In the case of Shapiro v. Greenfield, 136 Md. App. 1, 764 A.2d 270 (2001), minority stockholders brought a derivative action against a corporation and its officers challenging the transfer of a shopping center owned by the corporation to a limited partnership. The minority stockholders claimed that the transaction involved was invalid because it was both an interested director transaction and constituted the usurpation of a corporate opportunity.
The court first addressed the issue of corporate opportunity, saying that both parties to the case relied on the case of Independent Distributors, Inc. v. Katz, 99 Md. App. 441, 637 A.2d 886, cert. denied, 335 Md. 697, 646 A.2d 363 (1994), “for the proposition that officers or directors will not be held liable for usurpation of corporate opportunity if the transaction was fair and reasonable to the corporation.” In fact, Maryland Code, Corporations and Associations Article (CA), section 2-419 allows for certain “safe harbors” where a transaction is not void solely because a director has a personal interest in it. Specifically, under Maryland Code, CA, section 2-419(b)(2), a director can meet certain disclosure requirements or a board or the stockholders can meet certain ratification requirements to make the transaction valid. Furthermore, the statute also provides that a transaction may be valid simply because it is “fair and reasonable to the corporation.” The court noted, however, that the application of this standard to the usurpation of corporate opportunity question in Katz has drawn scholarly criticism. One commentator has argued that since it is inherently unfair to take a profitable opportunity from a corporation, fairness should not be a part of the corporate opportunity analysis in the same sense that it is when determining the fairness of a transaction under the interested director transaction doctrine. Before the court could address this criticism, though, it discussed the differences between the corporate opportunity doctrine and the interested director transaction doctrine.
Unlike interested director transactions, the court explained that most corporate opportunities do not involve transactions with the corporation, but rather involve transactions that are taken from the corporation. While a director’s interest in a transaction is determined by his involvement with the contract or transaction that the corporation is entering into, a corporate opportunity is based instead on the non-involvement of the corporation in a contract or transaction in which it may have an interest. The doctrine of corporate opportunity thus stands to keep a fiduciary from taking a business opportunity that rightfully belongs to the corporation and using it for his or her own benefit. Whether or not an opportunity constitutes a corporate opportunity is determined by the “interest or reasonable expectancy” test. The court explained that this test “focuses on whether the corporation could realistically expect to seize and develop the opportunity.” Id. at 448. If a corporation could take advantage of the opportunity, the director may not interfere by taking the opportunity for personal benefit.
While the Shapiro court gives a detailed description of the corporate opportunity doctrine, as well as explaining the criticism the application of the fairness/reasonableness standard to the doctrine receives, the court did not answer the criticism or apply the doctrine to case. This is because the court found that the Shapiro transaction was an interested director transaction instead of a usurpation of corporate opportunity. The transaction was not one where a director took advantage of an opportunity that belonged to the corporation. Rather, the transaction was between the corporation and other entities “in which certain directors had, or potentially had, a direct financial interest.” Shapiro, 136 Md. App. at 17. The correct test for the court was to see if the transaction was valid under the Maryland Code, CA, section 2-419 governing interested director transactions. The court remanded the case for reconsideration based on this standard, but also felt it was necessary to explain in detail the standard in Maryland for determining when exactly a director has an “interest” in a transaction.
The court’s explanation was necessary because the directors (appellants) argued that a director who is related to a party with a material financial interest was not an interested party. The appellants’ justification for this was that Maryland had rejected the Model Code and American Law Institute (ALI) definitions of “interested director” that contained the concept that a familial relationship could cause a party to be “interested.” The court stated that this conclusion was “too broad,” and then provided its position as to what factors create an interested party under Maryland law.
The court began its discussion by explaining that the Maryland statute was modeled after the statutes of other jurisdictions, such as Delaware, New York, and California. Similar to the Maryland statute, none of these states define the term “interested director” in their statutes. Rather, these state statutes look to the “director’s ability to exercise independent judgment and the expected influence of a particular relationship on the director” when making the determination of a director’s interest in a transaction. The court added that these were the appropriate factors to look at when trying to make such a determination. Based on this inquiry, it was clear to the court that “directors are required to avoid only those self-interested actions which come at the expense of the [corporation]” or the stockholders. Id. at 23. Not all interested transactions are to be held void, but rather only the ones where the director’s interest is such that it will impair his or her ability to make an unbiased decision in the corporation’s best interest.
With this in mind, the court observed that the Model Code and ALI provisions related to interested directors also incorporate this view. While it is easy to determine that a director is interested when he is directly involved in a transaction, the Model Code and ALI provisions state no per se rule that determines when a director with no direct interests will be considered an “interested director.” Though an interest can follow from a familial or business relationship, neither one of these automatically makes a director interested because such a relationship “does not necessarily destroy an individual’s independent judgment.” The Model Code and ALI standards put emphasis on the question of whether the relationship could “reasonably be expected to exert an influence on the director’s judgment.”
The court felt that the purpose of the Model Code and ALI provisions, as well as the Delaware, California, and New York statutes (which Maryland’s is based on) would be undermined by a per se rule such as the one appellants argued. The court argued that to hold that a director is interested simply because of a familial or business relationship in essence could preclude some directors who are able to maintain independent judgment from considering certain transactions. Conversely, to hold that a director was disinterested because of a lack of a direct interest could allow a director to act for the corporation when a familial or business relationship did impair the director’s judgment. For this reason, the court determined that the appellants’ assertion that a familial relationship could not cause a party to be classified as “interested” was incorrect. Rather, the standard in Maryland is to look at the facts and circumstances surrounding a director’s relationship. If “it would reasonably be expected that the director’s exercise of independent judgment would be compromised” because of the director’s relationship with an interested party, the director will also be classified as an interested director. Id. at 24.
Submitted by Venable, Baetjer and Howard, LLP