Business Associations

Fact pattern

Mr. A is a director for Company X, a closely held corporation. Company X is incorporated in a state that has adopted the Model Business Corporations Act (MBCA). Company X decides to sell its primary manufacturing facility, located in Wisconsin. The Wilson Family Trust (the trust) tenders the highest bid, and thus Company X’s directors approve the sale. Mr. A votes in favor of the sale, but does not tell the other directors that his first cousin is a beneficiary of the trust.  

The following year, Company X has a change of heart and decides to repurchase the Wisconsin facility. However, the facility is now owned by Mrs. B, the wife of Mr. A’s oldest nephew. Company X is preparing a bid for the facility, and Mr. A is concerned that the deal could represent a conflicting-interest transaction.

Mr. A decides to bring the matter before Company X’s full board of directors. During the board meeting, he tells the board about the potential conflict and everything he knows about the transaction. After conferring with a few board members, the chairman of the board tells Mr. A, “We appreciate your candor. We all know you cannot vote on the measure, but we would like you to stay during our discussion and provide insight into the deal’s terms.” Mr. A agrees. 

The meeting goes on for a long time, but by the end, Company X drafts a term sheet that Mrs. B later accepts. Afterwards, Mr. A begins to feel like he should not have participated in the discussion regarding the terms of the sale. He decides that the company should have the shareholders authorize the transaction, to avoid any appearance of impropriety. 

To that end, the company provides proper notice to all shareholders, informing them of Mr. A’s potential conflict and conveying all material information regarding that conflict. Company X has 3,000 outstanding shares, of which 1,550 shares vote to authorize the transaction. Mr. A’s wife owns 500 Company X shares; she votes to authorize the transaction.

After the sale closes, some shareholders grow displeased with the transaction, as pictures of Mr. A having dinner with his nephew and Mrs. B begin appearing on the Internet. An attorney representing a few of these shareholders contacts Mr. A, who says, “I disclosed my conflict and acted in good faith. There was no impropriety here. To tell you the truth, my nephew just filed for divorce, so I don’t think it’s even an issue anymore. Oh, and did I mention that six facilities very similar to the Wisconsin facility have been sold since we closed the purchase from Mrs. B? They all sold for far more than what Company X paid.”

Questions

1. Under the MBCA, was Company X’s sale of the Wisconsin facility to the trust a conflicting-interest transaction, considering that Mr. A’s cousin was a beneficiary of the trust? Explain.
2. Under the MBCA, was Company X’s purchase of the Wisconsin facility a conflicting-interest transaction because of Mr. A’s relationship to the purchaser? If so, did Mr. A properly sanitize the transaction, or make it legitimate, by informing the board of the potential conflict and abstaining from voting on the measure? Explain.
3. Under the MBCA, was Company X’s purchase of the Wisconsin facility properly sanitized by the shareholder vote? Explain.
4. For purposes of this question, assume that Company X failed to properly sanitize its purchase of the Wisconsin facility. If a group of shareholders sues Mr. A, claiming the purchase represented a conflicting-interest transaction that was not properly authorized, what is Mr. A’s best defense under the MBCA? Explain.