Board decisions must be made by disinterested directors. Even the appearance of a conflict of interest should be avoided, if possible, and disclosed if unavoidable.
Consistent with their duty of loyalty, directors and officers should avoid placing themselves or other representatives of the organization in a situation where their personal interest may, or appears to, conflict with the best interests of the organization. This restriction applies not only to obvious conflict situations where an individual is directly involved in both sides of a transaction, but also in more subtle situations. For example, if a director has a close relationship with a person dealing with the organization, the true independence of that director may be subsequently challenged. If an actual or perceived conflict exists, the directors and officers may be required to prove the intrinsic fairness of the challenged transaction to avoid liability.
Directors and officers should heighten their sensitivity towards conflict issues. Because individuals frequently do not focus on perceived conflicts, frequent inquiries and reminders concerning potential conflict situations are suggested.
Where a potential conflict is identified, the director or officer with the conflict should be removed from the decision making process, if at all possible. For example, a majority of disinterested directors should approve transactions directly affecting employee directors, such as decisions with respect to compensation arrangements and employment contracts. The director with the conflict should not only refrain from voting but also be excused from any board discussion involving the proposed transaction. When that director must unavoidably participate in the corporate decision, full disclosure of the conflict should be made not only to other persons involved in the decision making process, but also to members of the organization, when appropriate.
- Remove Director or Officer with conflict from decision making process
- If D&O must participate, full disclosure of conflict must be made
A particularly sensitive area of potential liability exposure exists when directors or officers also serve as plan fiduciaries of employee benefit plans for the organization. Such individuals are subject to inherent conflicts of interest when balancing the sometimes competing interests of the organization and plan participants. For example, decisions relating to the timing and method of the organization's funding of the plan present clear conflicts which must be addressed from the standpoint of both the corporation and the plan.
In summary when an actual, perceived or potential conflict is identified by any person, the following steps should be taken:
- Precisely identify the actual, perceived or potential conflict
- Fully disclose the conflict to legal counsel and, where appropriate, to some or all board members together with an evaluation of the effect and seriousness of the conflict
- Develop an appropriate response, including where necessary, disqualification from voting and discussion, disclosure to the members of the organization or other remedial action
When in doubt as to whether a conflict exists, advice from legal counsel should be obtained. Remember, if there is ANY sign of a conflict of interest, it can completely destroy any defense you may have against a claim.
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