Self-dealing directors/trustees and Interlocking Directors/Trustees Explained (Sections 31-32, RCC)

Summary

Attorney Chris Batan Lasko's video explores the legal implications of contracts involving self-dealing directors and interlocking directors in corporations. He explains that such contracts are generally voidable but can be valid under specific conditions outlined in the Revised Corporation Code, including fairness, reasonableness, and approval by independent directors or the board. The video clarifies the distinction between substantial and nominal interests of directors in intercorporate contracts and provides guidance on the validity of these contracts.

Takeaways

• 📜 The video discusses the effects of contracts involving self-dealing directors, trustees, or officers within a corporation.
• 🔍 A 'self-dealing director' is defined as any director, trustee, or officer who enters into a contract with the corporation, including their relatives or spouse.
• ⚖️ Generally, contracts with self-dealing directors are voidable at the option of the corporation, unless certain conditions are met as per Section 31 of the revised corporation code.
• 📝 Section 31 outlines specific conditions under which a contract with a self-dealing director can be considered valid, such as the director's presence not being necessary for a quorum or contract approval.
• 👥 The contract must be fair and reasonable, even if the director's vote was not necessary for its approval, and must be authorized by the board of directors if involving an officer.
• 🏢 For corporations with public interest, material contracts need approval by at least two-thirds of the board members, with a majority of independent directors voting in favor.
• 🔄 If any of the first three conditions of Section 31 are absent, the contract may still be ratified by the stockholders or members representing at least two-thirds of the outstanding capital stock.
• 🔄 The second part of Section 31 allows for a contract to be valid even if one of the first three conditions is not met, provided it is fair, reasonable, and ratified by the required stockholder or member vote.
• 🔗 Section 32 addresses contracts between corporations with interlocking directors, stating that such contracts are not invalidated solely on the basis of interlocking directorship, unless fraud is involved.
• 📊 If an interlocking director has a substantial interest in one corporation and a nominal interest in another, the contract may be subject to the same conditions as self-dealing director contracts under Section 31.
• 📈 A 'substantial interest' is defined as holdings exceeding 20% of the outstanding capital stock, which can affect the validity of inter-corporate contracts under certain conditions.

Q & A

What is the main focus of the video by Attorney Chris Batan Lasko?

The main focus of the video is to simplify the law, particularly discussing the effects of contracts between a corporation and its directors, trustees, officers, or their relatives, and the implications of contracts between two corporations with interlocking directors.

What is meant by 'self-dealing directors or trustees'?

Self-dealing directors or trustees refer to individuals who enter into a contract with a corporation they are associated with, even if the contract involves their spouse or relatives within the fourth degree of consanguinity or affinity.

What is the general rule regarding contracts entered into by self-dealing directors or trustees with a corporation?

As a general rule, such contracts are voidable at the option of the corporation.

What conditions must be present for a contract with a self-dealing director to be considered valid according to Section 31 of the Revised Corporation Code?

The conditions include: a) the presence of the self-dealing director in the board meeting was not necessary for a quorum, b) the vote of the self-dealing director was not necessary for the contract's approval, c) the contract is fair and reasonable, d) material contracts are approved by at least two-thirds of the board with a majority of independent directors, and e) for officers, the contract must be previously authorized by the board of directors.

What does Section 32 of the Revised Corporation Code state about contracts between corporations with interlocking directors?

Section 32 states that a contract between corporations with interlocking directors is not invalidated solely on that ground, provided there is no fraud and the contract is fair and reasonable. However, if the interlocking director has a substantial interest in one corporation and a nominal interest in the other, the contract may be subject to the provisions of Section 31.

What is considered a 'nominal interest' in the context of interlocking directors?

A 'nominal interest' is not explicitly defined in the script, but it is contrasted with a 'substantial interest,' which is defined as holdings exceeding 20% of the outstanding capital stock.

How can a voidable contract with a self-dealing director become valid if certain conditions are absent?

The contract can be ratified by the vote of stockholders representing at least two-thirds of the outstanding capital stock or of at least two-thirds of the members in a meeting called for the purpose, provided full disclosure of the adverse interest is made and the contract is fair and reasonable.

What is the relevance of determining whether a director's interest in a corporation is nominal or substantial?

The relevance is to determine whether the contract between two corporations with interlocking directors is voidable or valid. If the director has a nominal interest in one corporation and a substantial interest in another, the contract may be voidable according to Section 31.

What happens if an interlocking director has substantial interests in both corporations involved in a contract?

