Corporate directors who do business with the companies on whose board they serve can be exposed to charges of conflict of interest. While some companies adopt formal conflict of interest policies to identify and deal with conflicts, many – particularly private, closely-held corporations – do not. Failure to properly manage conflict of interest transactions can give rise to shareholder disputes and litigation. Recognition of the issues presented by such transactions and addressing them through proper corporate governance mechanisms at the front end can significantly reduce litigation risk.
The fiduciary duty owed by corporate directors to the corporations they serve includes a duty of loyalty. The duty of loyalty generally requires that directors act in the best interests of the corporation and put the company’s interests ahead of their own. Contracts or other transactions between a corporation and a director or director-affiliated business can be attacked as a violation of a director’s duty of loyalty – presumably, the better the contract is for the director, the worse it will be for the corporation. Human nature being what it is, a director’s self-interest can result in the director gaining the benefit of a “sweetheart deal” at the expense of the corporation.
Conflict of interest transactions are fairly common. For example, a private corporation with manufacturing operations may lease its manufacturing facility from the majority owner (who is also a corporate director) or another company affiliated with that owner. Similarly, it is not uncommon for an owner-director of a private company to make loans or advances to the company. To the extent that such business transactions unfairly benefit – or even appear to unfairly benefit – the director at the expense or to the detriment of the corporation, they may raise legitimate concerns on the part of minority shareholders who do not share in the benefits of the deal. Siphoning off corporate earnings through corporate leases, loans or other transactions favorable to majority shareholders can be a method used to “squeeze-out” or otherwise, marginalize minority shareholders.