Chapter 17
Duty of Loyalty
Outline
(last update 08 Nov 06)
Chapter 17
A.
Introduction: Conflicts of Interest


B.
D.
o
director on two sides of transaction with corporation
o
director predictably prefers self-interest
balance
o
director prefers own over corporate interests
o
director provides corporation additional flexibility
standards of judicial review
o
flat prohibition
o
shareholder ratification or approval
o
disinterested director validation
o
fairness review
Evolving Standards of Review
1.
The common law standard: 1880 – 1960
2.
Contemporary Statutory Approaches
o
Traditional analysis: Remillard Brick v. Remillard-Dandini
o
Interpreting interested Director Statutes
o
MBCA Subchapter F
o
Company Codes: the European approach
Entire Fairness: Fair Dealing and Fair Price
1.
2.
E.
definition and dangers of self-dealing
Overview of the Issues

C.
Duty of Loyalty
Fair dealing (Procedural fairness)
o
In Re the Walt Disney Company Derivative Litigation
o
In Re Oracle Corp. Derivative Litigation
o
Lewis Vogelstein
o
Harbor Finance Partners v. Huizenga
Fair price (Substantive fairness)
Corporate Opportunities
1.
Traditional corporate opportunity doctrine
o
2.
Farber v. Servan Land Company
What is a corporate opportunity?
o
o
o
Interest or expectancy

misappropriate assets

misappropriate information

interfere with expansion plans
Line of business

current operations

anticipated operations
Fairness
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3.
When can a manger take a corporate opportunity?
o
o
4.
corporate consent

rejection / acquiescence

corporate incapacity
ALI § 5.05

mandatory rejection

definition: expectancy + line of business
Remedies for usurping a corporate opportunity
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Class notes
B. Overview of the Issues
How might corporate law deal with a director's conflict of interest
transaction?

Flat prohibition: The corporation cannot enter into any
transaction with any person or entity in which a director has a
conflicting interest.

Shareholder ratification. The corporation can enter into
conflicting-interest transactions if the shareholders validate -ratification or approval.

What is relationship between
substance and procedure?
Director ratification. The corporation can enter into
conflicting-interest transactions if the uninterested directors
approve.

Fair. The corporation can enter into conflicting-interest
transactions if a judge says the transaction was fair.
C. Evolving Standards of Review
Remillard Buick Co v. Remillard Dandini Co
(Calif App 1952)
California court:
".. if the majority directors and
stockholders inform the minority that they
Stanley and Sturgis were in the brick business. They
are going to mulct the corporation [and
owned a majority of Brick Corp, a brick manufacturing
this were] an impervious armor against
firm. Stanley and Sturgis also owned all of Sales Corp,
attack on the transaction ... it would be
which contracted with Brick Corp to sell the bricks.
shocking reflection on the law of
California"

What's the problem? Who sued?

Wasn't the relationship with Sales Corp approved
"The point is that large profits that should
by the board of Brick Corp?
have gone to the manufacturing
Didn't the stockholders of Brick Corp approve, as
companies were diverted to the sale
well?
corporation.

