Directors of all corporations – including family owned businesses – owe a fiduciary duty of loyalty to the company. This duty requires a director to put the interests of the company ahead of his or her personal interest and not to divert corporate opportunities or assets for his or her own benefit. Many state statutes further address potential conflicts of interest and allow for such conflicting interest transactions as long as the director makes prior disclosure and obtains the approval of all non-interested directors or shareholders before embarking on the transaction. This statutory process protects the corporation from the potential damage of a self-interested deal by one or more directors. It also provides cover for the director when acting for his or her own benefit as long as the director makes the proper prior disclosures and receives the needed approval.
A recent decision from the United States District Court for the Western District of Washington – RRW Legacy Management Corp. v. Campbell Walker – serves as a cautionary tale for corporations and directors and highlights the downside of a director’s failure to go through this notice and approval process before embarking on transactions that benefit him personally over the corporation. The corporation in that case (Campbell Investments Corporation, Inc.) was formed by Robert Walker to manage the family’s various investments in oil and gas wells. Robert formed a separate limited partnership (RRW) to hold his shares in CIC. Robert’s five children were the remaining minority owners of CIC.
A recent decision… serves as a cautionary tale for corporations and directors…
In 1999, Robert transferred all of his majority ownership interests in CIC to his son Campbell Walker, who then became the president of CIC. Campbell was also a director of the company. Campbell retained these positions until 2014. The other siblings remained minority owners of CIC. While he was president of CIC, Campbell refused to provide his siblings with any financial information regarding the company, relocated all the company’s records to Nevada in violation of the by-laws and caused CIC to engage in a series of transactions with entities in which he had an interest. Specifically, Campbell terminated the company’s existing management agreement with an entity in which all siblings held an interest and entered into a new agreement with an off-shore company (Darshan League, Ltd) that Campbell owned and controlled. During his tenure Campbell caused CIC to pay over $3,000,000 to Darshan in management fees. Neither the relationship with Darshan nor the payments were ever presented to the CIC board for consideration or approval by any of the disinterested directors.
The siblings voted to remove Campbell “for cause” based on these claimed misdeeds. CIC then sued Campbell for breach of fiduciary duty, claiming that he had entered a number of unauthorized “conflicting interest transactions.” At the summary judgment stage, the court ruled that Campbell had in fact breached his fiduciary duty by entering into the agreement with Darshan, by causing CIC to make those substantial payments to Darshan over the years, and by personally benefitting from those payments at the expense of CIC. The court then conducted a trial on the damages to CIC. After trial, the court made additional findings in support of the conclusion that Campbell breached his fiduciary duties:
- CIC did not hold any board meetings or shareholder meetings while Campbell was president
- Campbell created false minutes of board and shareholder meetings that never took place
- Campbell directed $200,000 in “consulting fees” to be paid to his father
- Campbell directed over $300,000 to be paid to him as reimbursement for “extensive international travel,” even though all of CIC’s business interests were based in the United States
- Campbell caused certain of CIC’s interests in oil and gas wells to be transferred to companies which Campbell owned or managed
- None of CIC’s business or management decisions were ever presented to the CIC board for approval
- In particular, none of the transactions with the entities that Campbell owned or managed were presented to the board for approval by any disinterested board members
After trial, the court awarded CIC a judgment in excess of $4,500,000 as damages for Campbell’s improper conflicting interest transactions. Campbell has appealed this judgment to the Ninth Circuit Court of Appeals and it remains to be seen what will happen on further review. Nonetheless, this case offers a stark reminder of the risks of inappropriate conflicting transactions.
- For the company, there is a risk that a faithless director will engage in self-interested transactions, extract valuable assets or opportunities, and leave the company and its other stakeholders with the chore of bringing suit to recover the damages
- For the director, there is the risk that a conflicting interest transaction will become voidable if not presented to independent directors in advance for approval. In such a case, the director may also be found liable in any later suit for the amounts transferred from the company in connection with the transaction
Directors should therefore be sure to carefully consider whether any transaction they propose between their company and themselves or a separate entity in which they have an interest qualifies as a conflicting transaction under the applicable state statute. If so, directors should present this transaction to the board for consideration and approval. For their parts, other corporate directors or shareholders should insist upon access to and receipt of timely and accurate corporate records so they can monitor the company’s (and the other directors’) performance. Not only is doing so good corporate governance, but it also will promote and ensure transparency in the company’s decision making and help all parties avoid the risk of loss or liability.