If the interlocking director has substantial interests in both corporations, the contract is considered valid, and the conditions required under Section 31 do not apply.

What is the role of independent directors in approving material contracts with self-dealing directors according to Section 31?

At least a majority of the independent directors must approve the material contract for it to be considered valid.

How does the video aim to help viewers understand complex legal concepts?

The video aims to simplify the law by discussing legal concepts and principles in an accessible manner, focusing on specific sections of the Revised Corporation Code and providing clear explanations of the conditions under which certain contracts are considered valid or voidable.

Outlines

00:00

📚 Introduction to Self-Dealing Contracts in Corporations

Attorney Chris Batan Lasko introduces his YouTube channel, which aims to simplify the law in under 10 minutes per video. In this video, he discusses the implications of contracts involving a corporation and its directors, trustees, officers, or their relatives. He explains the term 'self-dealing directors' and outlines the general rule that such contracts are voidable, but can be valid under certain conditions as stipulated in Section 31 of the Revised Corporation Code.

05:02

🔍 Conditions for Validity of Self-Dealing Contracts

The video delves into the specific conditions under Section 31 that must be met for a self-dealing contract to be considered valid. These include the non-necessity of the self-dealing director's presence for a quorum, the irrelevance of their vote for contract approval, the contract's fairness and reasonableness, approval by two-thirds of the board for corporations with public interest, and prior authorization by the board for contracts with officers. The explanation includes examples to clarify each condition.

10:05

📜 Ratification of Self-Dealing Contracts Despite Absent Conditions

The second part of Section 31 is explored, which allows for the ratification of self-dealing contracts even if the first three conditions are not met. The contract can still be valid if ratified by at least two-thirds of the outstanding capital stock or members, provided full disclosure of the director's adverse interest and the contract's fairness and reasonableness are established.

15:06

🤝 Validity of Contracts with Interlocking Directors

The script moves on to discuss contracts between corporations with interlocking directors, as per Section 32 of the Revised Corporation Code. It clarifies that such contracts are generally valid unless fraud is involved and the contract is fair and reasonable. However, if an interlocking director has a nominal interest in one corporation and a substantial interest in another, the contract may be voidable, and the conditions of Section 31 would apply to the corporation with the nominal interest.

20:08

🏢 Conclusion on Self-Dealing and Interlocking Director Contracts

The final paragraph summarizes the rules for contracts involving self-dealing directors and interlocking directors. It emphasizes that contracts are valid unless specific conditions make them voidable, and provides examples of different scenarios to illustrate when these contracts are considered valid. The video concludes with a reminder of the importance of understanding these legal nuances and an invitation for viewers to engage with the channel for more educational content.

Keywords

💡Self-dealing Director

A self-dealing director is a board member of a corporation who enters into a contract with the corporation for personal gain. This concept is central to the video as it explores the potential conflicts of interest when a director, trustee, or officer engages in transactions that may benefit them personally. The video discusses the legal implications and the conditions under which such contracts can be considered valid or voidable.

💡Voidable Contract

A voidable contract is one that can be invalidated at the discretion of one of the parties involved. In the context of the video, contracts between a corporation and a self-dealing director are typically voidable at the corporation's option, unless certain legal conditions are met. The video details the specific requirements that can make such contracts valid despite the potential conflict of interest.

💡Quorum

A quorum is the minimum number of members required to be present for a meeting to be legally valid and for decisions to be made. The video explains that for a contract involving a self-dealing director to be valid, the director’s presence must not be necessary to constitute a quorum during the board meeting where the contract is approved. This ensures that the decision is made without undue influence from the self-dealing director.

💡Interlocking Director

An interlocking director is a person who serves as a director on the boards of two or more corporations that enter into a contract with each other. The video discusses the legal status of contracts between corporations with interlocking directors, emphasizing that such contracts are generally valid unless the director has a substantial interest in one corporation and only a nominal interest in the other, which may render the contract voidable.

💡Section 31

Section 31 refers to a specific provision in the Revised Corporation Code that outlines the conditions under which contracts involving self-dealing directors, trustees, or officers may be considered valid or voidable. The video focuses on these conditions, explaining that the contract must be fair, reasonable, and approved without the influence of the self-dealing party to be valid.

💡Fair and Reasonable

A contract is considered fair and reasonable if the terms and conditions are comparable to what would be offered to a third party without any conflicts of interest. The video emphasizes that for contracts involving self-dealing directors or interlocking directors to be valid, they must be fair and reasonable under the circumstances, ensuring that the corporation is not disadvantaged.

