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Arkansas Corporate Fiduciary Standards—Interested Directors' Contracts and the Doctrine of Corporate Opportunity

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Arkansas Corporate Fiduciary Standards—Interested Directors' Contracts and the Doctrine of Corporate Opportunity University of Arkansas at Little Rock Law Review Volume 5 Issue 1 Article 2 1982 Arkansas Corporate Fiduciary Standards—Interested Directors' Contracts and the Doctrine of Corporate Opportunity Susan Webber Follow this and additional works at: https://lawrepository.ualr.edu/lawreview Part of the Business Organizations Law Commons, and the Commercial Law Commons Recommended Citation Susan Webber, Arkansas Corporate Fiduciary Standards—Interested Directors' Contracts and the Doctrine of Corporate Opportunity, 5 U. ARK. LITTLE ROCK L. REV. 39 (1982). Available at: https://lawrepository.ualr.edu/lawreview/vol5/iss1/2 This Article is brought to you for free and open access by Bowen Law Repository: Scholarship & Archives. It has been accepted for inclusion in University of Arkansas at Little Rock Law Review by an authorized editor of Bowen Law Repository: Scholarship & Archives. For more information, please contact [email protected]. ARKANSAS CORPORATE FIDUCIARY STANDARDS- INTERESTED DIRECTORS' CONTRACTS AND THE DOCTRINE OF CORPORATE OPPORTUNITY Susan Webber * INTRODUCTION The occasions for the determination of honesty, good faith and loyal conduct are many and varied, and no hard and fast rule can be formulated. The standard of loyalty is measured by no fixed scale.' An officer, director, or majority shareholder of a corporation owes to the corporation and its shareholders a duty to act in good faith for the benefit of the corporation, but all too often this fiduci- ary obligation is in direct conflict with or otherwise runs afoul of personal interests. One treatise even asserts that this conflict of in- from terest is a natural outgrowth of the separation of ownership 2 control that characterizes the corporate form of doing business. Modem incorporation statutes recognize the fiduciary relation- ship and dictate that certain responsibilities and liabilities will flow from it,3 but no statutory scheme can possibly determine the bound- aries of the corporate fiduciary's duties. Any attempt to codify di- rectors' fiduciary duties would create more problems than it would solve, and majority shareholders have demonstrated that there are innumerable ways to benefit personally by controlling a corporation to the detriment of the corporation or its shareholders while remain- ing within statutory guidelines. Recent decisions demonstrate that the United States Supreme Court is reluctant to expand the application of federal securities laws to breaches of corporate fiduciary duty.' As a result, state com- mon law and statutes frequently provide the only remedies. * B.A., Randolph-Macon Woman's College; M.P.A., J.D., University of Arkansas at Fayetteville. Associate Professor of Law, University of Arkansas at Little Rock School of Law. 1. Guth v. Loft, 23 Del. Ch. 255, 270, 5 A.2d 503, 510 (1939). 2. A. BERLE & G. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 112- 16 (rev. ed. 1967). 3. E.g., ARK. STAT. ANN. § 64-308 (1980). 4. E.g., Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). UALR LAW JOURNAL [Vol. 5:39 This article presents the Arkansas courts' treatment of two basic areas of director conflicts of interest. Because the Arkansas courts have not addressed many of the issues, the presentation is not a complete discourse on the law in either area. To give the reader some general background and to put the Arkansas decisions in a comparative perspective, law from other jurisdictions is included. The first topic presented is interested directors' contracts, those in which the corporate fiduciary contracts with his corporation or causes another business in which he is interested to contract with it. Because the standard for upholding these self-dealing contracts is fairness, courts have had to determine what is fair and who should carry the burden of proof. Although a number of Arkansas deci- sions concern self-dealing transactions, the standards applied in Ar- kansas have not been uniform, perhaps because the Arkansas Supreme Court has failed always to distinguish between transac- tions attacked by corporate creditors and those attacked by the cor- poration or its shareholders. Although the relief sought most often in these cases is avoid- ance of the transaction, in some instances the plaintiff seeks to "pierce the corporate veil" to reach beyond the corporate assets for satisfaction of corporate obligations. Therefore, a discussion of piercing the veil as a remedy for wrongful self-dealing is included. The Arkansas decisions granting this remedy seem sound, although piercing the veil decisions in other jurisdictions have been the sub- ject of much scholarly criticism. Finally, self-dealing contracts for directors' compensation re- ceive special attetion, for they are the subject of specific statutory treatment in Arkansas and elsewhere. Some of the Arkansas pre- statute decisions on this type of contract are discussed to determine whether they retain any value as precedent for cases involving other types of self-dealing contracts unaffected by statute. The second topic is corporate opportunity, a situation in which the corporate fiduciary appropriates for his own benefit a business opportunity which is allegedly that of the corporation. More than one judicial test exists for determining when a business opportunity is a corporate one. There is only one definitive Arkansas decision in this area, and it involved a clear breach of fiduciary duty. The di- rection Arkansas would take in a closer case remains to be seen, and cases from other jurisdictions provide a variety of precedents. Included in the corporate oppoitianity category are cases in- volving a director's purchase of claims against the corporation. 