Don’t Be Conflicted
Just like anyone else, corporate officers and directors can be sued. But, the law in Arizona does provide officers and directors protection from legal liability if corporate actions are taken with the corporation’s best interests in mind. If you, as an officer or director, act in good faith, with the care of an ordinarily prudent officer or director under the circumstances, and in a manner reasonably believed to be in the best interests of the corporation, he or she generally will not be liable for corporate actions.
In determining whether an officer or director acted appropriately, the law allows officers and directors to rely on information, opinions, reports, or statements prepared or presented by reliable officers, employees, professionals, or committees. Moreover, an officer or director is presumed in all cases to have acted, failed to act or discharge his or her duties in accordance with the law. The burden is on the party challenging the officer’s or director’s actions to establish clear and convincing evidence to rebut the presumption.
The rules, however, change a bit when an officer or director is engaging in what is known as a “director’s conflicting interest transaction.” If the director of a corporation is entering into a corporate transaction when the director is a party to the transaction, this creates a potential conflict of interest, and additional duties are imposed on the director to ensure that the transaction is in the best interest of the corporation. The same applies if the director enters into a transaction which has a beneficial personal financial impact, or, the transaction is of such financial significance to the director that it could be expected to exert an influence on the director’s judgment if called upon to vote on the transaction.
These types of transactions will be closely scrutinized and set aside if they are unfair to the corporation. Once there is a showing that the director is personally interested in a corporate transaction, the burden shifts to the director to show that the decision with respect to the particular transaction is fair and serves the best interests of the corporation and its shareholders.
According to the Arizona Model Business Corporation Act, the concept of “fairness” is intended to examine the terms of the transaction (such as price, structure and other terms), the benefit to the corporation, and the decision-making process leading up to the approval of the transaction. The third aspect of the fairness inquiry — the decision-making process — is very important, and examines the candor and completeness of the director’s disclosure to his fellow directors of relevant facts, and any undue influence or other improper coercion utilized by the interested director to effect the consummation or approval of the transaction.
To make sure a director’s conflicting interest transaction is fair, Arizona statutes establish what disclosures must be made for a director’s conflicting interest transaction. When a director enters into a conflicting interest transaction, the law requires that the interested director make the “required disclosure” so that the other directors of the corporation can act with full knowledge and can independently determine if such a transaction is in the best interests of the corporation.
If the interested director discloses (1) the conflict, (2) all material facts about the transaction, and (3) the nature of the conflict, then the corporation cannot set aside the transaction after it enters into it. Perhaps more importantly for the interested director, s/he will have complied with the fiduciary duty to act in the best interest of the corporation. If the interested director fails to make the required disclosure, then the transaction must be found to be fair to the corporation. If not, it will be set aside, and the interested director will be exposed to liability for engaging in a corporate act s/he should have known was not in the best interest of the corporation. An officer or director breaches the fiduciary duty owed the corporation when s/he puts self-interest before the corporation.
The statutory duties apply to officers and directors of non-profit corporations as well. In fact, a greater burden may be imposed on non-profit board officers and directors. Non-profit corporation boards are required by law to adopt a corporate policy regarding transactions between the corporation and interested officers or directors. With regard to directors’ conflicting interest transactions, non-profit officers and directors must not only comply with the “required disclosure” required by law, but also comply with the corporation’s policy on transactions between the non-profit corporation and interested persons. The corporate policy may impose greater burdens on the interested director than the law does.
Full disclosure of a conflict and all relevant material facts about the nature of the transaction is paramount to ensuring that an interested director complies with his or her duty, despite the interest the director may have in the transaction. If you are an officer or director and are proposing that the corporation enter into a transaction from which you may personally expect to gain, disclose, disclose, disclose.