Entire Fairness: How to Prove Self-Dealing

One area of constant concern in a corporation is self-dealing. Self-dealing takes many forms, and some may not even realize that they have engaged in such actions. The most common scenarios of self-dealing include transactions between the corporation and directors/officers; transactions between the corporation and a business entity in which directors or officers have significant interests; transactions between a partially-owned subsidiary and its parent corporation; and transactions between a corporation and another corporation with common or interlocking directors/officers. For all intents and purposes, directors and officers should steer away from self-dealing. However, the situation may arise where a director or officer retroactively realizes that they engaged in such actions, in violation of his duty of loyalty to the corporation. In often times, the directors and officers are subject to scrutiny from the corporation and could be facing penalties.

There are two ways to avoid implicating a breach in duty of loyalty if self-dealing has occurred. The first is to look to the state’s corporation statute and understand the safe harbors granted to directors and officers whereby such transactions are still permissible. These are fairly cut and dry. The other method is a bit more flexible in that there is no steadfast rule. This method involves going to court and proving that the transaction was entirely fair. Although this method of proving self-dealing was not in violation of the duty of loyalty, this is the least deferential standard a court will use. Courts, in essence, second guess every decision made by the board members who engaged in self-dealing because these types of transactions are very suspicious.

To prove that a self-dealing transaction was entirely fair in retrospect, there are two main factors the director or officer must prove: that both the process was fair and that the price was fair. Generally, when self-dealing is not implicated, transactions are only subject to reviewing whether or not the process going into it was fair; it is understood that it is only natural that some transactions do not pan out as well as others. However, when it comes to self-dealing transactions, those defending the transaction must prove that both the process and price was fair. This is necessary to overcome the presumption that a conflict of interest clouded the transaction and that it was not in the best interests of the corporation.

Self-dealing is a very dangerous area of corporate law. As a general rule of thumb, directors and officers must avoid engaging in self-dealing. There generally is only one main defense that an interested director can avail himself of self-dealing aside from the state’s corporate statute: proving the transaction was entirely fair. Consulting with an experienced legal team can help understand whether or not self-dealing has occurred, and whether it was in violation of the duty of loyalty. Call the Trembly Law Firm at (305) 431-5678 today to schedule your consultation.