Meaning
Agreement where a fiduciary stands on both sides of a corporate transaction. These self-dealing transactions occur when a director or officer uses their position to enter into a contract that benefits them personally or an entity they control. While not always illegal, they are subject to strict scrutiny to ensure the terms are fair to the corporation.
The conflict of interest must be disclosed to the board.
Approval Protocol
Validating a deal with an insider requires a vote by disinterested directors or the shareholders after full disclosure of the material facts. If the self-dealing transactions are approved this way, they are often protected by the business judgment rule. In cases where no such approval exists, the person who benefited must prove the entire fairness of the transaction.
This involves showing both a fair price and a fair process.
Typical Scenario
Founders often engage in this behavior when they lease property to the company or provide consulting services through a separate firm. These arrangements can become a source of friction if the new management believes the company is overpaying. Because the records are often less formal in the early days, proving the market value of the services is difficult.
The risk of litigation increases when the company experiences a downturn.
Evidence Requirement
Comparative data from similar deals with third parties justifies the pricing of an internal contract. If no such data exists, the deal is vulnerable. Clarity in the record prevents future disputes.
