Friday, October 12, 2012

Corporations Law: The Duty of Loyalty outline

The Duty of Loyalty

A. Contracts with Interested Directors

Del. § 144. Interested Directors
  1. No contract or transaction between a corporation and its own directors or between a corporation and another corporation with common directors shall be voided if:
    1. The conflict and facts of transactions are disclosed and the disinterested directors approve the contract or transaction, even if the disinterested directors be less than a quorum; or
    2. The conflict and facts of transactions are disclosed and the shareholders approve the contract or transaction; or
    3. The contract or transaction is fair to the corporation as of the time it is authorized, approved or ratified, by the board, or a committee or the shareholders.
  1. Common or interested directors can be counted in determining a quorum which authorizes the contract or transaction.

Cookies Food Products, Inc. v. Lakes Warehouse Distributing, Inc. (Iowa 1988)
  • Even if the one of the three statutory alternatives is met, the director still needs to show he acted in “good faith, honesty, and fairness”.
  • Self-dealing transactions must have the “earmarks of arms-length transactions”.
  • Was the contract price fair and reasonable?

What does “conflicting interest” mean? ALI Principles §1.23(a) provides that a director is interested if the director has a business, financial, or familial relationship with a party to the transaction and that relationship would reasonable be expected to affect the director’s judgment with respect to the transaction in a manner adverse to the corporation.

What is the scope of disclosure? Director should disclose every material fact that they know about the transaction.

What is the correct standard for “fairness”? It has long been settled that a “fair” price is any price in that broad range of reasonableness which an unrelated party might have been willing to pay or accept following an arm’s length business negotiation. Is it fair market value?
B. Parent-Subsidiary Dealings

Sinclair Oil Corp. Levien (Del. 1971)
  • In parent-subsidiary context, the parent owes the subsidiary a fiduciary duty.
  • However, this alone will not evoke the intrinsic fairness standard.
  • This standard will only be applied when there is self-dealing, meaning that the parent receives a benefit from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary (benefit-detriment test)

C. Corporate Opportunity Doctrine

The corporate opportunity doctrine is based on a transaction that should belong to the corporation, but was instead taken by a director or officer.

Guth v. Luft, Inc. (Del. Ch. 1939).
  • The Guth Rule provides that if a business opportunity is presented to a corporate officer or director in his representative capacity the law will not permit him to take the opportunity for himself if:
    • The corporation is financially able to undertake it;
    • The opportunity is in the line of the corporation’s business and is of practical advantage to it;
    • The opportunity is one in which the corporation has an interest or a reasonable expectancy.
  • The Guth Corollary provides that when a business opportunity comes to a corporate officer or director in his individual capacity he can seize the opportunity for himself, as long as he does not steal corporate assets, if:
    • The opportunity, because of the nature of the enterprise, is not essential to the corporation
    • The opportunity is not one in which the corporation has an interest or expectancy;
  • Even if it was not feasible for the corporation to pursue the opportunity or if it had no interest or expectancy in the project, a fiduciary can still be estopped from seizing the opportunity for himself if he used corporate asset’s to develop or acquire the opportunity.
    • Corporate assets include “company” time, cash, facilities, contracts, goodwill, and corporate information.
  • The tough question is how do you determine whether someone is in their representative versus individual capacity? Are they ever in an individual capacity?

Burg v. Horn (2nd Cir. 1967)- the court held no corporate opportunity, because the directors were not full-time employees of the company and already had prior real estate ventures.

Alexander & Alexander of N.Y., Inc. v. Fritzen (NY 1989)- no corporate opportunity to property and casualty insurance corporation, when director started his own life insurance company. It was a new line of business that corporation showed no prior interest in taking up.

In re: eBay Shareholders Litigation (Del. Ch. Ct. 2004)
  • The court held that certain eBay directors and officers usurped a corporate opportunity by taking lucrative IPO offerings made by Goldman Sachs, an investment bank that regularly did business with eBay.
  • Defendants argue that this means every investment opportunity that comes to an officer or director will be considered a corporate opportunity.
  • On the contrary, the court believes these circumstances to be quite unique.
    • Goldman Sachs was offering these highly profitable opportunities to maintain and secure corporate business (basically bribing eBay for future business).
    • This was not a case of merely “a broker’s investment recommendations” to a wealthy client.

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