Complete Home & Office Legal Guide/Complete Home and Office Legal Guide (Chestnut) (1993).ISO/stat/mbiz/busi6t.asc

Text File | 1993-08-01 | 55KB | 1,129 lines

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(2) Party to the Transaction-The Corporation

Transaction by what entity? In the usual case, the transaction in
question would be by X Co.  But assume that X Co. is the
controlling corporation of 5 Co. (i.e., it controls the vote for
directors of 5 Co.). D wishes to sell a building he owns to X Co.
and X Co. is willing to buy it.  As a business matter, it will
often make no difference to X Co. whether it takes the title
itself or places it with its subsidiary S Co. or another entity
that X Co. controls. The applicability of subchapter F cannot be
allowed to depend upon that formal distinction. The subchapter
therefore includes within its operative framework transactions by
a subsidiary or controlled entity of X Co. See the Note on Parent
Companies and Subsidiaries below.

(3) Party to the Transaction-The Director

Subdivision (1)(i) and subdivision (1)(ii) differ as to the
persons covered and as to the threshold of transactional
significance. Subdivision (1)(i), addressed to D and related
persons of D, includes as directors' conflicting interest
transactions all transactions that meet the substantive criteria
prescribed.  By contrast, subdivision (1)(ii), addressed to
transactions involving other designated persons, excludes from
its coverage transactions that are not sufficiently significant
to the corporation to warrant decision at the boardroom level.

As a generalization, the linkage between a director and a
"related person" is closer than that between the director and
those persons and entities specified in subdivision (1)(ii).
Correspondingly, the threshold of conflicting interest under
subdivision (1)(i) is lower than that set for subdivision
(1)(ii). Thus, all routine transactions of X Co. are excluded
from the definition of director's conflicting interest
transaction unless they fall within subdivision (1)(i).  If Y
Co., a computer company of which D is also an outside director,
sells office machinery to X Co., the transaction will not
normally give rise to a conflicting interest for D from the
perspective of either company since the transaction is a routine
matter that would not come before either board. If, however, the
transaction is of such significance to one of the two companies
that it would come before the board of that company, then D has a
conflicting interest in the transaction with respect to that
company.

Implicit in subdivision (1)(ii) is a recognition that X Co. and Y
Co., particularly if large enterprises, are likely to have
routine, perhaps frequent, business dealings with each other as
they buy and sell goods and services in the marketplace.  The
terms of these dealings are dictated by competitive market forces
and the transactions are conducted at personnel levels far below
the boardroom.  The fact that D has some relationship with Y Co.
is not in itself sufficient reason to open these smaller scale
impersonal business transactions to challenge if not passed

through the board in accordance with section 8.62 procedures.  It
would be doubly impractical to do so twice where X Co. and Y Co.
have a common director.

Subchapter F takes the practical position. The definition in
subdivision (1)(ii) excludes most such transactions both by its
"knowledge" requirement and by its higher threshold of economic
significance.  In almost all cases, any such transaction, if
challenged, would be easily defensible as being "fair." In
respect of day-to-day business dealings, the main practical risk
of impropriety would be that a director having a conflicting
interest might seek to exert inappropriate influence upon the
interior operations of the enterprise, might try to use his
status as a director to pressure lower level employees to divert
their business out of ordinary channels to his advantage.  But a
director's affirmative misconduct goes well beyond a claim that
he has a conflicting interest, and judicial action against such
improper behavior remains available. See also the Official
Comment to section 8.62(b) regarding common directors.

The absence of the significance threshold in subdivision (1)(i)
does not impose an inappropriate burden on directors and related
persons.  The commonplace and oftentimes recurring transaction
will involve purchase of the corporation's product line; it will
usually not be difficult for D to show that the transaction was
on commercial terms and was fair, or indeed, that he had no
knowledge of the transaction.  As a result, these transactions do
not invite harassing lawsuits against the director.  A purchase
by D of a product of X Co. at a usual "employee's discount,"
while technically assailable as a conflicting interest
transaction, would customarily be viewed as "fair" to the
corporation as a routine incident of the office of director.  For
other transactions between the corporation and the director or
those close to him, D can, and should, have the burden of
establishing the fairness of the transaction if it is not passed
upon by the arm's length review of qualified directors or the
holders of qualified shares.  If there are any reasons to believe
that the terms of the transaction might be questioned as unfair
to X Co., D is well advised to pass the transaction through the
safe harbor procedures for subchapter F.

Note on Parent Companies and Subsidiaries

If a subsidiary is wholly owned, there is no outside holder of
shares of the subsidiary to be injured with respect to
transactions between the two corporations.

Transactions between a parent corporation and a partially-owned
subsidiary may raise the possibility of abuse of power by a
majority shareholder to the disadvantage of a minority
shareholder. Subchapter F has no relevance as to how a court
should deal with that claim.

If there are not at least two outside directors of the
subsidiary, the subsidiary and the board of directors must
operate on the basis that any transaction between the subsidiary
and the parent that reaches the significance threshold in
subdivision (1 Xii) may, as a technical matter, be challengeable
by a minority shareholder of the subsidiary on grounds that it is
a director's conflicting interest transaction.  In that case, the
directors of the subsidiary will have to establish the fairness
of the transaction to the subsidiary.  In practice, however, the
case law has dealt with such claims under the rubric of the
duties of a majority shareholder and that is, in reality, the
better approach.  See the Official Comment to section 8.61(b).

3. Related Person

Two subcategories of "related person" of the director are set out
in subdivision (3).  These subcategories are specified,
exclusive, and preemptive.

The first subcategory is made up of closely related family, or
near-family, individuals, trusts, and estates as specified in
clause (i).  The clause is exclusive insofar as family
relationships are concerned.  The references to a "spouse" are
intended to include a common law spouse or unrelated cohabitant.

The second subcategory is made up of persons specified in clause
(ii) to whom or which the director is linked in a fiduciary
capacity as, for example, in his status as a trustee or
administrator.  (Note that the definition of "person" in the
Model Act includes both individuals and entities.  See section
1.40(16).) From the perspective of x Co., D's fiduciary
relationships are always a sensitive concern. A conscientious
director may be able to control his own greed arising from a
conflicting personal interest. And he may resist the temptation
to assist his wife or child. But he can never escape his legal
obligation to act in the best interests of another person for
whom he is a trustee or other fiduciary.

4. Required Disclosure

Two separate elements make up the defined term "required
disclosure.  They are disclosure of the existence of the
conflicting interest and then disclosure of the material facts