Director Breaches Fiducary Duty in Selling Corporate Shares to Himself

On December 24, 2013, Justice Whelan of the Suffolk County Commercial Division issued a decision in KNET, Inc. v. Ruocco, 2013 NY Slip Op. 33543(U), addressing the propriety of a director's sale of additional shares to himself.

In KNET, Inc., the court addressed a number of issues, including whether a corporate director breached his fiduciary duty by selling additional shares of the corporation to himself. The court held that in light of the facts of that action, he did, explaining:

As a general rule, directors of a corporation cannot issue or dispose of the corporate stock to themselves for an inadequate consideration. Directors owe a fiduciary responsibility to the shareholders in general and to individual shareholders in particular to treat all shareholders fairly and evenly. So, a breach of fiduciary duty is established by proof that the directors failed to treat all stockholders fairly and evenly. When issuing new stock, a director, such as [defendant], must treat existing shareholders fairly. It is an inflexible rule that directors cannot exercise the corporate powers for their private or personal advantage or gain. [A] director breaches his obligation to shareholders when he obtains stock at an inadequate price. [A] clearly inadequate consideration invokes the same principles as the absence of consideration.

[The defendant] is considered an interested director since he is receiving a direct financial benefit from the challenged transactions, that are different from the benefit received generally by all shareholders. Where directors have an interest in the challenged action, the burden of proof shifts to the interested director to establish that the actions involved were reasonable and fair. His testimony failed to satisfy that standard.

(Internal quotations and citations omitted) (emphasis added).

The interested share sale discussed above was just one of the defendant's many improper acts addressed in the court's opinion. Yet the particular point addressed above is something to which corporate directors and their counsel should be sensitive even in more innocent contexts. Controlling shareholders in close corporations that also control the company as directors need to remember that whatever their interests as a shareholder, their duties as a director run to all shareholders.