding the circumstances under which a Massachusetts corporation or business trust can obtain dismissal of derivative litigation under the business judgment rule.  A federal appellate decision from late last year had suggested that a Massachusetts corporation could rely on the business judgment rule to obtain dismissal of derivative litigation only if the corporation’s board had rejected the shareholder demand before suit was filed.  Examining the issue in the context of a derivative suit filed against the trustees of a registered investment company organized as a Massachusetts business trust, the SJC rejected that view, holding that the business judgment rule serves as a basis for dismissal of derivative litigation for a Massachusetts corporation or business trust regardless of when rejection of the demand occurs. 

Derivative Litigation under the Massachusetts Business Corporation Act.  In 2004 Massachusetts adopted a comprehensive revision of its Business Corporation Act (the “MBCA”).  Among other things, the revised statute included new provisions requiring shareholders to make a demand on a corporation’s board in all cases before filing a derivative lawsuit, and set forth a procedure by which the corporation could obtain dismissal if (among other things) a majority of independent directors determines in good faith after a reasonable inquiry that maintenance of the action would not be in the best interest of the corporation.  See Mass. G. L. c. 156D, § 7.44.

The Rejection of the Demand Letter and Related Litigation.  In this case, a shareholder served a demand letter on the board of trustees of a group of mutual funds organized as a Massachusetts business trust.  The independent trustees began an investigation into the demand’s allegations, but before the investigation was complete, the shareholder filed a derivative action in federal court in Manhattan.  Six weeks later, the independent trustees completed their investigation and rejected the shareholder demand.  In July 2007, the federal district court dismissed the lawsuit under the new procedure set forth in the MBCA.  The shareholder appealed to the U.S. Court of Appeals for the Second Circuit, arguing that this procedure did not apply because the statute referred to a derivative proceeding “commenced after rejection of a demand” and his lawsuit was commenced before the demand was rejected.  The Second Circuit suggested that the statutory language supported the shareholder’s argument, but certified the issue to the SJC because no Massachusetts court had yet addressed it.

The SJC’s Decision.  On August 23, 2010, the SJC issued a decision that, after analyzing the statute’s language, structure, and purpose, concluded that the statute enables a corporation to obtain dismissal under the business judgment rule using the new statutory procedure regardless of whether the demand is rejected before or after commencement of the lawsuit. The SJC also clarified that the derivative suit provisions in the MBCA apply not just to Massachusetts corporations, but also to Massachusetts business trusts, a form of organization used by many mutual funds.  Halebian v. Berv., SJC-10641 (Mass. Aug. 23, 2010).  Click here for a copy of the decision. 

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Goodwin Procter represented the business trust and its independent trustees before the Supreme Judicial Court of Massachusetts.