By Daniel O. Carroll, Esq.

Under the business judgment rule, courts will normally defer to decisions made by a corporation’s board of directors, however, that deference may be challenged or eliminated where a conflict of interest exists. Failing to adequately address conflicts of interest may expose directors to liability for breaches of fiduciary duties and invalidate action taken by the board.  However, New Jersey statutory law expressly provides that contracts or transactions involving a corporation and one or more of its directors will not be void or voidable solely because of a director’s conflict of interest if certain requirements are met.  If the contract or transaction that is tainted by a director’s conflict of interest is either fair and reasonable to the corporation at the time it is approved or the conflict of interest is known or disclosed and such contract or transaction is approved or ratified by a majority of disinterested (i.e., not conflicted) members of the board, then the board’s approval of such contract or transaction should be respected and not set aside. 

Importantly, merely following the manner for approving a conflict-of-interest transaction set forth in New Jersey statute does not provide the board’s approval absolute protection from attack.  New Jersey courts may still scrutinize, and even set aside, conflict-of-interest transactions where equitable bases dictate.  Following the statute only means that the transaction is not voidable solely because of the conflict.  In some circumstances, after a court reviews the disclosure of the conflict and the board’s approval process, the court may undertake a further inquiry of the fairness of the transaction.  Accordingly, boards of directors should take affirmative steps to avoid structural bias in their decision-making process and establish a record of true diligence, deliberation, and inquiry by members of the board (or committee) that are not interested or otherwise conflicted in the subject transaction or contract.

Corporations are well advised to adopt, maintain, and routinely review a conflict-of-interest policy for transactions and contracts that involve interested directors or related parties.  Court cases in New Jersey and Delaware have acknowledged the importance of corporations proactively documenting steps taken by their board to identify conflicts and follow established procedures for ensuring directors with conflicts do not participate in the discussions or approval of a conflict-of-interest transaction or contract in a way that suggests undue influence or impropriety.  Such measures may help avoid the board action from being later attacked and invalidated.

While New Jersey law would permit a corporation’s board to approve a conflict-of-interest transaction by written consent, proceeding in such manner may not be sufficient to establish adequate deliberation, and approval by disinterested directors. For this reason, written consent of a conflict-of-interest transaction or contract should be avoided as the sole means of memorializing board action.

A best practice and a safe way to approve a conflict-of-interest transaction or contract is the use of a board committee consisting exclusively of disinterested directors.  This will likely require the board to create a new special committee of disinterested board members specifically for the transaction or contract in question.  Even if less than a majority of directors are disinterested, a transaction or contract may be approved provided the board can readily establish that the approval was not unduly influenced by directors who are conflicted.

Additional best practices that boards may use to help establish a record of unbiased deliberation and fairness in the decision-making and approval process include (1) routinely using and reviewing conflicts-of-interest questionnaires, and (2) engaging outside independent consultants to render fairness opinions and valuations for disinterested directors to rely on when taking action to approve transactions or contracts with complex fact patterns. 

Taking steps to establish a procedure for directors to follow will help corporations diminish the taint of conflicts.  Implementing procedural safeguards, with the intent of purging conflicts of interest from board action and approval, should protect the board of directors from being second guessed and allow the board to fully exercise its corporate management authority.  Finally, maintaining a record of these procedural safeguards will provide courts with a sound basis for affording a corporation’s board of directors the benefits of the business judgment rule. 

For more information, contact Daniel O. Carroll at doc@spsk.com or 973-631-7842.