Interested Directors' Contracts, Corporate Opportunities, and Directors' and Officers' Personal Liability

• Author: Christopher C. Nicholls
• Pages: 313-342

313

CHAPTER ELEVEN

Interested Directors’ Contracts,

Corporate Opportunities, and

Directors’ and Officers’

Personal Liability

INTRODUCTION

Chapter 10 introduced the general principles that underlie the legal duties of a corpora-

tion’s directors and officers. This chapter will look at the role of directors and officers

from a different perspective, focusing on three areas of potential liability for directors

and officers:

•interested directors’ and officers’ contracts (that is, contracts between the corpora-

tion and one of its own directors or officers);

•corporate opportunities (that is, cases in which a corporate director or senior officer

seizes for his or her own benefit a profitable business opportunity in which the

corporation itself may be said to have had the prior right or interest); and

•personal liability of directors and officers to third parties.

INTERESTED DIRECTORS’ CONTRACTS

Framing the Issue

Corporate directors may, from time to time, have goods or services that they wish to sell

to the corporation on whose board they sit. Alternatively, the corporation may have assets

or services that it wishes to sell, and that one of its directors is willing and able to buy.

Transactions like these inevitably place the directors involved in a position where their

personal interests may conflict with their duty to the corporation. If a director is selling

an asset to the corporation, for example, the director’s duty to the corporation requires

him or her to try to negotiate the lowest possible purchase price. But, the director’s

personal interest, as seller, is to try to obtain the highest possible sale price.

The law has always taken a dim view of such conflicts of interest. Honourable

directors, it was long thought, ought never to permit their duty to come into conflict with

their personal interest. As will be seen below, historically, the law would often treat such

Copyright © 2005 Emond Montgomery Publications. All Rights Reserved.

314 Chapter 11 Directors’ Contracts, Corporate Opportunities, Personal Liability

transactions between a corporation and any of its directors as voidable at the instance of

the corporation.

This harsh common law rule is understandable in the case of a corporation that has

multiple shareholders but only one director. That director might well be tempted to use

her position to enrich herself personally by committing the corporation to one-sided

contracts in her own favour. But suppose a corporation has not one director, but many. If

those directors, acting in the best interests of the corporation, collectively decide that the

corporation ought to enter into some contract or other transaction with one member of the

board, is it clear that the law should always forbid such matters? Why should the

corporation not be permitted to decide for itself (through its impartial directors) whether

it wishes to deal with an “interested director”? After all, the non-interested directors

would surely be no less aware of their fellow directors’ conflicts than are judges or

legislators. If the non-interested directors, acting in good faith, are satisfied that a con-

tract with one of their own is, all things considered, to the benefit of the corporation, why

should courts or statutes interfere with that business judgment?

Two answers to this question are sometimes suggested. First, it has been argued that a

corporation has a right to expect the full attention and decision-making skills of all of its

directors.1 In other words, if a corporation has, for example, a board of five directors, it is

not right for one of them—the interested director—to remove himself or herself from the

business decision-making dynamic by proposing to deal with the corporation. There is

also a second consideration. Many doubt whether it is ever really possible for directors of

a corporation to deal objectively and independently with one of their colleagues. These

doubts are especially poignant when the interested director is also a senior manager of

the corporation. The interested director may exercise a degree of undue influence on the

remaining board members—sometimes subtle, even unconscious, and sometimes, sadly,

not subtle at all.

If the influence, or pressure, exerted by one director over his or her fellows were

always overt or heavy handed, then perhaps the legality of such contracts could be dealt

with on a case-by-case basis. But, more often than not, directors approving a contract

between the corporation and a member of the board may be subject to influence that is

quite incapable of proof after the fact. Better, then, to equip non-interested directors with

a ready answer to the aggressive “interested” director by imposing an unforgiving rule of

contract voidability.

It seems, however, both impractical and unnecessary to forbid all contracts between

corporations and directors. And such a total ban also does seem to be an excessive

intrusion into private business relationships. Accordingly, the law of interested directors’

contracts attempts to balance and resolve these tensions. Judges and legislators do not

wish to interfere unduly with what are, after all, private organizations that must normally

be permitted to make (and live with) their decisions. However, at the same time, this

laissez-faire ideal must be balanced against an awareness that we do not live in a utopian

world of philanthropy and altruism, and that things are not always what they seem. A

board’s decision to permit a corporation to enter into a contract with one of its own

1As Lord Radcliffe put it in Gray v. Augarita Porcupine Mines Ltd., [1952] 3 DLR 1 (PC), “The company,

it has been said, has a right to the services of its directors as an entire Board.”

Copyright © 2005 Emond Montgomery Publications. All Rights Reserved.