Del. G. Corp. L. § 144 [edited a little]
California court:
(a) No transaction between a corporation and any other
"If the conditions provided for in the
corporation in which its directors have a financial interest,
section appear, the transaction cannot be
shall be void or voidable solely for this reason if:
set aside simply because there is a
common directorate."
(1) The material facts are disclosed and the
board authorizes the transaction by the affirmative
"But neither section 820 of the
votes of a majority of disinterested directors
Corporations Code nor any other
provision of law automatically validates
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(2) The material facts are disclosed to the
such transactions simply because there
shareholders and the transaction is approved in
has been a disclosure and approval by
good faith by vote of the shareholders
the majority of the stockholders"
(3) The transaction is fair as to the corporation
Even though the requirements of section
as of the time it is approved.
820 are technically met, transactions that
are unfair and unreasonable to the
corporation may be avoided. ... It would
be a shocking concept of corporate
morality to hold [otherwise]
Delaware Supreme Court (Marciano v. Nakash
-Del 1987)
"... approval by fully-informed
Hypothetical
disinterested directors under Section
Is there any way for Brick Corp to delegate the sales
144(a)(1) or disinterested stockholders
function to an outside company owned by Stanley and
under section 144(b)(2) permits
Sturgis? Advise.
invocation of the business judgment rule
and limits judicial review to issues of gift
or waste with the burden of proof on the
party attacking the transaction."
Consider the result under NC Bus Corp
Law § 8.31
Overly v. Kirby
Del. G. Corp. L. § 144 [edited a little]
(Del 1991)
(a) No transaction between a
The FM Kirby Foundation is a Delaware non-stock charitable
corporation and any other
corporation. The foundation's largest asset was a 15% stake in
corporation in which its directors
Alleghany, a large publicly-traded conglomerate with holdings in
have a financial interest, shall be
American Express. But federal tax laws forced the foundation to
void or voidable solely for this reason
divest itself of its Alleghany holdings. Faced with the prospect of
if:
the foundation selling its ALleghany stock to the market, Alleghany
management considered redeeming it (buying it back) and learned it
(1) The material facts are
could so by using its American Express stock as consideration. (In
disclosed and the board
this way Alleghany would not have to pay capital gains tax on its
authorizes the transaction by
appreciated AmEx stock - and realize tax savings of $26 million!)
the affirmative votes of a
The problem to a tax-driven deal made in tax-heaven was that Fred
majority of disinterested
Kirby was both a Kirby Foundation director (along with his siblings,
directors
Allan, Grace and Ann) and the Chief Operating Officer of
(2) The material facts are
Alleghany. So the Foundation’s attorney sought to negotiate a deal
disclosed to the
with Alleghany. What were Alleghany's options? Who might it sell
shareholders and the
its AmEx stock to? What is SEC Rule 144? What are the
transaction is approved in
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transaction costs in a registered securities offering? What were
good faith by vote of the
Alleghany's options in selling its AmEx stock? What did the
shareholders
Foundation’s investment banker opine?
(3) The transaction is fair
as to the corporation as of
The Delaware attorney general challenged the sale. On what
the time it is approved.
grounds? What standard applies? Why is "legally irrelevant" that
the interlocking directors, Fred and Allan Jr., absented themselves
from meetings involving the transaction? Why were the other
Foundation directors interested? Would it have made a difference
if only non-interested directors approved the transaction for the
Foundation? Why does the court have the "sole" role to determine
intrinsic fairness? How did the court determine the transaction was
fair?
D. Entire Fairness: Fair Dealing and Fair Price
Illinois Supreme Court:
"The directors of a corporation .... are subject
to the general rule ... that they cannot in their
Shlensky v. South Parkway Building Corp.
dealings with the business or property of the
(Illinois 1960)
trust, use their relation to it for their own
personal gain."
Building Corporation owns a 3-story commercial
building in Chicago. Its majority shareholder
"dealing with the corporation ... will be subject
Englestein, who also sits on the board, is an
to the closest scrutiny. .... a director may deal
entrepreneur. Englestein also owns two other
with the corporation of which he is a member
corporations that do business with Building Corporation:
provided he acts fairly and for the interest of
the company ..."


Store (a tenant) sold $100,000 of fixtures to
Building Corporation
"transactions between corporations with
the lease with Store was modified to eliminate
common directors may be avoided only if
all percentage rents (a 40% reduction) and
unfair, and ... the directors [must] sustain the
waive accrued rent of $24,316
challenged transaction have the burden of
overcoming the presumption against the
What's wrong with this? Aren't these business
validity of the transaction by showing
decisions entrusted to the board? Isn't keeping a tenant
fairness ..."
happy and fiscally sound of relevance to a landlord?
"courts have stressed factors
In any event, Englestein did not deal personally with

full value in commodities purchased
Building Corporation. Instead it was Store. Is

corporation's need for the property
Englestein really on both sides of the transactions?

whether transaction was at market price
Who sued? Why?

