Sanitizing Interested Transactions
Claire Hill & Brett McDonnell
How should corporate law deal with a controlling person’s entry into a transaction with the corporations he controls? How should corporate law deal with transactions or decisions where one or more board members are interested? In this Article, we argue that Delaware law could do a better job answering these questions than it presently does.
We propose a modest strengthening of judicial review of interested transactions. For transactions where one or more directors have a conflicting interest and defendants attempt to cleanse the transaction using approval by the disinterested directors, we propose that the defendants show that the approving disinterested directors exercised independent business judgment. Only when the defendants make this showing would the transaction receive the protection of the business judgment rule. For all transactions with a controlling shareholder, the Weinberger entire fairness frame work should apply.
Since many duty of loyalty cases will be characterized as derivative actions, we would also revise the first prong of Aronson. We propose that if the plaintiff shows that at least one director is interested, demand is excused unless defendants show that the approving disinterested directors exercised independent business judgment and the plaintiffs cannot rebut that showing. If the plaintiffs can show that the transaction was with a controlling shareholder (as defined in the Weinberger line of cases), demand should be excused.
Our proposal is far from radical. Rather, it provides weaker oversight of interested transactions than the traditional common law approach,which simply deemed all interested transactions void. It fits well within the purview of current Delaware law, which applies procedural scrutiny when independent direct or approve such a transaction. It balances the danger that shareholders will be abused by interested transactions with the danger of encouraging strike suits. Indeed, the fact that Delaware does not already follow a variant of this approach is somewhat surprising.