Renouncing Corporate Opportunities in Spin-offs, Carve-out IPOs and Private Equity Investments

Christopher E. Austin and David I. Gottlieb, Cleary Gottlieb Steen & Hamilton LLP (New York)

In its 2000 session, the Delaware General Assembly gave corporations of that state the power to renounce corporate opportunities in their certificates of incorporation. Since then, relatively few corporations appear to have adopted such provisions. Parent companies considering partial spin-offs or carve-out IPOs and private equity investors in public (or expected-to-be public) companies may well be underestimating the usefulness of corporate opportunity provisions.

It has been more than three years since the Delaware General Assembly enacted Section 122(17) of the Delaware General Corporation Law, a broadly worded statute permitting corporations of that state to renounce, in advance, the corporation's interest or expectancy in specified business opportunities.1 Since the enactment of Section 122(17), it appears that only a small number of corporations have gone public with or adopted corporate opportunity provisions in their charters. Moreover, significant investors in public companies have not, for the most part, insisted on such charter provisions as a condition to their investments. Partially as a result of the limited number of corporate opportunity charter provisions, the Delaware courts have not yet had occasion to consider the scope of, or limitations on, a corporation's right to renounce business opportunities.

In the wake of the Delaware legislature's grant of this valuable additional power to Delaware corporations, parent companies contemplating a partial spin-off or carve-out IPO, and private equity or other financial investors planning a significant investment in a public company (or a private company that is expected to be taken public in the future), should consider including corporate opportunity provisions in the charters of the relevant company. In the case of a spin-off or carve-out, the parent company, which may well be in the same or similar line of business as its subsidiary, may want to preserve its flexibility to pursue potential business opportunities that might also be of interest to the subsidiary without running afoul of its fiduciary duties. In the private equity or financial investor context, funds that make multiple investments in the same or similar industries may want to avoid any undue restrictions imposed by the duty of loyalty on their ability to pursue other investments, even competing ones, or to direct a particular opportunity to the entity for which it is best suited. Including a corporate opportunity provision in the company's charter at the time of the IPO or initial investment may serve to minimize or eliminate such concerns as opportunities arise in the future.

The Legal Framework

The "Corporate Opportunity" Doctrine

Delaware law contains fiduciary duty principles designed to protect a corporation and its minority shareholders in dealings between the corporation and its directors, officers and significant shareholders. One of these fiduciary duties is the duty of loyalty, which has generated the corporate opportunity doctrine. This doctrine provides that directors and officers, as insiders, cannot use their strategic position for their own or their affiliate's advantage to the exclusion or detriment of the corporation they represent. The Delaware courts have held that the rule is also applicable in determining whether a controlling shareholder has preempted an opportunity that rightfully belongs to the corporation.2 A "corporate opportunity" exists when a proposed activity, in which the corporation has the ability to engage, is related to the corporation's present or prospective business.3

The determination of whether a controlling shareholder or corporate fiduciary has usurped a corporate opportunity that rightfully belongs to the corporation is a fact-intensive inquiry that turns on a number of elements. These elements include whether (1) the corporation is financially able to undertake the opportunity; (2) the opportunity is in the corporation's line of business; (3) the corporation has an interest or reasonable expectancy in the opportunity; and (4) in taking advantage of the opportunity, the self-interest of the corporate fiduciary will come into conflict with the interests of the corporation.4

The Elements of a Corporate Opportunity Claim

For an opportunity to be a corporate opportunity under Delaware law, the corporation must be "financially able" to undertake it. Although it is not clear under the law of Delaware whether a corporation must be actually insolvent to be unable to avail itself of a corporate opportunity,5 the courts have held that a corporation in a precarious financial position, having recently emerged from bankruptcy and subject to negative covenants significantly restricting its ability to incur new debt, was not financially capable of exploiting an acquisition opportunity.6 By contrast, a corporation that simply has no cash on hand may be financially able to undertake an opportunity if, for example, it has access to financing sources or owns a valuable asset that it could liquidate.7

The business strategy and financial health of a corporation may also be relevant to a determination whether an opportunity is within the corporation's "line of business."8 "Where a corporation is engaged in a certain business, and an opportunity is presented to it embracing an activity as to which it has fundamental knowledge, practical experience and ability to pursue . . . having regard for its financial position . . . it may be properly said that the opportunity is in the line of the corporation's business."9 The line of business test is liberally construed in Delaware to include the corporation's current activities and those "consonant with its reasonable needs and aspirations for expansion."10 In determining what is within the reasonable scope of the corporation's activities, the Delaware courts will generally allow for development and expansion of the business, but private parties may prefer not to rely solely on judicial notions of the appropriate scope of a business.

