An Overview Of Conflict Of Interest Provisions

A majority of states have statutes that address director and officer conflicts of interests in corporate transactions. The conflict of interest provisions vary from state to state; however, most states have enacted some version of the conflict of interest provisions contained in the Revised Model Business Corporation Act.

Under the model provisions, a director may have a “conflicting interest” in a corporate transaction under the following circumstances:

• The director knows at the time that he or a related person is a party to or has a beneficial interest in a transaction or is closely linked to the transaction OR
• The transaction is brought before the board of directors for action, and the director knows of a relationship, beneficial interest in the transaction, or a close link to the transaction with respect to:
  • another entity of which he is a director, general partner, agent, or employee
  • a person who controls one or more of the above-listed entities, or is controlled by, or is under common control with, such entity or entities OR
  • an individual who is a general partner, principal, or employer of the director

Generally, a director is required to disclose all facts known to him about the subject matter of a transaction when a conflict of interest exists. This information includes all information that an ordinarily prudent person would reasonably believe to be material to a decision as to whether or not to proceed with the transaction. Interested directors should abstain from a transaction in which they have a conflict of interest.

Corporate directors rarely work exclusively for the corporation and have other obligations and interests upon which to focus their attention. The potential for a director to have some conflict due to past and present business associations is great. Thus, many corporation statutes provide directors with a “safe harbor” from liability in conflict of interest situations. Generally, these safe harbors provide that a transaction is not invalid when a conflict of interest exists if the director adequately disclosed the conflict in advance, the board (or the shareholders entitled to vote on the transaction) had full knowledge of the conflict in advance, or the transaction was fair to the corporation and its shareholders when it was authorized, approved, or ratified. The interested director has the burden to prove his or her utmost good faith and the fairness of the transaction. One case in Delaware stands for the proposition that one interested director’s “colorable” self-interest in a transaction is insufficient “to deprive a board of the protection of the business judgment rule presumption of loyalty.”