Duty of Loyalty (Corporations)
Directors and officers owe a duty of loyalty to the corporation and its shareholders. They must not place personal interests — or the interests of a third party — above the interests of the corporation. Self-dealing transactions are subject to entire fairness review unless ratified by a disinterested body after full disclosure.
Elements
A duty of loyalty claim requires:
- Fiduciary capacity: defendant is a director, officer, or controlling shareholder
- Conflict of interest: the fiduciary had a personal financial interest in the transaction not shared by shareholders, OR was dominated or controlled by an interested party
- Transaction on non-arm’s-length terms: the corporation was disadvantaged or the fiduciary personally benefited at the corporation’s expense
A director is “interested” if they receive a personal financial benefit from the transaction that differs from the benefit received by shareholders generally.
Safe Harbors — DGCL § 144
An interested-director transaction is not void or voidable if:
- (a) Disclosed to and approved by disinterested directors after full disclosure, OR
- (b) Disclosed to and approved by disinterested shareholders after full disclosure, OR
- (c) Fair to the corporation at the time of authorization, approval, or ratification
Ratification under (a) or (b) shifts the standard of review back toward the business judgment rule. Ratification does not guarantee BJR applies if the ratifying body was not truly independent.
Review Standards
| Situation | Standard |
|---|---|
| No conflict | Business Judgment Rule |
| Interested transaction — no ratification | Entire fairness (defendant bears burden) |
| Interested transaction — ratified by disinterested directors | Entire fairness (but burden may shift to plaintiff) |
| Ratified by disinterested shareholders | Business Judgment Rule (in some jurisdictions) |
| Controlling shareholder freeze-out — MFW conditions met | Business Judgment Rule (Kahn v. M&F Worldwide) |
Policy
- Fiduciaries should not benefit personally at the corporation’s expense; the market cannot adequately monitor conflicts between insiders and shareholders
- Disclosure and ratification restore the arm’s-length quality of the transaction
- Entire fairness review provides a backstop when ratification is unavailable or inadequate
- Duty of loyalty is the “crown jewel” of corporate law — cannot be exculpated (unlike duty of care violations)
Key Cases
| Case | Rule |
|---|---|
| Sinclair Oil Corp. v. Levien (Del. 1971) | Parent-subsidiary conflict; intrinsic fairness required for transactions that benefit parent at expense of subsidiary |
| Bayer v. Beran (N.Y. 1944) | Corporate payments to spouse are an interested transaction requiring scrutiny |
| In re Wheelabrator Technologies (Del. Ch. 1992) | Shareholder ratification of interested transaction restores BJR; but must be fully informed and disinterested |
| Kahn v. M&F Worldwide Corp. (Del. 2014) | MFW standard: BJR applies to controlling-shareholder merger if (1) special committee of independent directors AND (2) majority-of-minority vote, both conditioned from the outset |