💡Material Contract

A material contract is a contract that is significant to the corporation, often involving large sums of money or critical business operations. The video mentions that for corporations vested with public interest, material contracts involving self-dealing directors must be approved by a significant majority of the board, including independent directors, to be considered valid.

💡Ratification

Ratification is the approval of a contract by a corporation’s shareholders or members after the contract has been entered into. The video explains that if the conditions required under Section 31 for a contract involving a self-dealing director are not met, the contract may still be ratified by a vote of at least two-thirds of the outstanding capital stock or members, making it valid.

💡Substantial Interest

Substantial interest is defined as holding more than 20% of the outstanding capital stock in a corporation. The video uses this term to explain the exception in Section 32, where contracts between corporations with interlocking directors may be voidable if the director has a substantial interest in one corporation and only a nominal interest in the other.

💡Nominal Interest

Nominal interest refers to a small or insignificant ownership stake in a corporation, typically less than 20% of the outstanding capital stock. The video explains that when an interlocking director has a nominal interest in one corporation and a substantial interest in another, contracts between those corporations may be subject to additional scrutiny under Section 31, making them potentially voidable.

Highlights

Introduction to simplifying the law in under 10 minutes.

Discussion on the effects of contracts between a corporation and its directors, trustees, or officers.

Definition of self-dealing directors, trustees, and officers in contracts.

General rule that contracts with self-dealing directors are voidable.

Conditions under Section 31 for a voidable contract to be considered valid.

Explanation of the necessity of director presence in board meetings for quorum.

Clarification on the necessity of the self-dealing director's vote for contract approval.

Requirement for contracts to be fair and reasonable under the circumstances.

Special conditions for corporations with public interest and material contracts.

Authorization by the board of directors required for officer contracts to be valid.

Ratification of contracts with absent conditions by stockholders or members' vote.

Contracts between corporations with interlocking directors under Section 32.

Validity of contracts with interlocking directors unless involving fraud.

Substantial and nominal interests of interlocking directors in contracting corporations.

Voidability of contracts when interlocking directors have substantial interests in one corporation.

Application of Section 31 conditions to voidable contracts with interlocking directors.

Conclusion on the validity of contracts with interlocking directors based on their interests.

Encouragement for viewers to subscribe and engage with the channel for new content.

Transcripts

foreign

[Music]

hi i am attorney chris batan lasko

this is my virtual classroom welcome to

my youtube channel

in this channel i shall aim to simplify

the law i will discuss concepts and

principles of law in under 10 minutes

hi again everyone welcome to mbl

classroom for this video i want us to

talk about

what would be the effect of having a

contract between a corporation

and

one of their directors or trustees or

officers

and also what would be the effect of a

contract between

two corporations with interlocking

directors

so let's begin

now let's talk about first contracts

entered into between a corporation and

one of the directors or trustees or

officers or even the spouse of any of

the director trustee or officer or a

relative within the fourth degree of

consanguinity or affinity of any dir of

any such director trustee or officer

now

what do we call such director trustee or

officer who is entering into a contract

with a corporation what do we call them

we actually call them the self-dealing

directors or trustees

we also call them self-dealing directors

or trustees even if the contract was not

entered into between the corporation and

them

we still call themselves dealing

directors or trustees even if the

contract was entered into between the

corporation or their spouse or between

the corporation or their relative or

relatives within the fourth degree of

consanguinity or affinity

now what is the status of the contract

entered into between a corporation and a

self-leading director or trustee or a

self-dealing officer

as a general rule that contract is

voidable

are there contracts entered into between

a corporation

and a self-leading director or trustee

or officer that would be considered as

valid

yes there are

however

section 31 of your revised corporation

code requires certain circumstances to

be present for that contract to be

considered as valid what are these

circumstances let's take a look at

section 31.

