COMMENT

Source: Model Act, proposed § 8.61. This replaces former § 14-2-155(a).

Section 14-2-861 is the operational section of Part 6 as it prescribes the judicial consequences of the other sections.

Subsection (a) provides that if a transaction is not a director's conflicting interest transaction as defined in Section 14-2-860, then the transaction may not be enjoined, rescinded or made the basis of other sanction on the ground of a conflict of interest of a director, whether or not it went through the procedures of Part 6. It draws a bright line circle, declaring that the definitions of Section 14-2-860 wholly occupy and preempt the field of directors' conflicting interest transactions. Of course, outside this circle there is a penumbra of director interests, desires, goals, loyalties and prejudices that may in a particular context run at odds with the best interests of the corporation; but Section 14-2-861(a) forbids a court to ground remedial action on any of them. In that sense, Part 6 is specifically intended to be both comprehensive and exclusive.

It must be emphasized that subsection (a) limits the court only with respect to claims based on interest conflicts on the part of a director or a person having a personal economic or other association with the director. Also, as previously noted, subsection (a) is inapplicable in non-transactional situations, such as a director's usurpation of a corporate opportunity or improper competition with the corporation. Subsection (a) does not apply to a claim that a parent corporation or other controlling shareholder has violated a duty owed to minority shareholders.

Subsection (b) provides that, if the procedure set forth in Section 14-2-862 or in Section 14-2-863 is complied with, or if the transaction is fair to the corporation, the director's conflicting interest transaction is immune from attack on any ground of a personal interest or conflict of interest of the director. The narrow scope of Part 6 must again, however, be strongly emphasized; if the transaction is vulnerable to attack on some other ground, Part 6 does not make it less so for having passed through the procedures of Part 6.

Clause (1) of subsection (b) provides that if a director has a conflicting interest respecting a transaction, neither the transaction nor the director is legally vulnerable if the procedures of Section14-2-862 have been properly followed. This follows former § 14-2-155(a), which provided that "no contract . . . shall be void or voidable" solely because of a conflict of interest, if it met the standards specified.

Subsection (b)(2) provides a similar rule for shareholders' approval obtained pursuant to Section14-2-863. This, too, follows former § 14-2-155(a).

Clause (3) of subsection (b) follows former § 14-2-155(a)(3), and provides that a director's conflicting interest transaction will be secure against judicial intervention if the interested director can establish that the transaction was fair to the corporation. The term "fair" (and in clause (4) the term "unfair") accord with traditional language in the cases. But it must be understood that, as used in the context of those cases and of Part 6, they have a special flexibility in meaning and a wide embrace. For a transaction to be fair, the price and terms must be fair, and it must also be one that the directors could have believed to be in the best interests of the corporation. This would be particularly true if the transaction related to a loan of the corporation's assets or credit to a director or related person. Loans to assist relocated personnel are obvious examples. The forms of benefit that might be identified are many and varied.

No inference should be drawn that there is a single "fair" price, so all others are "unfair." It has long been settled that a "fair" price is any price in that broad range which a board of directors might have been willing to pay, or willing to accept, as the case may be, for the property, following a normal arm's-length business negotiation, in the light of the knowledge that the board would reasonably have acquired in the course of such negotiations.

The range of this "fair" criterion is only a segment of the full spectrum of the directors' discretion associated with the exercise of business judgment. That is to say, the scope of decisional discretion that a court would have allowed to the board in the absence of a director's conflicting interest is wider than the range of "fairness" contemplated for judicial determination where Section 14-2-861(b) (3) is the governing provision.

In judging the fairness of a transaction, courts have traditionally considered the process by which the decision was reached. It should then compare those components with the process of decision-making the board would have followed and the spectrum of judgments that the board would have made if D had not had a special stake in the outcome. This does not mean that the court should evaluate the merits or wisdom of the decision made by the board, but whether the manner of reaching the decision has been adversely influenced by the director's conflicting interest. "Unfairness" means any substantial variance arising from that comparison.

A few corporate transactions in which directors inherently have a special personal interest are of a unique character and are addressed not by Part 6 but by special provisions of the Code: indemnification arrangements (see Sections 14-2-851 and 852); directors' and officers' liability insurance (see Section 14-2-858); and termination of derivative proceedings by board action (see Section 14-2-744). Any corporate transaction or arrangement affecting directors that is authorized or permitted by those sections of the Code is governed thereby and is not covered by, addressed under, or affected by Part 6. The Model Act created a special statute for loans to directors (Section 8.32) which has been eliminated in the Code, on the theory that the general conflict of interest provisions of this part provide sufficient safeguards.

Note to 1989 Amendment The 1989 amendment deleted subsection (b)(4), which insulated from attack on the basis of a conflict of interest a transaction if the "transaction pertained to the compensation, or the reimbursement of expenses, of one or more directors unless the transaction, judged in the circumstances at the time of commitment, is established to have been unfair to the corporation." Elimination of this safe harbor follows the final version of this Model Act provision. The effect is to admit that decisions involving compensation of directors inevitably involve conflicts of interest, and to return to traditional approaches to legitimating these transactions, which is either to seek shareholder approval or to establish the fairness of the transactions.

Cross-References Action by the board of directors, see §§ 14-2-821 &14-2-824. Action by shareholders, see § 14-2-725 et seq. Committees of the board of directors, see § 14-2-825. Compensation of directors, see § 14-2-811. "Entity" defined, see § 14-2-140. Indemnification of directors, see § 14-2-851. Limits on liability of directors, see § 14-2-202(b)(4). Standards of conduct for directors, see § 14-2-830.

JUDICIAL DECISIONS

RESEARCH REFERENCES