1982] CORPORATE FIDUCIARY STANDARDS There is authority, not universally accepted, that such a purchase can constitute a breach of the director's fiduciary duty to a solvent corporation. However, authorities are in agreement that a director of an insolvent corporation may not purchase claims against the cor- poration at a discount and recover more than he has paid for them. The two Arkansas decisions related to this problem involved insol- vent corporations, and one decision seems unsound. There are other areas of director conflicts of interest which are not included in this article. For example, no mention is made of cases involving liability for sale of the controlling interest of a cor- poration, or for mismanagement resulting from conflicts of interest which do not entail self-dealing or usurpation of a corporate oppor- tunity. Statutes and decisions governing nonprofit corporations, banks, and insurance companies are not within the scope of this ar- ticle unless they apply to business corporations generally. Federal and state securities laws and regulations are also excluded. Although this article frequently refers to corporate directors, much of what is said also applies to corporate officers. So many of the cases researched. involved close corporations in which the de- fendants were both officers and directors that the distinction seemed unimportant. Moreover, many cases refer to an officer or a director.5 I. INTERESTED DIRECTORS' CONTRACTS The validity of a contract between a corporation and one of its directors or between corporations with interlocking directorates is traditionally determined by considerations of fairness to the corpo- ration, ratification by disinterested directors or by shareholders, and disclosure.6 As in most other jurisdictions,7 the standards applied in Arkansas have not been uniform, and the Arkansas legislature has not dealt with the problem by statute,8 except to restrict the author- 5. For a discussion of the merits of distinguishing between officers and directors with regard to the extent of their fiduciary obligations, see Note, CorporateOpportunity, 74 HARV. L. REV. 765, 769 (1961). 6. H. HENN, CORPORATIONS § 238 (2d ed. 1970); N. LATTIN, CORPORATIONS § 80 (2d ed. 1971). Professor Henn indicates that rules governing contracts between corporations with common directors might be less strict. H. HENN, spra at 465. For example, the Supreme Court of Delaware has said self-dealing between parent and subsidiary corpora- tions occurs when "the parent has received a benefit to the exclusion and at the expense of the subsidiary." Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971). 7. A thorough treatment of the development of the law in the United States in this area appears in Marsh, Are Directors Trustees?, 22 Bus. LAw. 35, 36-48 (1966). 8. For analyses of statutory treatment of this problem, see Bulbulia & Pinto, Statutory UALR LAW JOURNAL [Vol. 5:39 ity of corporations to enter into contracts of guaranty or suretyship for the benefit of officers, directors, and ten-percent shareholders.9 A. Directors as Trustees and Development of the "Fairness"Standard Whether directors are trustees and for whom they are trustees are questions that have received a considerable amount of attention over the years.'0 In the context of self-dealing, the prevailing rule in the United States in the latter part of the nineteenth century was that a director was a "trustee" for the corporation and its sharehold- ers, and therefore a contract between a director and his corporation was voidable at the instance of the corporation or its shareholders without regard to the good faith of the director or fairness to the corporation." This rule was based on the principle that a director could not simultaneously be an agent for the corporation and an adverse party without violating his fiduciary responsibilities to the corporation. Approval by disinterested directors had no effect. 2 This is also the English rule, which renders voidable a self-dealing transaction unless it is expressly permitted by the articles of 3 incorporation.' For reasons not altogether clear, this rule had been abandoned in most American jurisdictions by 1910, by which time the prevail- ing view was that a contract between a director and his corporation was valid if it was approved by a disinterested majority of the board and if it was fair and not fraudulent to the corporation.
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