The Duty of Loyalty & Conflicting Interest Transactions

The most recent post focused on the duty of care for the directors in a corporation. The other duty for directors that is likely to be tested in a Corporations essay is the duty of loyalty. This duty is often tested within the scope of conflicting interest transactions.

First, it's important to know the circumstances under which there has been a potential violation of the duty of loyalty. A director has a conflicting interest with respect to a transaction if the director knows that the director or someone related to the director (spouse, parent, child, grandchild, etc.) is either a party to the transaction or has a beneficial financial interest in the transaction such that the interest would reasonably be expected to influence the director's judgment if the director were to vote on the transaction. In addition, the duty of loyalty is potentially breached if the director is also a director, general partner, agent, or employee of another entity with which the director is transacting business and if the transaction is of such importance to the corporation that it would in the normal course of business be brought to the other members of the board of directors.

Often tested on the essays are situations in which the elements above are all satisfied and yet the transaction moves forward. A conflicting interest transaction will not be enjoined if any of the following is true:

--The transaction was approved by a majority of the directors (but must be at least 2) who did not have a conflicting interest after all material facts have been disclosed to the board.

--The transaction was approved by a majority of the votes entitled to be cast by shareholders who did not have a conflicting interest after all material facts have been disclosed to those shareholders.

--The transaction, judged according to circumstances at the time of the transaction, was fair to the corporation.

Fairness is quite a vague term and so specific factors are used to determine whether the transaction is fair to the corporation. Courts looks to factors such as adequacy of consideration, the corporate need to enter into the transaction, the financial position of the corporation, and any reasonably available alternatives.