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CALIFORNIA CORPORATE & SECURITIES LAW

Louis D. Brandeis Takes On Section 310

Before being named to the U.S. Supreme Court, Justice Louis D. Brandeis wrote an influential series of articles for Harpers Weekly magazine.  Eventually, these articles were collected and published under the title “Other People’s Money–and How the Bankers Use It”.   In Chapter III, Brandeis attacked the practice of interlocking directorates with the claim that it “offends laws human and divine.”

Brandeis viewed the evil of  interlocking directorates as encompassing both transactions between two corporations with a common director and transactions between the corporation and a director.  In his article, he condemns recent court decisions upholding contracts when “it was shown that in making the contract, the corporation was represented by independent directors and that the vote of the interested director was unnecessary to carry the motion and his presence was not needed to constitute a quorum”.   Years later, the California legislature codified much the same exception in Corporations Code Section 310.  Subdivision (a) deals with transactions between the corporation and either (i) one or more of its directors; or (ii) any corporation, firm or association in which one or more of its directors has a material financial interest.  Subdivision (b) concerns transactions between a corporation and any corporation or association of which one or more of its directors are directors.

What was Brandeis’ objection to those court decisions (and by extension to the future Section 310)?  Here is what he said nearly a century ago:

[The exception] ignored the rule of law that a beneficiary is entitled to disinterested advice from all his trustees, and not merely from some; and that a trustee may violate his trust by inaction as well as by action.  It ignored, also, the laws of human nature, in assuming that the influence of a director is confined to the act of voting.  Every one knows that the most effective work is done before any vote is taken, subtly, and without provable participation.  Every one should know that the denial of minority representation on boards of directors has resulted in the domination of most corporations by one or two men; and in practically banishing all criticism of the dominant power.  And even where the board is not so dominated, there is too often that “harmonious cooperation” among directors which secures for each, in his own line, a due share of the corporation’s favors.

While Section 310 is often viewed as a validating provision, it might be more accurately characterized as a non-invalidating provision.  Basically, it provides that a contract or transaction is not void or voidable if specified conditions are met.  The effect of Section 310, therefore, is to save contracts or transactions that might otherwise be invalid because one or more directors was or were parties or present at the board or committee meeting authorizing the transaction.  Because Section 310 does not proscribe any contracts or transactions, it is not accurate to characterize a contract or transaction as “violating Section 310”.

Section 310 is sharply at odds with Brandeis’ moralistic and absolutist position with respect to interlocking director transactions. Brandeis’ criticism does, however, make a strong case for cumulative voting in the election of directors.

The University of Louisville’s Louis D. Brandeis School of Law has published this online version of Other People’s Money–and How the Bankers Use It.  

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