For a corporation to have an "interest or expectancy" in a particular opportunity, there must be some tie between that opportunity and the nature of the corporate business.11 That tie may involve the need to secure the steady supply of a third-party product12 or the desire to acquire a customer for the corporation's own products and services. In finding that a corporation had no interest or expectancy in a particular business opportunity, the Delaware courts have pointed to circumstances in which the corporation had rejected an almost identical offer only one month before.13

Finally, the corporate opportunity doctrine is implicated only in situations in which, by exploiting the opportunity, the self-interest of the fiduciary will be brought into conflict with the interests of the corporation. If, in the ordinary course, the opportunity is presented to the director or officer in his individual rather than corporate capacity and is not essential to the business of the corporation, a court in Delaware is unlikely to find that the director or officer improperly usurped the corporate opportunity.14

Mitigating a Finding that a Corporate Opportunity was Usurped

While not a prerequisite under Delaware law to a finding that a corporate opportunity has not been usurped, presenting an opportunity to the board of directors of the corporation creates a "safe harbor" for the fiduciary that pursues the business opportunity after it has been declined by the corporation.15 This approach, however, may not be practical or desirable in circumstances in which the opportunity must be acted on quickly, the fiduciary serves more than one company at the same time or the fiduciary is the controlling shareholder. For example, it may not be practical for the director of a partially owned subsidiary who is also a director or officer of the parent to present the opportunity to both corporations before allowing either to pursue it, or pursuing it himself. If both corporations want to pursue the same opportunity, the director or officer may face an impossible conflict. If the opportunity was independently offered to both corporations, but the fiduciary feels that it is better suited for one over the other, he or she may legitimately want to direct it to the more appropriate entity.

In an effort to address these issues, corporations planning acquisitions, joint ventures and other business combinations have in the past sometimes included charter provisions purporting to eliminate the liability of their directors for breaches of fiduciary duty in circumstances involving the taking of corporate opportunities. In addition to exculpating the directors explicitly, these provisions have sought to define which business opportunities would belong to the directors, officers or controlling shareholders and which would belong to the corporation or subsidiary.

In Siegman v. Tri-Star Pictures, Inc.,16 the Delaware Chancery court had occasion to consider such a charter provision. The Tri-Star case arose on a motion to dismiss a challenge to Tri-Star's corporate opportunity charter amendments on the grounds that such amendments exceeded the exemptive authority permitted by Section 102(b)(7) of the Delaware General Corporation Law, because they purported to exculpate Tri-Star directors for breach of their duty of loyalty to the corporation.17 The defendants argued that, far from being designed to exculpate directors, the charter provisions were intended to delineate the types of business opportunity in which Tri-Star would or would not have an interest, and the situations in which a Tri-Star director would be considered to have received the offer of a corporate opportunity in his capacity as a Tri-Star director. In refusing to grant the defendants' motion, the court held that there was at least a plausible state of facts on which to conclude that Tri-Star's charter provision violated Section 102(b)(7).18 Although it arose in the context of a motion to dismiss, Tri-Star cast considerable doubt on the ability of Delaware corporations to include corporate opportunity provisions in their certificates of incorporation.

The 2000 Amendment to the Delaware General Corporation Law

Principally in response to the Tri-Star decision, the Delaware legislature in its 2000 session enacted Section 122(17), which permits a corporation to "determine in advance whether a specified business opportunity or class or category of business opportunities is a corporate opportunity of the corporation rather than to address such opportunities as they arise."19 The section provides that a corporation may renounce in advance, in its certificate of incorporation or by action of its board of directors, its interest or expectancy in specified business opportunities or specified classes or categories of business opportunities. According to the legislative synopsis, the classes or categories of business opportunities may be defined or delineated in any manner, including by line or type of business, identity of the originator of the opportunity or identity of the recipient.20 In addition, the synopsis makes clear that the amendment was not intended to change the level of judicial scrutiny that applies to the renunciation of an interest or expectancy in a corporate opportunity, which continues to be determined based on the common law of fiduciary duty.21

Drafting and Implementing an Effective Charter Provision

Scope of Corporate Opportunity Charter Provisions

The amendment to the Delaware General Corporation Law was designed to address the problems caused by the need to allocate corporate opportunities between two companies, particularly in the case of overlapping directors and officers. Given the variety of circumstances in which corporate opportunity charter provisions will be relevant, there is no single boilerplate provision that would seem to be appropriate in all cases.22 Parent companies considering partial spin-offs or carve-out IPOs and equity investors contemplating significant investments in public companies will want to consider a number of possibilities being developed by the corporate bar. Such possibilities include provisions relating to competition for corporate opportunities, allocation of opportunities between directors and officers of the corporation who are also directors and officers of the shareholder, matters deemed not to be corporate opportunities of the corporation and methods of approving agreements and transactions designed to achieve the above. All such provisions, whatever the form, should be written in terms of disclaiming an expectancy and should not attempt to limit fiduciary duties.

