Full Disclosure*
Following the rules that pertain to “insider” loans (i.e. loans to officers, directors or shareholders with a financial interest in the loan) can help avert a future challenge by another shareholder, a creditor, or other party that might claim an interested insider should be personally liable for any advantage or financial gain they received in a transaction with their corporation.
To help ward off such an attack, it has been recommended that three tests be met:
1) full disclosure is given to the disinterested directors and shareholders before they vote to approve the transaction that favors the interested insider (for example, an abstaining director);
2) the majority of disinterested shareholders ratify and confirm the disinterested directors’ approval of the transaction with an interested insider; and
3) the transaction is, in fact, fair to the corporation.
See again NRS 78.140.
All this information should be recorded in the board’s minutes, approved by resolutions adopted by the directors, and subsequently ratified and confirmed in minutes of the shareholders.
Generally, conflict of interest matters focus mainly on disclosure by the interested director or other party. There’s nothing inherently wrong with many insider transactions as long as the conflicting interests are fully aired to the disinterested directors and shareholders before they authorize and approve such transactions.
Note that an interested director is counted when constituting a quorum when an actual board meeting is called and held; however, a majority vote of the remaining disinterested directors is all that’s required to carry the motion at such a meeting. (See NRS 78.140(3).) The interested director will usually abstain from voting because of the conflict of interest, but there may be certain exceptions that I will not address here.
When no actual meeting is called and held, but the board instead acts by written consent in lieu of meeting, the same level of full disclosure should be given to the board by the interested insider. For example, an interested director would explain to the remaining directors the reason she is abstaining on the vote: because she has a beneficial financial interest in the transaction. This disclosure should be stated in clear terms in the written consent that is submitted to the remaining directors for their approval. Again, see NRS 78.315 for more details on directors’ consents.
A careful reading of state statutes will frequently reflect that the statutes govern matters where the subject corporation’s articles of incorporation or bylaws are silent. (For example, in Nevada, see NRS 78.120) So, do not forget to consult the corporation’s articles and bylaws for further authorizations, restrictions or requirements for consents in writing, unanimous approvals, abstaining from votes, conflicts of interest, interested directors, and so on.
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*This is the second 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 1: Conflicts of Interest