detriment to the corporation
Who has the burden of showing fairness? What is
"no justification for giving Store all the
fairness? What is entire fairness?
financial benefits, and requiting other tenants
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Wasn't this
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transaction approved by the outside director - Bernstein,
to pay rents which were 10 to 20 times higher
Englestein's lawyer? Who is liable? What are
per square foot"
damages?
Hayes Oyster Co. v. Keypoint Oyster Co.
(Wash Sup Ct 1964)
Coast Oyster Company was in bad financial shape and
to solve its cash flow problems sold its valuable oyster
beds to Keypoint Oyster Company. What was the
problem with this arrangement -- from the standpoint of
Coast Oyster shareholders? One Verne Hayes had
multiple allegiances -- president, manager, 23% SH of
Coast Oyster / co-signor of note to Engman for start-up
/ capital in Keypoint shareholder in Hayes Oyster,
which became 50% shareholder of Keypoint
What do we know about human nature? Verne Hayes
got a promise from Joe Engman (the owner of Keypoint)
that Hayes Oyster would receive a 50% interest in
Keypoint, if Verne lent Joe $15,000 in start-up capital for
Keypoint. The issue for the court: who owns this 50%
interest (249 shares) -- Hayes Oyster or Engman or
Coast Oyster? What was the argument of Hayes
Washington Supreme Court:
"... nondisclosure by an interested director
or officer is itself unfair ... [Coast
shareholders and directors] had the right to
know of Hayes' interest in Keypoint in order
to intelligently determine the advisability of
retaining Hayes as president and manager."
"... direction to order Keypoint Oyster
Company to issue a new certificate for 250
shares of its stock to Coast Oyster ..."
Oyster? The argument of Coast?
Coast lost no money in its transaction with
Keypoint. All agree that the oyster beds were worth
$250,000 -- the purchase price. How could Coast claim
that the transaction was unfair? What is the remedy for
self-dealing? What remedy did Coast pursue?
Fliegler v. Lawrence
Del. G. Corp. L. § 144 [edited a little]
(Del. 1976)
(a) No transaction between a corporation and
Silvergold Mines (known as Agau) is thinking of getting
any other corporation in which its directors have
an option to buy US Antimony in an exchange of
a financial interest, shall be void or voidable
stock. Problem is that US Antimony is mostly owned by solely for this reason if:
directors and officers of Agau. You represent Agau's
management. Assume there are no problems with the
(1) The material facts are disclosed
way US Antimony was set up. Advise. What should
and the board authorizes the transaction
Agau's board do? What if, as happened, the Agau
by the affirmative votes of a majority of
shareholders vote on and approve the transaction? Do
disinterested directors
you see a conflict? What did the Delaware Supreme
Court say was the standard of review?
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(2) The material facts are disclosed to
the shareholders and the transaction is
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What does fairness mean? What about the statute!!
approved in good faith by vote of the
shareholders
(3) The transaction is fair as to the
corporation as of the time it is approved.
HYPOTHETICAL
Agau's management also owns US Platinum. Agau
agrees to buy platinum from USP over the next ten
years at a fixed $700 an ounce. The outside directors
Fliegler v. Lawrence:
of Agau approve the deal, though never learn that USP
would have sold cheap at $650. The non-management
"... the individual defendants stood on
shareholders of Agau approve the deal, on the strength
both sides of the transaction in
of the outside director's recommendation. Judicial
implementing and fixing the terms of the
review, anyone?
option agreement.
"Accordingly, the burden is upon them
to demonstrate its intrinsic fairness."
"... objectively, was [800,000 shares] a
fair price for Agau to pay for USAC as a
wholly-owned subsidiary?
Regarding the question at the class today, I would like to try to explain how self dealing is treated under
Japan Commercial Code.
1, The self dealing by a corporate director must be reported to and approved by the board of directors. The
matter should be discussed and ratified only by disinterested directors.
2. This approval does not indemnify interested directors. Furthermore, the disinterested directors who
agreed to the transaction -- together with the interested director -- have responsibility to shareholders.
3. The self-dealing must be reported to shareholders in the annual report. Although it is very rare case in
Japan, the liability of interested and disinterested directors can be discussed at shareholders' meeting and
released only by supermajority (3/4) share approval.
4. Nothing in the Code prevents an interested shareholder from voting, but the Code says interested
shareholders may also be liable to the corporation.
5. Given that it is almost impossible to release liability at the shareholders' meeting, I think such liability will
be usually be challenged through the derivative suit brought by a shareholder. Usually, D&O insurance in
Japan does not cover such liability.
6. I heard that recently that the new Commercial Code enables corporations to set forth the indemnification
clause in the article of corporation. But it is not clear to me what extent of liability can be indemnified. I need
to study this!
Kazuya Shiki (LLM 2004)
Director conflict of interest transactions
ALI Principles of Corporate Governance
Gries Sports Enterprises v. Cleveland
ALI Principles of Corporate Governance
Browns Football Co
§ 1.23 Interested defined
(Ohio 1986)
(a) A director ... is "interested" in a transaction if:
(1) The director ... is a party to the transaction ...
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The corporation that owned the Cleveland
(2) The director ... has a business, financial or familial
Browns football team purchased the
relationship with a party to the transaction .... and that
company owning Cleveland
relationship would reasonably be expected to affect the
Stadium. Modell, the Cleveland Browns
director’s judgment with respect to the transaction in a
CEO, owned 53% of the Browns and 80% of manner adverse to the corporation.
the stadium company.
(3) The director .... has a material pecuniary interest in
When Gries, a 43% Cleveland Browns
the transaction (other than usual and customary directors'
shareholder, challenged the purchase price
fees and benefits and that interest .. would reasonably be
as excessive, the question was whether an
expected to affect the director's ... judgment in a manner
independent majority of directors had
adverse to the corporation .
approved it:
(4) The director ... is subject to a controlling influence by

