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Tread Carefully with Director Conflicts

Corporate directors have a fiduciary duty to exercise their directorial powers in the best interests of the corporation rather than in pursuit of their own advantage. However, business deals are rarely a zero sum game. Situations frequently arise where a corporation’s decision to do business with a director in his or her personal capacity — such as by leasing or buying property owned by the director — can provide significant benefits to both parties. Unfortunately, even if the benefits to the corporation are clear, self-dealing with a director or officer can be a sensitive subject with a high potential to draw suspicion and criticism from shareholders. That is why it is always necessary to tread carefully during these types of transactions.

A corporate transaction is generally not prohibited simply because a director or officer has a financial interest in its outcome. However, most state corporation codes do give shareholders certain rights to hold such transactions up to additional scrutiny. For instance, in Virginia a corporate transaction in which a director had a conflict of interest may be voided after the fact unless one of the following conditions was present:

  • The director’s interest in the transaction was disclosed or known to the board or any subdivision thereof responsible for the transaction, and a majority of disinterested directors still approved it.
  • The director’s interest in the transaction was disclosed to the shareholders and a majority of voting shares, excluding those owned by the conflicted director, still voted to approve it.
  • The transaction was fair to the corporation.

Generally a policy of transparency and openness is best when dealing with potential conflict transactions. Boards should realize that is it often necessary to have the support of the shareholders when engaging in such transactions but that such deals can still take place over the objections of a limited number of shareholders. Consulting with an experienced Washington, DC corporate governance law firm can help companies take the precautions necessary to avoid litigation and other complications following conflict transactions.

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