it states

a contract of the corporation with one

or more of its directors trustees

officers or their spouses and relatives

within the fourth civil degree of

consanguinity or affinity is voidable of

the option of such corporation

unless all of the following conditions

are present

a the presence of such director or

trustee in the board meeting in which

the contract was approved was not

necessary to constitute a quorum for

such meeting b

the vote of such director or trustee was

not necessary for the approval of the

contract

c the contract is fair and reasonable

under the circumstances

d in case of corporations visited with

public interest material contracts are

approved by at least two-thirds of the

entire membership of the board with at

least a majority of the independent

directors voting to approve the material

contract and

e in case of an officer the contract has

been previously authorized by the board

of directors that is the first part of

section 31. where you see that as a

general rule contracts entered into

between a corporation and any

self-dealing director trustee or officer

becomes voidable at the option of the

corporation it becomes valid if the

conditions enumerated therein are

present

let's talk about these conditions the

first condition

says

that the presence of that self-dealing

director or trustee

must not be necessary to constitute a

quorum in that meeting where the

contract was approved

what does this mean

let me give you an illustration for you

to understand

condition number one

so if there are ten directors

and you have director a who is the

self-dealing director

in the meeting where the contract was

approved for example

there were seven directors who were

present out of them

seven directors out of ten clearly

constitutes a quorum because that's one

half plus one

is the presence of e necessary to

constitute the quorum

so let's have the seven

if this is a and he was present in the

coral

if

a

will not be counted in the meeting will

there still be a quarrel

that's one two three four five and six

are they still in a quarrel the answer

is yes so the first condition then is

present because the presence of uh a

is not necessary to constitute a quorum

there having been seven out of ten who

were present such that out of the seven

if he was included in the seven even if

he was the president there there would

still be six and that would still

constitute aquaro that is what is meant

by the first condition second condition

says

that the vote of that self-dealing

director or trustee was not necessary

for the approval of the contract now

let's go back to our example earlier on

where there were seven directors who

were present and among them was your

a who was who is the self-dealing

director now

since they're in a quorum of course they

can conduct business and they can

actually vote on the approval of the

contract with a

now from the seven

if

four voted

to

approve the contract because what is

needed is again still just the majority

if four voted to approve and among the

four who voted is a so the four voted

is

is vote necessary

to

approve the contract in that example

the answer is yes why because if you

remove a

then that would only have been three

whole voting

and the three out of seven is clearly

not the majority

how about

if

from the seven who attended the meeting

five voted to approve the contract

and two

voted not to approve it

and among the five who voted

a voted also to approve it

if you remove a from the equation from

the five who voted would the contract

still be approved

if there were seven of them there

so you have only four who approved

the answer is yes because four out of

seven is still the majority

in other words the vote of a is not

needed to approve the contract so that

is condition number two condition number

three is that the contract must be fair

and reasonable under the circumstances

in other words had it been another

another person whom the corporation is

dealing with it would have been

more or less the same terms and

conditions it must be fair and

reasonable

what is condition number four condition

number four

requires

in corporations vested with public

interest that in case of material

contracts entered into with self-dealing

directors or trustees it must be

approved by at least two-thirds

of the entire membership of the board it

is not based on the forum or not based

on the members present during the

meeting in the approval of the contract

but rather it is based on the entire

membership in other words it must be

two-thirds of the entire membership of

the board additionally condition number

four under section 31

um requires that at least a majority of

the independent directors must have also

approved the contract

condition number five

specifically applies to

contracts entered into by the

corporation with their officers

in case of officers for it to be valid

there must be

authorization by the board of directors

to make that contract valid so that's

basically the first part of section 31.

now what is the second part of section

31 the second part of section 31

actually gives you

the requisites provided for by law to

still make the contract valid

even if one of the first three

conditions are absent from the five that

we have mentioned

so in other words your revised

corporation code will still allow the

contract to be considered as valid even

if any of the first three conditions are

absent

what does the second part of section 31

say it says where any of the first three

conditions set forth in the preceding

paragraph is absent in the case of a

contract with the director or trustee

such contract may be ratified by the

vote of the stockholders representing at

least two-thirds of the outstanding

capital stock or of at least two-thirds

of the members in a meeting called for

the purpose

provided that full disclosure of the

adverse interest of the directors or

trustees involved is made at such

meeting and the contract is fair and

reasonable under the circumstances so

what does that tell you when you

actually read the second part of section

31 it tells you first that the contract

must always be fair and reasonable under

the circumstances in other words your

section 31 while it says that if any of

the three

first three conditions are absent

where number one that the presence of

the self-dealing director is not

necessary to constitute the quorum the

second condition is that the approval of

the self or the vote rather of the

self-leading director is not necessary

for the approval of the contract and

third is that it must be fair and

reasonable under the circumstances

when you actually read

the second part of section 31 the third

condition must always be present because

your second part of section 31

actually makes that a requirement so

that brings us to the first two

conditions

in other words if any of the first two

conditions are absent as what we have

mentioned

your contract with the self-dealing

director can actually still be

considered as valid if it is ratified by

the stockholders or members

and such ratification requires a vote of

at least two-thirds of the outstanding

capital stock if a stock corporation or

at least two-thirds of the members

if a non-stock corporation

now how about contracts between two

corporations with interlocking directors

or trustees

what is the status of that contract

between these two corporations

the answer to that question can be found

in the next provision your section 32 of

the revised corporation code let's take

a look at section 32.

