Conflicts of Interest in Business Divorce


By: Robert A. Royal


In a closely held business the owners usually act as management and as discussed in a prior column, owe fiduciary duties to the entity and the other owners.It is quite common for an owner to be involved in a transaction with the company which may directly or indirectly benefit the owner financially.Parties participating in a business divorce often use the conflict of interest statutes in the Arizona Corporation Code to leverage a settlement.

CONFLICTING INTEREST DEFINITION

A conflict of interest transaction involving a director requires a careful examination of the statutory definitions set forth in A.R.S. S10-860.A conflicting interest begins with a transaction effected or proposed to be effected by the corporation, by a subsidiary, or by any other entity in which the corporation has a controlling interest.If at that time the director knows that he or she is a party to the transaction with the corporation, has a beneficial financial interest, or is so close to the transaction that one would expect their judgment would be influenced if the director was called to vote on the transaction, a conflicting interest transaction is present.If the transaction is of such a character and significance it would normally be brought before the board of directors for action, and the director knows that another entity for which he/she is a director, general partner, agent or employee is involved, a conflicting interest is presented.In addition, if the proposed transaction is with an individual who is a general partner, principal, or an employer of a director, it is a conflicting interest.

THE REMEDIES

When a transaction is effected or proposed by the corporation, by a subsidiary, or an entity in which a corporation has a controlling interest, that is a director's conflicting transaction it shall be enjoined, set aside, or may be subject to damages or other sanctions in a proceeding by a shareholder brought in the right of the corporation, or by the corporation itself because the director has a personal or economic interest in the transaction.The court shall not enjoin, set aside or give damages where the director has met the standard for a director's safe harbor or a shareholder's safe harbor, or if the transaction is established to be fair to the corporation.

THE DIRECTORS' SAFE HARBOR

A director's safe harbor requires an affirmative vote of a majority of disinterested directors who have no familial, financial, professional or employment relationship with the director.Another safe harbor for the director exists where a disinterested committee of the board voted to approve the transaction after full disclosure.A third safe harbor exists if the director, bound by confidentiality, simply discloses the conflicting interest, the nature of the required non-disclosure, and plays no part in the board's vote concerning the transaction.

SHAREHOLDER SAFE HARBOR

A director may find a safe harbor by obtaining a majority of the votes of disinterested shareholders after the proper notice is issued describing the conflicting transaction, required disclosure by the director in full to the shareholders, and the director discloses before the shareholder vote, which shares the director(s) controls.

REQUIRED DISCLOSURE

In order to meet the standard of full disclosure, the director must reveal all facts known regarding the subject matter that an ordinary prudent person would deem material in exercising their judgment concerning the transaction.Virtually any family member is a related person to the director.As a result, disinterested voters on the transaction should have no familial interest nor be connected to the director by virtue of a trust or similar relationship.

Conflict of interest transactions are tricky and are present in the transactions of most family or closely held businesses.If the transaction is not fair to the corporation, a disputing owner will seize upon the conflict of interest laws and utilize them to their benefit to achieve a more leveraged, negotiated business divorce.
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