Conflicts of Interest*
It is not unusual for corporate shareholders or directors to have a personal interest in business decisions that affect the company they own or manage. For example, directors usually vote on setting their own compensation and that of the officers, which, in many small and closely held corporations, include themselves. This is an example of routine corporate business that boards of directors commonly deal with, and that usually do not require any special approval because state laws generally permit such actions.
However, directors may also be involved in considering and approving major corporate acquisitions of property from a director with a financial interest in the deal, such as real estate or a patent held by the interested director and sold to the corporation.
Nevada’s Example
It is so common for directors, officers and shareholders to have a financial interest in corporate decisions that corporate statutes in all states address this subject to one degree or another. For instance, Nevada addresses “interested” directors and officers in NRS 78.140:
1. A contract or other transaction is not void or voidable solely because:
(a) The contract or transaction is between a corporation and:
(1) One or more of its directors or officers; or
(2) Another corporation, firm or association in which one or more of its directors or officers are directors or officers or are financially interested
(b) A common or interested director or officer:
(1) Is present at the meeting of the board of directors or a committee thereof which authorizes or approves the contract or transaction; or
(2) Joins in the signing of a written consent which authorizes or approves the contract or transaction pursuant to subsection 2 of NRS 78.315; or
(c) The vote or votes of a common or interested director are counted for the purpose of authorizing or approving the contract or transaction, if one of the circumstances specified in subsection 2 exists.
The next part of this section of the statute goes on to provide examples where an interested director or officer with a financial interest in a matter being considered by the board would abstain due to a conflict of interest without it adversely affecting the corporation or the interested director or officer. Continuing on with NRS 78.140(2):
2. The circumstances in which a contract or other transaction is not void or voidable pursuant to subsection 1 are:
(a) The fact of the common directorship, office or financial interest is known to the board of directors or committee, and the board or committee authorizes, approves or ratifies the contract or transaction in good faith by a vote sufficient for the purpose without counting the vote or votes of the common or interested director or directors.
(b) The fact of the common directorship, office or financial interest is known to the stockholders, and they approve or ratify the contract or transaction in good faith by a majority vote of stockholders holding a majority of the voting power. The votes of the common or interested directors or officers must be counted in any such vote of stockholders.
(c) The fact of the common directorship, office or financial interest is not known to the director or officer at the time the transaction is brought before the board of directors of the corporation for action.
(d) The contract or transaction is fair as to the corporation at the time it is authorized or approved.
A corporate director or officer can have a legitimate financial interest in a contract that is being considered by the board without fear that a conflict of interest will prohibit, or potentially void, that contract or transaction. This is the case in Nevada when the conflict is known by the board in advance of their vote (see subsection 2(a) above); and also where a director is unaware she has a financial interest in a transaction at the time the matter is being considered and acted on by the board (see subsection 2(c) above).
Important Concerns
What is important? Good faith, for one thing. When a director or officer has a known financial or other beneficial interest in an act, contract or transaction the corporation is about to authorize and approve, that fact should be fully disclosed to the board and stockholders. Preferably in advance of any vote. Preferably in writing. Also, look at NRS 78.315 and 78.320 that addresses additional concerns about directors’ and shareholders’ (respectively) consents for actions taken without meeting.
What else is important? An interested director should abstain from voting on the conflicted matter. The remaining disinterested directors’ majority vote to approve the transaction is generally sufficient to carry the motion or resolution. (See subsection2(b) above.)
And, what else is important? The contract or transaction under consideration by the board should be “fair” to the corporation at the time of the board’s vote (see section 2(d) above). Show this by including facts in the minutes that demonstrate the fairness. For example, if the corporation is acquiring real estate from a director, provide a supporting list of comparable property sales in the most recent six- or twelve-month period that demonstrates to the board (and shareholders) that the price the corporation will pay the interested director is commensurate with local fair market value.
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*This is the first installment in a series of four posts that focus mainly on loans that “insiders” give to or get from their corporations. The information is not exhaustive, but hopefully it will help you better understand general principals to consider when dealing or self-dealing with your small, closely held business company or incorporated professional practice. My posts are not offered or intended as legal or tax advice. For that, always consult a qualified licensed legal or tax advisor, or both. If you read this first, you may be better able to discuss this subject with your professional advisors.
See also:
Insider Loans Part 2: Full Disclosure