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Judge Kaplan Declines to Apply Business Judgment Rule Where Corporate Board’s Decision Lacked Rational Support

Key Takeaway: Where there were “serious questions” about the independence of a board and the good faith of its decision not to pursue a derivative suit against a former director, Judge Kaplan refused to apply the business-judgment rule (BJR).

Background: Jennifer Brining, a shareholder of Sendlater, Inc., a corporation formed under Vermont law, brought direct claims against the company’s former director, John Donovan. Brining alleged that Donovan took money that she invested in Sendlater and used it for his personal affairs, not for the benefit of Sendlater. Brining also sent Sendlater’s counsel a demand letter requesting that Sendlater’s board of directors cause the company to bring suit against Donovan. The directors launched an investigation; ultimately, the accountants hired by the directors uncovered a number of unusual financial transactions. Despite the outcome of the investigation, the board determined that it was not in Sendlater’s best interests to pursue legal action against Donavan now or in the future. With the board’s decision in hand, Sendlater moved to dismiss the shareholder’s derivative claims. 

Ruling: Applying Vermont law, and filling in gaps with Massachusetts and Delaware law, Judge Kaplan ruled that the BJR was inapplicable to the facts at hand. Judge Kaplan questioned not only the board’s independence, but also whether the board acted in good faith. He summed up his findings this way:

[T]he court finds that the [accountants’ report] suggests the likelihood of a substantial recovery from Donovan and finds no rationale supporting the Board’s contrary conclusion. The Board’s reasons for not permitting Brining to pursue the claims against Donovan at her own expense are suspect. Further, the court finds no basis for the Board’s failure to take any steps to attempt to preserve Sendlater’s claims against Donovan, let alone its decision that the claims should never be prosecuted.

Based on his findings Judge Kaplan denied Sendlater’s motion to dismiss.

Brining v. Donavan, et al.

September 14, 2017

Full decision here.

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