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Legal Memorandum: Corporate Director's Duty of Loyalty

Issue: When does a corporate director’s conflicting interests defeat a defense based on the business judgment rule?

Area of Law: Business Organizations & Contracts
Keywords: Common law fraud; Duty of loyalty or good faith; Corporate director
Jurisdiction: Arizona, Federal
Cited Cases: 96 A.2d 810
Cited Statutes: Ariz. Rev. Stat. § 10-861(B), § 10-862, § 10-863, § 10-830
Date: 03/01/2009

Where directors issue and acquire shares of the voting stock of a corporation, primarily out of a desire to perpetuate or seize control of a corporation from other shareholders, such conduct violates the directors’ fiduciary duty of good faith, is unlawful, and the person wrongfully deprived of control may sue for redress.*FN1 

A corporate director’s duty of loyalty or good faith derives from the prohibition against self-dealing that inheres in the fiduciary relationship.  Pepper v. Litton, 308 U.S. 295, 306-07 (1939).  Generally, “once a prima facie showing is made that directors have a self-interest in a particular corporate transaction, the burden shifts to them to demonstrate that the transaction is fair and serves the best interest of the corporation and shareholders.”  Norlin, 744 F.2d at 264; see Schoen, 804 P.2d at 795 (indicating Arizona Court of Appeals follows the analysis set out in Norlin).   

Ariz. Rev. Stat. § 10-861(B) precludes various remedies in certain cases of “director’s conflicting interest transactions” as a defense.  However, this defense is inapplicable if the directors’ action at issue was neither fair to the corporation (§ 10-861(B)(3)), nor taken in compliance with either § 10-862 (because there were not two “qualified directors” who could have approved the transaction) or § 10-863 (because there was no shareholder action approving the transaction). 

In Arizona, directors have the duty to use “the care an ordinarily prudent person in a like position would exercise under similar circumstances.”  Ariz. Rev. Stat. § 10-830. […]

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