“Self-dealing” is a legal concept which is applied to a transaction in which a fiduciary (such as a trustee, general partner, controlling shareholder, director, or officer) derives a personal benefit from a transaction with or involving the entity to which he owes the fiduciary duty. In re Nat'l Auto Credit S'Holders Litig., 2003 Del. Ch. LEXIS 5, 30 (Del. Ch. Jan. 10, 2003), (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)). A common example of self-dealing occurs when a corporate director appears on both sides of a transaction or receives a benefit not shared by the shareholders generally. Cede & Co. v. Technicolor, 634 A.2d 345, 362 (Del. 1993). This article will examine how “self-dealing” transactions are addressed under Delaware law.
The General Rule: A fiduciary may not place his private interests in conflict with those of the party he owes a duty to
“First, and fundamentally, one who . . . is a shareholder, officer and director of a closely held corporation, is under a duty ‘to deal fairly, in good faith and with loyalty’ to the corporation and other shareholders. This requires that he exert his best efforts in behalf of the corporation and not compete with it or profit at its expense, or place his private interests in conflict with it. The scope of this fundamental duty is determined, however, by the circumstances of each case, and does not run to every act having any semblance of employee self-interest.” Uniflex, Inc. v. Endurapack, Inc. (In re Uniflex, Inc.), 319 B.R. 101, 106 (Bankr. D. Del. 2005), (quoting Am. Fed. Group, Ltd. v. Rothenberg, 136 F.3d 897, 905 (2d Cir. 1998)).
The Exception: When the fiduciary can demonstrate the inherent fairness of the transaction
“‘When directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain. . . The requirement of fairness is unflinching in its demand that where one stands on both sides of a transaction, he has the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts.’” Nixon v. Blackwell, 626 A.2d 1366, 1376 (Del. 1993), quoting Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 710 (1983). In other words, when a corporate officer engages in a self-dealing transaction not approved by an independent board (acting in accordance with certain standards), the transaction is unlawful unless the proponent of the transaction carries the burden of showing that it was “entirely fair.” Merritt v. Colonial Foods, Inc., 505 A.2d 757, 763-66 (Del. Ch. 1986)). The entire fairness standard has two aspects: “fair dealing and fair price.” Gesoff v. IIC Indus., 902 A.2d 1130, 1144 (Del. Ch. 2006), (quoting Weinberger 457 A.2d at 708).
The Test: “Entire Fairness - Fair Dealing and Fair Price”
Fair dealing “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” Weinberger, 457 A.2d at 711. For instance, there was no fair dealing where controlling shareholders failed to disclose to minority shareholders material information about bargaining positions of the parties in a merger. Id. at 703. The proponent must provide full disclosure with respect to the circumstances of the transaction and cannot be misleading. Id. at 711. Finally, the transaction must be objectively fair; even an honest belief that it is fair will not satisfy the standard. Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del. Ch. 2006).
Fair price “relates to the economic and financial considerations of the [litigated transaction], including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.” Id. “[T]he pricing terms of a transaction that is the product of an unfair process [must] be justified by reference to reliable markets or by comparison to substantial and dependable precedent transactions,” otherwise “the burden of persuading the court of the fairness of the terms will be exceptionally difficult.” Valeant Pharms. Int’l v. Jerney, 921 A.2d 732, 748 (Del. Ch. 2007). “However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.” Weinberger, 457 A.2d at 711.
The Warning: Proving “Entire Fairness” is often a “daunting task”
The “burden of proving entire fairness is often a daunting task,” involving “a standard so exacting that it ordinarily, but not invariably, results in a finding of liability.” Solomon v. Armstrong, 747 A.2d 1098, 1113, n.39 (Del. Ch. 1999). Proponents of a self-dealing transaction are “required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.” Weinberger, 457 A.2d at 710. The “entire fairness” standard is considered very exacting and, therefore, is often outcome determinative. Nixon v. Blackwell, 626 A.2d at 1376 (quoting Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1279 (Del. 1988)).