it provides

except in cases of fraud and provided

the contract is fair and reasonable

under the circumstances a contract

between two or more corporations having

interlocking directors shall not be

invalidated on that ground alone

provided that if the interest of the

interlocking director in one corporation

is substantial and the interest in the

other corporation or corporations is

merely nominal the contract shall be

subject to the provisions of the

preceding section in so far as the

latter corporation or corporations are

concerned

holdings exceeding 20

of the outstanding capital stock shall

be considered substantial for purposes

of interlocking directors so first what

is an interlocking director an

interlocking director is where between

two corporations having a contract with

each other that corporation that

director rather is a director in one

corporation and is also a director of

that other corporation so if abc

corporation is having a contract with

xyz corporation you have

one director who is also a director in

abc and also a director in xyz

corporation

now with that example

is the contract between abc and xyz

considered as valid

section 32 says so long as there is no

fraud involved and the contract is fair

and reasonable under the circumstances

the general rule is the contract between

abc and xyz is considered as valid even

if you have an interlocking director

that's the general rule what is the

exception

the exception is that

it becomes voidable if that director has

a nominal

interest in one corporation and a

substantial interest in the other

corporation

let me give you an example

you have abc corporation and then you

have xyz corporation

they enter into a contract with each

other

and then you have

mr v

mr b is a director in abc corporation

and is also a director in xyz

corporation

again as a general rule even if mr v is

an interlocking director in the two

corporations the general rule is the

contract between the two corporations is

considered as valid

it is considered as voidable

only when

mr v has a nominal nominal interest in

one corporation and a substantial

interest in another corporation now what

is considered as a nominal interest and

what is considered as a substantial

interest your section 32 also tells you

what is considered as a substantial

interest in a corporation

your section 32 says that you are

considered to have a substantial

interest in the corporation if your

interest exceeds 20

so let's go back to our example with mr

v so you have abc corporation where he

is a director and you have also xyz

corporation where he is also a director

if for example mr v's interest in ebc

corporation is 15

and his interest in xyz corporation is

25

what does that tell you that tells you

that he has a nominal interest in abc

while a substantial interest in xyz

what does section 32 tell you if that is

the case

it tells you that it now becomes

voidable at the option of the

corporation which corporation

it becomes voidable at the option of the

corporation where mr v has a nominal

interest and in our example your abc

corporation

so what is the relevance now of knowing

which corporation can treat it as

voidable

its relevance now is that we now follow

the rules of the preceding provision or

the rules under section 31 on

self-dealing directors

in other words

in abc corporation they will now have to

look at whether all the five conditions

are present

if all the five conditions are present

then the contract is

valid

if any of those conditions first

preconditions are absent then it may

still be considered as valid if it is

stratified by at least two-thirds of the

outstanding capital stock or at least

two-thirds of the members

now

supposing

mr v's

interest in abc corporation is 25

and his interest in xyz corporation is

50

now both his interests in the two

corporations

having a contract with each other are

both substantial

what happens now

the contract is considered as valid and

you do not apply the conditions required

under section 31 in any of the

corporations

another example

if

the interest of mr v in abc corporation

is fifteen percent fifteen one five

percent and you and his interest rather

in xyz corporation is 10

in this example the interest of mr v in

both corporations are nominal

do you apply section 31 on the five

conditions the answer is no

it's considered as valid why do we say

so because section 32 only

tells you that it becomes voidable where

you follow section 31 on the five

conditions

if the interest of the interlocking

director is nominal in one corporation

and is substantial in another if both

his interests are nominal in the two

corporations or both his interests in

the two corporations are substantial

then the contract entered into by the

two corporations would be considered as

valid

so that is section 31 and section 32 of

the revised corporation code i hope i

was able to simplify the concepts

of

self-leading directors and also on

interlocking directors i hope you have

learned again something new from this

video and i will see you in the next

so if you find this video helpful please

click like subscribe and that

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notified of new video uploads thank you

for watching see you next time in mbl

classroom

[Music]

you