Gries - the victim
a party to the transaction ..... and that controlling

Modell - the culprit
influence could reasonably be expected to affect the

Modell's wife
director's ... judgment with respect to the transaction ... in a

Bailey (full-time general counsel of
manner adverse to the corporation.
Browns)

Berick (outside counsel and 1%
owner)

Cole (full time Brows employee)

Wallack (full time Browns employee)
Bailey, Berick, Cole and Wallack also owned
stock in the stadium company.
Assume that the sale of the stadium company
to the Browns was based on outside
appraisals. What more is required? Is
approval of the by the Browns board
sufficient? What if Modell had absented
himself? What if the bylaws permitted a
quorum of one director and Berick had
approved the purchase? Is Berick
independent? How do you know?
What are the ALI Principles of Corporate
Governance?
ALI Principles of Corporate Governance
§ 5.02 Transactions with Corporation
(a) General rule. A director... who enters into a transaction
How does this case come out under the ALI
Principles? Is this relevant to the
non-voidability statutes?
with the corporation (other than compensation) fulfills the
duty of fair dealing with respect to the transaction if:
(1) disclosure concerning the conflict of interest and the
transaction is made to the corporate decision-maker ....
(2) either
(A) the transaction is fair to the corporation ...
(B) the transaction is authorized in advance, following
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disclosure .... by disinterested directors .... who could
reasonably have concluded that the transaction was fair to
the corporation ....
(C) the transaction is ratified, following such disclosure, by
disinterested directors ....
(D) the transaction is authorized in advance or ratified,
following such disclosure, by disinterested shareholders
and does not constitute a waste of corporate assets ....
(b) Burden of proof. A party who challenges a transaction
between a director ... and the corporation has the burden of
proof, except that if such party establishes (B), (C), or (D) is
not satisfied, the director ... has the burden of proving the
transaction was fair to the corporation.
Del. G. Corp. L. § 144 [edited a little]
(a) No transaction between a corporation and any other
corporation in which its directors have a financial interest,
shall be void or voidable solely for this reason if:
(1) The material facts are disclosed and the board
How does the approach of the ALI Principles
authorizes the transaction by the affirmative votes of a
change the statutory approach?
majority of disinterested directors
(2) The material facts are disclosed to the shareholders
and the transaction is approved in good faith by vote of the
shareholders
(3) The transaction is fair as to the corporation as of the
time it is approved.
Lewis v. Vogelstein
(Del. Ch. 1997)
Shareholders of Mattel challenged the board's
stock option compensation plan for directors,
which had been ratified by shareholders. Under
the plan directors received: (1) 15,000
one-time options with an exercise price equal to
market price on the date granted, and
exercisable for up to ten years, (2) 5,000 (or
10,000 for longer-serving directors) annual
options that vest over a four-year period, with
an exercise price equal to market price when
granted, and exercisable for up to ten
years. What were the issues? What is the
effect of shareholder ratification?
Chancellor Allen:
What choices did Chancellor Allen have, as he ... it has long been held that shareholder may not ratify a
saw it, in giving effect to the shareholder
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waste except by a unanimous vote. .... IN all events,
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ratification?
informed, uncoerced, disinterested shareholder

complete defense
ratification of a transaction win which corporate directors

shift review from fairness to waste
have material conflict of interest has the effect of

shift burden to plaintiff to show
protecting the transaction from judicial review except on
unfairness
the basis of waste.

