Thanks to the BLPB for inviting me to guest blog!  I'm excited to be here.  I'll probably write a few substantive posts to start out and finish up with some musings on teaching.

    Here’s a head scratcher:  interested director provisions have long been a part of corporation statutes, and they are making appearances in LLC statutes as well.  The statutes generally address transactions between a corporation and one or more of its directors (or between the corporation and another entity to which the director is affiliated) and provide a mechanism for cleansing the “stink” of the conflict of interest. 

    The fundamental problem with interested director transactions is that we do not trust the interested director to put the entity’s interests before his own.  Correspondingly, in such transactions there is a need to find a “trustworthy decisionmaker” to review the transaction with the entity’s interests in mind.  See, e.g., Franklin Gevurtz, Corporation Law § 4.2.1, at 325 (2000); Douglas K. Moll & Robert A. Ragazzo, Closely Held Corporations § 6.03[B][2][b], at 6-59 (LexisNexis 2015).  Interested director statutes in corporate law can be viewed as providing three trustworthy decisionmaker options:  disinterested directors, disinterested shareholders, or a court.  Section 144 of the Delaware General Corporation Law is fairly typical of such statutes:

§ 144 Interested directors; quorum.

(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director's or officer's votes are counted for such purpose, if:

(1) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or

(2) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or

(3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the stockholders.

(b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction.

    Although § 144(a)(2) does not explicitly indicate that a vote of disinterested shareholders is required, case law in Delaware has imposed a disinterested requirement.  See, e.g., Marciano v. Nakash, 535 A.2d 400, 405 n.3 (Del. 1987); In re Wheelabrator Technologies, Inc. S'holders Litig., 663 A.2d 1194, 1203 (Del. Ch. 1995).  If the purpose of the statute is to find a trustworthy decisionmaker—i.e., a decisionmaker lacking a conflict of interest in the transaction at issue—this disinterested requirement is eminently sensible.  Moreover, why require disinterested directors for director authorization, but permit interested shareholders for shareholder authorization?  After all, particularly in a closely held corporation, the interested directors are almost always significant shareholders.  If they are not to be trusted to bless the conflicted transaction at the director level, why trust them to bless the transaction at the shareholder level?  See also MBCA §§ 8.61(b)(2), 8.63(a) (requiring disinterested shares for shareholder authorization purposes).

    At least to me, all of this makes sense.  But here comes the head-scratcher part:  some statutes explicitly indicate that interested shares may be counted for purposes of shareholder authorization—even though the same statutes require disinterested directors for purposes of director authorization.  See, e.g., Ind. Code. § 23-1-35-2; Or. Rev. Stat. § 60.361.  As mentioned, if the point of interested director statutes is to find someone trustworthy to review the transaction (because the interested party is conflicted and, therefore, is not someone we can trust), it makes little sense to allow the same interested party to authorize the transaction at the shareholder level.  What explains this seemingly inconsistent language?

    The official comment to the Indiana statute states the following:

The GCA [General Corporation Act] did not prohibit the voting of shares owned or controlled by a director who had an interest in the transaction being voted upon. See IC 23-1-10-6(b).  The Commission believed the disclosure and approval procedures of IC 23-1-35-2(a) are sufficient to protect the interests of disinterested shareholders, and that a director qua shareholder should have the same rights as other shareholders, notwithstanding his interest in a transaction.  Finally, in situations where interested directors own a majority of the shares, it would be inequitable to allow a minority to determine whether a transaction should be allowed.

For all these reasons, the BCL [Business Corporation Law] deleted the RMA’s [Revised Model Business Corporation Act’s] disqualification provisions and retained the GCA rule in this area.

    To say the least, this comment is puzzling.  First, how are disinterested shareholders protected by the ability of interested directors (who may very well own a majority of the stock) to cleanse their own conflict?  If we think conflicts are potentially harmful because the directors may be putting their own interests ahead of the company’s interests, it makes no sense to allow the conflicted parties to make the conflict disappear.  Even full disclosure by the interested parties of the material facts related to the conflict and the transaction (which the statutes generally require) wouldn’t help if those same interested parties can bless their own conflicted transaction.

    Second, what is this nonsense about the minority determining whether the transaction should be allowed?  If disinterested shareholders refuse to approve the transaction under the shareholder authorization provisions of the statute, it does not mean that the transaction cannot go forward.  Shareholders do not manage the corporation, and they have no authority to block the transaction from occurring.  It simply means that the benefit of the interested director statute will not be conferred upon the transaction.  That benefit, depending on the jurisdiction, is usually returning the business judgment rule as the standard of review for the transaction, or retaining a fairness standard of review for the transaction, but shifting the burden of proof to the plaintiff to demonstrate unfairness.  When disinterested minority shareholders vote under an interested director statute, in other words, their vote of disapproval does not determine whether the transaction should be allowed (unless, of course, the corporation’s charter, bylaws, or shareholder agreement requires a disinterested vote).  Instead, it simply denies the transaction the benefits of the interested director statute.  For practical purposes, this means that the interested directors must demonstrate that the transaction is fair to the corporation if they wish to avoid liability for breach of fiduciary duty.  If they meet their burden of establishing fairness, the transaction is allowed.

    In short, I’m not following the logic of allowing interested shares to bless a conflict of interest transaction.  I’m still scratching my head . . . .  What about you?