Directors may be vulnerable to a claim of breach of the duty of loyalty if they transact personal business with the corporation or if the corporation conducts business with a third party in which the corporation's directors are also the directors or have a financial interest. When a director engages in self-interested transactions, the subsequent ratification of the transaction by the board and/or shareholders may absolve her from personal liability and any requirement to disgorge the personal profits reaped from the self-interested transaction. It is important to note at the outset that, in general, illegal and void ab initio transactions and transactions that are against public policy may not subsequently be ratified. Many jurisdictions have adopted statutes similar to Delaware's corporation statute and follow judicial interpretations of the statute. The law of the state of incorporation must be consulted to determine if it varies from Delaware corporation law.

The Delaware General Corporation Law provides that a transaction is not void or voidable solely because one or more directors and/or officers has a financial interest in the transaction under the following circumstances:

• The material facts about the director's (or officer's) relationship to or interest in the transaction is disclosed or known to the board of directors or an appropriate or
• The material facts about the director's (or officer's) relationship to or interest in the transaction is disclosed or known to shareholders that are entitled to vote and those shareholders specifically approve the transaction in good faith or
• The transaction is fair to the corporation at the time it is authorized, approved, or ratified as described above

In a breach of loyalty claim involving shareholder ratification, the ratification alone is typically insufficient to extinguish the claim. However, ratification removes the transaction "from the purview of entire fairness review." As stated by one Delaware chancery court, "a validly accomplished shareholder ratification relates back to cure otherwise unauthorized acts of officers and directors." The court reviews to determine whether ratification pursuant to the statute "cloaks the board's decision with the protection of the business judgment rule." The plaintiff essentially has the burden to prove corporate waste, i.e., that no person of ordinary sound business judgment could view the benefits received as a fair exchange for the consideration paid by the corporation. Again, ratification does not necessarily extinguish duty of loyalty claims arising out of transactions that are not covered by the Delaware statute (for example, mergers or corporate transactions with a controlling shareholder). Ratification makes the business judgment rule the applicable standard of review and shifts the burden of proof to the plaintiff.

The duty of disclosure is an essential component of the duty of loyalty in a situation where directors seek to obtain approval for their conflicted interests. The validity of any ratification depends upon whether there was a full and fair disclosure of all material facts. Generally, a fact is material if there is a substantial likelihood that a reasonable person would consider it important or consequential in making a decision. The party relying on the ratification (typically a director) has the burden to prove that the ratification resulted from a fully informed electorate. It is important to distinguish the effect of the ratification. The questioned transaction is generally considered to be valid unless or until it is rejected or repudiated by the corporation.

Copyright 2009 LexisNexis, a division of Reed Elsevier Inc.