Roughly, a waste entails an exchange of
no effect
Why not a complete defense - what are
corporate assets for consideration so
"collective action" problems? Why is
disproportionately small as to lie beyond the
"ratification" different from prior approval?
range at which any reasonable person might be
What is the meaning of "waste"? How is it
willing to trade.
different from the BJR?
In this age in which institutional shareholder
have grown strong and can more easily
communicate, however that is, I think a more
rational means to monitor compensation than
Del. G. Corp. L. § 144 [edited a little]
judicial determination of the "fairness" or
(a) No transaction between a corporation and
sufficiency of consideration, which seems a
any other corporation in which its directors
useful technique principally, I suppose to those
have a financial interest, shall be void or
unfamiliar with the limitations of courts that their
voidable solely for this reason if:
litigation processes.
(1) The material facts are disclosed and the
I cannot conclude that no set of facts could be
board authorizes the transaction by the
shown that would permit the court to conclude
affirmative votes of a majority of disinterested
that the grant of these options particularly upon
directors
the one-time options, constituted an exchange to
(2) The material facts are disclosed to the
shareholders and the transaction is approved in
which no reasonable person not acting under
compulsion and in good faith could agree.
good faith by vote of the shareholders
(3) The transaction is fair as to the
corporation as of the time it is approved.
E. Corporate Opportunities
Corporate opportunity - traditional approach
Farber v. Servan Land COmpany
Fifth Circuit:
(5th CIr. 1981)
In Florida .... if one occupying a fiduciary relationship
Servan Land owns a 180-acre golf course and
to a corporation acquires "in opposition to the
country club. Farquhar offers to sell the
corporation, property in which the corporation has an
corporation an abutting 160-acre tract.
This idea interest or tangible expectancy or which is essential to
is presented at the 1968 annual shareholders'
its existence, he violates ... the doctrine of corporate
meeting, but nothing happens. Then, within a
opportunity. ... the opportunity must fit into the
year, Servan's principals (majority shareholders
present activities of the corporation or fit into an
and principal officers) buy the tract for themselves. established corporate policy which the acquisition of
Scoundrels or entrepreneurs?
the opportunity would forward
The plot thickens. At the next annual
... the opportunity to acquire the Farquhar land was an
shareholders' meeting in 1969, nothing is said
advantageous one that fit into a present, significant
about the Farquhar purchase. But in 1973 the two corporate purpose
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Servan principals agree to sell the corporation's

assets and the 160-acre tract to an outside
buyer. Of the $8.4 million purchase price, they
acquiring abutting land

allocate 42.3% to themselves! The directors and
shareholders (except for one Farber) all agreed to
the sale, and to dissolve Servan
What is wrong with what Serriani and Savin did


corporation needed the land on perimeter of
golf course

corporation had bought additional land from
Farquhar in the past
"We find that [failure of stockholders to vote at meeting
what is the definition of "corporate
to commit funds to purchase Farquhar property] does
opportunity"?
not indicate a decision to refrain from pursuing the
o
what is the expectancy test?
opportunity. .... [Serianni] may not now translate his
o
what is the line of business test?
own inaction [to initiate the investigation on the
internal decision-making / notice and
corporation's behalf] into a corporate rejection of the
rejection?
opportunity ...
o
o
o

sense of shareholders approved idea of
must the fiduciary have offered the "Serianni and Savin may not bind Farber by ratifying
opportunity to the corporation?
their own inappropriate acts. ... Both of the
what constitutes corporate
purchasing directors were present, and between the
rejection / ratification?
two of them, they had four-sevenths of the
is the corporation's financial ability
stock. [Query: what about the other
to take the opportunity relevant?
directors-shareholders?]
If a corporate opportunity existed the corporation and
remedy
o
what is "constructive trust"?
its stockholders would have been entitled to the profits
o
how are profits computed? less
from the sale of both parcels. .... Serianni and Savin
net purchase price?
made a handsome profit on the sale. The two
causation defense: would
directors must hold those profits in trust for the
corporation have realized same
corporation.
o
profits?
Nature of duty
POSSIBLE RULES
What kind of fiduciary rule is the "corporate
Which is more likely to encourage parties to enter
opportunity" doctrine?
into corporate relationships?

Majoritarian
FLAT PROHIBITION - A corporate fiduciary is

Tailored
prohibited from engaging in any outside business
Can the parties opt out of the duty?
ventures.
NO PROHIBITION - A corporate fiduciary
may take any and all outside business
Consider Del GCL § 122(17):
ventures, so long as the parties have not
"Every corporation has the power to .... renounce,
agreed otherwise.
in its certificate of incorporation or by action of its
MANDATORY NOTICE AND CONSENT - A
board of directors, any interest or expectancy of the
corporate fiduciary is prohibited from
corporation in ... specified business opportunities ...
engaging in any outside business venture
that are presented to the corporation ...
unless he first offers the opportunity to the
What about in a state without this statute? What
corporation, which then formally rejects it.
about a Delaware corporation that does not have
DOCTRINE - A corporate fiduciary is
this provision? And if one does, is this corporate
prohibited from usurping any corporate
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power still subject to corporate duty?
opportunity, unless rejected by the
corporation.
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