The law regulates contracts where directors have a personal interest, to prevent abuse. A self-dealing director is one who enters into a contract with their own corporation. Such a contract is voidable at the option of the corporation, unless all of the following conditions are present: the presence of the director in the board meeting approving the contract was not necessary to constitute a quorum; the vote of that director was not necessary for approval; the contract is fair and reasonable under the circumstances; and, in the case of an officer, the contract was previously authorized by the board. If any condition is absent, the contract may still be ratified by a two-thirds vote of the stockholders, provided full disclosure of the adverse interest is made and the contract is fair and reasonable. Interlocking directors are directors who sit on the boards of two corporations that contract with each other. Such contracts are generally valid, but if the interest of the interlocking director in one corporation is substantial and in the other merely nominal, the contract is scrutinized under the self-dealing rules to prevent the director from favoring the corporation in which they have a greater stake. The goal is to ensure fairness and full disclosure.
Self-Dealing Directors
A self-dealing director contracts with their own corporation. The contract is voidable at the corporation's option unless conditions are met.
When the Contract Is Valid
- The director's presence was not necessary for a quorum;
- Their vote was not necessary for approval;
- The contract is fair and reasonable; and
- (For an officer) it was previously authorized by the board.
Ratification and Interlocking Directors
If a condition is absent, the contract may be ratified by a two-thirds stockholder vote with full disclosure. Interlocking directors (on two contracting corporations' boards) — the contract is generally valid, but scrutinized under the self-dealing rules where the interests are substantial vs. nominal.
Practical Takeaways
- A director's contract with their corporation is voidable unless the fairness/quorum/vote conditions are met;
- It can be ratified by two-thirds of stockholders with disclosure;
- Interlocking-director contracts face scrutiny where interests differ greatly.
Frequently Asked Questions
Can a director contract with their own corporation? Yes, but the contract is voidable at the corporation's option unless the director's presence was not needed for quorum, their vote was not needed for approval, the contract is fair and reasonable, and, for an officer, it was previously authorized.
Can a self-dealing contract be validated? Yes. If a condition is absent, the contract may be ratified by a two-thirds vote of the stockholders, provided full disclosure of the adverse interest is made and the contract is fair and reasonable.
What are interlocking directors? Directors who sit on the boards of two corporations that contract with each other. Such contracts are generally valid but scrutinized where the director's interest is substantial in one and merely nominal in the other.
Why are these contracts regulated? To prevent abuse and ensure fairness and full disclosure, so directors do not profit personally at the corporation's expense or favor a corporation in which they have a greater stake.
This commentary is for general informational purposes only and does not constitute legal advice. For guidance specific to your situation, please consult a licensed attorney.
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