In the dynamic landscape of corporate governance, officers and directors must tread lightly to avoid increased exposure to legal liability. Especially for smaller companies, a common concern of fiduciaries includes participating in “interested” transactions, as doing so may violate duties of loyalty and care.
An interested officer or director transaction occurs when an officer or director maintains a financial interest in an engagement involving the corporation in which they serve. This can take a variety of forms, such as executive compensation agreements, stock option arrangements, asset transfers, transactions involving affiliate corporations with overlapping boards, or dealings with other companies in which the officer or director holds a significant interest.
Like most states, Delaware places a strong emphasis on the fiduciary duties of loyalty and care, which directors and officers owe not only to the corporation in which they serve but also to its shareholders. However, interested transactions inherently raise concerns about potential conflicts of interest, which can compromise one’s ability to fulfill their fiduciary obligations faithfully. Recognizing these issues, Delaware General Corporation Law Title 8 §144 (DGCL §144) delineates certain safe harbors whereby an interested director or officer transaction is not presumptively void or voidable if:
1. the interested relationship is fully disclosed to the board and a majority of uninterested directors approve the transaction; or
2. the interested relationship is fully disclosed to the voting stockholders and the stockholders approve the transaction; or
3. the transaction is fair to the corporation at the time of approval by the board, a committee, or the stockholders.
Meeting the requirements of any of these safe harbors typically ensures that courts will apply the “business judgment rule” in the event the validity of the interested transaction is challenged; this rule provides a presumption that officers and directors fulfilled their fiduciary duties in making decisions on behalf of the company, thereby shifting the burden of proof onto the party challenging the interested transaction to demonstrate bad faith or gross negligence.
However, the safe harbors provided in DGCL §144 were not intended to serve as an all-encompassing solution for every variety of interested transaction. The Delaware Court of Chancery has specified that traditional common law principles requiring the application of the “entire fairness” standard may apply in precise circumstances. As such, approving interested transactions in Delaware while avoiding unnecessary exposure to legal liability requires considerable expertise.
If you have questions surrounding interested transactions in any jurisdiction or would benefit from ensuring that your operations are in legal compliance, please contact John Bennett at jrb@fellplaw.com or (858) 746-6488 or any member of the FELLP Law team at (858) 746-6480 to schedule a consultation.