Corporate Litigation: Are Your Directors Acting Fairly?

Corporate litigation attorneys are often involved in corporate litigation that challenges the fairness of corporate director and officer acts. What happens when corporate directors and officers have a conflict of interest and engage in transactions in which they have personal interests?

Corporate Conflicts of Interest

Corporate attorneys involved in lawsuits over allegedly unfair corporate acts should look to see whether the director or officer involved is personally interested in the transaction. A director can be ‘interested’ in a transaction if the contract is between the corporation and the director individually. Another potential ‘interested’ transaction is if the director has a ‘material financial interest’ in a company with which the corporation is doing business.

Shareholder Approval After Full Disclosure

Corporate attorneys who are faced with a conflict of interest situation should advise the corporation that the corporation must follow certain statutory procedures to avoid conflict of interest challenges. In California the rule is that transactions between the corporation and a corporate director are not necessarily void or voidable just because the conflict of interest.

The California Corporations Code provides that the corporation may disclose all of the material facts to the shareholders and then hold a vote. If a majority of the disinterested shares approve the contract, the contract will not be void or voidable for conflict of interest. The director with the potential conflict of interest may not vote his or her shares on this issue. If a majority of the disinterested shareholders vote in good faith in favor of the transaction, the transaction is not subject to challenge for being unjust or unreasonable.

Director Approval Of A Fair Transaction After Full Disclosure

An ‘interested’ transaction approved by shareholders (as set forth above) need not be shown to be just and reasonable. If, however, the transaction was only voted on by the corporation’s disinterested majority of directors, then the contract must be ‘just and reasonable’ to the corporation at the time it was approved. The burden of proof is on the person seeking to uphold the contract to prove it was just and reasonable. If the party cannot meet this burden of proof, then the contract will be set aside.

Remedies: What Are The Remedies In A Conflict Of Interest?

The corporation has two potential remedies in the event a contract or transaction does not meet the requirements of the California Corporations Code. The contract can be rescinded and any monies can be returned. Or the corporation can allow the contract to stand but recover any damages it may have caused to the corporation.

Corporate Lawsuits: How Do Shareholders Get Justice?

Shareholders who feel that they or the corporation have been injured by a contract which involved a conflict of interest can bring either a direct action or a derivative action. In smaller corporations, such as close corporations, a direct action may be possible. In a direct action, the shareholder is suing individually for injuries specific to himself or herself.

A derivative action, on the other hand, is an action filed on behalf of the corporation when the corporation itself refuses to sue. In other words, if the injury is one to the corporation as a whole and not specific to one certain shareholder, the correct cause of action is derivative. In a derivative action any money collected will be returned to the corporation. The money may end up benefitting the shareholder in that he or she will receive their percentage share of any additional distribution but in many cases it may simply be returned to the corporation and the individual shareholder will not see any specific benefit.

Corporate litigation attorneys who are filing litigation should be clear about what type of action they are bringing against the corporation. The issue of whether a shareholder lawsuit is direct or derivative is a common issue in corporate litigation. Shareholders in small corporations should also think through what will happen once they file their lawsuit. Will this lead to the dissolution of the corporation or an irreparable split with your working partners?

Corporate litigation attorney Los Angeles: Laine T. Wagenseller handles numerous shareholder lawsuits relating to proper governance of a business. Wagenseller Law Firm represents numerous businesses and business owners in business litigation in Los Angeles and Southern California. For more articles on partnership and corporate litigation, please visit www.wagensellerlaw.com. You can contact Mr. Wagenseller at (213) 286-0371 or ltw@wagensellerlaw.com.