The corporate opportunity doctrine prohibits a corporate fiduciary from exploiting an opportunity related to the corporation's business unless he or she first offers that opportunity to the corporation. There is no question whether the doctrine applies to small businesses. Indeed, countless cases confirm that it does. The more interesting question is how it applies, given the unique characteristics of many small businesses. In the small-business setting, challenges may arise as to whom, if anyone, the opportunity must be disclosed; whether the holder of a distributional interest in the business can challenge the business' decision to turn down an opportunity; what happens when basic corporate formalities are not followed; and whether the persons taking the opportunity have violated any duty to the business' creditors. This article explores those issues.
Rule of Disclosure
The officers, directors, and shareholders of a small business owe a fiduciary duty to their company that includes the obligation to refrain from usurping so-called corporate opportunities that rightfully belong to the company. A corporate opportunity exists when a proposed activity is reasonably related to the company's present or prospective business and is one in which the company has the capacity to engage.
The corporate opportunity doctrine is, in essence, a rule of disclosure: When a company's fiduciary wants to take advantage of an opportunity that is in the company's line of business, "the fiduciary must first disclose and tender the opportunity" to the company. As the Supreme Court of Illinois explained in Kerrigan v. Unity Savings Association, 58 Ill. 2d 20 (1974), "[I]f the doctrine of business opportunity is to possess any vitality, the corporation or association must be given the opportunity to decide, upon full disclosure of the pertinent facts, whether it wishes to enter into a business that is reasonably incident to its present or prospective operations."
Despite the heavy emphasis the doctrine places on disclosure, the law of some states does not require the formal presentation of a potential opportunity when the company does not have any interest in pursuing the opportunity or the financial ability to engage in it. In Broz v. Cellular Information Systems., Inc., 673 A.2d 148 (Del. 1996), for example, the Supreme Court of Delaware held that presentation is a form of safe harbor, "which removes the specter of a post hoc judicial determination that the director or officer has improperly usurped a corporate opportunity." The courts of other states, including George, Rhode Island, and Connecticut have adopted similar approaches.
But this "safe harbor" is not universal. Illinois courts, for instance, view the failure to disclose a corporate opportunity as undermining the "prophylactic purpose" of the rule. In such circumstances, the failure to disclosur "forecloses" the interested fiduciary from exploiting the opportunity, even in cases where he or she reasonably believes the company is incapable of claiming the opportunity. Thus, in Kerrigan, the court held that defendant-directors' belief that their savings and loan association was precluded by law from capitalizing on an opportunity in the insurance business could not "operate as a substitute for [their] duty to present the question" to the corporation for independent evaluation.
Application to Small Businesses
Disclosure of a corporate opportunity is, at least in theory, a simple process: The interested fiduciary tenders the opportunity to the company, fully discloses all pertinent information, and disinterested fiduciaries then evaluate whether the company should engage in the opportunity. The problem, however, is that this process does not always neatly apply in the context of a small business, where (1) each fiduciary may want to pursue the opportunity for himself; (2) distributional interests may be held by someone other than an owner; (3) corporate formalities are not always observed; and (4) the company may be insolvent or nearly insolvent.
Absence of Disinterested Fiduciaries
An interesting practical question can arise in small businesses when every owner knows about or is personally interested in the corporate opportunity. What happens when there are no disinterested officers, directors, or owners to evaluate an opportunity on behalf of the business? Must the opportunity be presented to a disinterested third party for independent evaluation?
In re Tufts Electronics, Inc. , 746 F.2d 915 (1st Cir. 1984) (Massachusetts law), was one of the first cases from any jurisdiction to consider this issue in detail. There, the former president, director, and sole shareholder (Martin) of a bankrupt corporation appealed from the judgment of the district court that had affirmed the imposition of a constructive trust on property he personally owned. Martin had acquired the property in part with corporate funds, and then leased the property back to his corporation. The bankruptcy and district courts had found that, under the corporate opportunity doctrine, Martin had breached his duty to the corporation by using corporate funds to help purchase the property for himself rather than for the corporation.
The First Circuit Court of Appeals disagreed. Emphasizing that Martin was the sole shareholder, director, and president of the company, the appellate court held that the corporate opportunity doctrine was inapplicable because Martin's actions "necessarily involve[d] the knowledge and assent of the corporation." The court further recognized that even though Martin and the corporation were separate persons, "absent some element of defrauding, Martin was not obliged, in every action he took, to prefer the corporation's interests to his own. No one could operate a corporation solely on such a basis."
A number of courts in other jurisdictions have applied similar reasoning to reach the same conclusions. For example, in L.R. Schmaus Co. v. Commissioner of Internal Revenue, 406 F.2d 1044 (7th Cir. 1969) (Wisconsin law), the court found that "if an officer of the company owns all the stock, he may use the corporate assets as he sees fit and there can be no misappropriation of corporate assets by him." Likewise, in Mediators, Inc. v. Manney, Adv. 93 Civ. 2304 (CSH), 1996 WL 297086, at *10 (S.D.N.Y. June 4, 1996) (New York law), the court dismissed a corporate opportunity claim because the corporation had "necessarily consented" to diversion of its assets through the acts of its sole owners and officers, who were accused of usurping opportunity. To the same effect is In Committee of Unsecured Creditors of Specialty Plastic v. Doemling, 127 B.R. 945, 952 (Bankr. W.D. Pa. 1991), where the court reversed a usurpation finding because the corporate opportunity doctrine was "difficult to apply" to a small business where "there were no other shareholders to whom [the sole fiduciary] owed a duty of disclosure and loyalty." And in Pittman v. American Metal Forming Corp., 649 A.2d 356 (Md. 1994), the court, upon surveying the law in other jurisdictions, held that the sole shareholder could not not liable for usurpation of a corporate opportunity in the absence of any harm to creditors.
The logic of these cases is compelling. After all, as the Seventh Circuit recognized in In re Doctors Hospital of Hyde Park, 474 F.3d 421 (7th Cir. 2007), a sole shareholder can "hardly . . . defraud himself or breach a fiduciary duty to himself." Other courts have reached the same conclusion, as in In re Hearthside Baking Co., Inc., 402 B.R. 233 (Bankr. N.D. Ill. 2009) (a "sole shareholder does not owe a fiduciary duty against its own corporation and cannot breach a fiduciary duty to itself"); and In re Gordon Car & Truck Rental, Inc., 65 B.R. 371, 376 (Bankr. N.D.N.Y. 1986) (corporate opportunity doctrine inapplicable where sole stockholders and officers "cannot be accused of withholding information from themselves").
A minority of courts have reached the same result through a different-but-related doctrine--ratification. For example, in In re Safety International, 775 F.2d 660 (5th Cir. 1984), the Fifth Circuit held that "even when [a] transaction is detrimental to the corporation, no cause of action will lie if all of the [interested] shareholders have ratified the transaction." According to the court, "[e]ven if [the directors/shareholders] breached their duty to [the corporation] by taking the purchase option in their own names, no party to this action can complain of the breach. There are no non-consenting shareholders."