Competition for Corporate Opportunities

Parent companies with partially owned public subsidiaries and other significant investors in public companies often will want to make clear that they can take advantage of certain or all business and corporate opportunities that become available to them, without offering the corporation any such opportunity, informing the corporation of the existence of such opportunity or giving the corporation the right to participate in such opportunity. A corporate opportunity provision should clarify, where relevant, that the shareholder has no duty to refrain from engaging in the same or similar activities or lines of business as the corporation and will have the right to pursue or acquire any opportunity for itself or to direct such opportunity to any other person or entity. The controlling shareholder and its affiliates, on the one hand, and the corporation and its affiliates, on the other, should be provided the right separately to compete for the same acquisition opportunities, in the development or acquisition of the same or similar technology or intellectual property rights (particularly in the case of high-tech companies) and for the same customers and the same suppliers. As permitted by the Delaware statute, but without limiting the corporation's right separately to take advantage of any corporate opportunity, the corporation should specifically renounce its interest or expectancy in, or being offered an opportunity to participate in, corporate or business opportunities that are presented to the shareholder or any of its directors, officers or employees, except as specifically set forth in the charter provision.

Allocation of Corporate Opportunities

If any of the shareholder's officers, directors or employees is also likely to serve on the board or as an officer or employee of the corporation, the shareholder will want to consider a provision that specifically allocates corporate opportunities between the two companies. Examples of such provisions include an allocation on the basis of whether the recipient of the offer is a director, in which case one level removed from the management of the affairs of the corporation, or an officer or employee, who is charged with the day-to-day business of the corporation. Such provisions often state that a corporate opportunity offered to a director (but not an officer or employee) of the corporation who is also an officer or employee (whether or not a director) of the shareholder belongs to the shareholder, unless the opportunity is expressly offered to the director in his or her capacity as a director of the corporation. By contrast, an opportunity offered to an officer or employee (whether or not a director) of the corporation who is also a director (but not an officer or employee) of the shareholder belongs to the corporation. Where the corporate opportunity is offered to a person who serves in the same capacity as an officer, employee or director of both the corporation and the shareholder, the rule may depend upon the capacity in which the offeree received the offer, and whether or not the offeror expressly identified the beneficiary. In the case of an offer whose beneficiary was not identified, the question of who should be entitled to the offer is more complex. While many corporate opportunity charter provisions do not address this possibility at all, the right way to handle such offer may be to assume that it belongs to both corporations, and that both corporations may pursue the opportunity separately without any obligation on the part of either (or of the director or officer) to the other company.

Opportunities that are Not Corporate Opportunities

A corporate opportunity charter provision crafted by a controlling shareholder or investor might also attempt to define what is not a corporate opportunity. In addition to those opportunities that the corporation is not financially able to undertake, that are not within the line of the corporation's business and in which the corporation has no interest or reasonable expectancy — which, as a matter of law, are not deemed to be corporate opportunities — a shareholder may effectively exclude certain activities as business opportunities of the corporation by expressly limiting the corporation's purpose, as permitted by Section 102(3) of the Delaware General Corporation Law.23 For example, the corporation's purpose clause may allow it to provide Internet services to residential and business customers but not to supply content over the Internet. Any opportunity to acquire a content provider would not then be a corporate opportunity for such limited-purpose corporation. Of course, limiting a corporation's purpose in advance may unduly restrict its business in the future, particularly if markets converge or evolve in unexpected ways.

Approving Corporate Opportunity Transactions

In the event that a parent company considering a spin-off or carve-out IPO or a private equity investor contemplating a significant investment may from time to time enter into agreements or transactions that purport to allocate (or not to allocate) opportunities between, or refer (or not to refer) opportunities to, a corporation, the parent or investor would also be well advised to specify the conditions under which an agreement or transaction of this sort will be permitted. The conditions might include that the agreement or transaction was (1) entered into prior to or concurrently with the spin-off, carve-out or private equity investment; (2) approved or ratified by a majority of the disinterested directors, a committee comprised solely of disinterested directors or a disinterested officer or employee; (3) fair to the corporation at the time the agreement or transaction was entered into; or (4) approved or ratified by a majority of the minority shareholders. Satisfying these conditions is obviously designed to ensure that a fiduciary's decision to approve the agreement or transaction enjoys the presumptions of the business judgment rule rather than the heightened judicial scrutiny imposed by the Delaware courts' "entire fairness" analysis.24

Limitations on Corporate Opportunity Charter Provisions

Even a broadly drafted charter provision by which a corporation renounces any and all interest in corporate opportunities that might also be opportunities of its controlling shareholder or investor ought to withstand judicial review if carefully crafted and properly adopted. In drafting a corporate opportunity charter provision, language expressly purporting to exculpate directors and officers for taking a corporate opportunity should be scrupulously avoided to alleviate any concern that Tri-Star may have some continuing vitality even after the enactment of Section 122(17). Such an argument would be based on the Delaware legislature's admonition that Section 122(17) was not meant to alter the level of judicial scrutiny that applies to the renunciation of a corporate opportunity, which must be consistent with the exercise of a director's fiduciary duties. And corporate opportunity charter provisions would seem to be just as effective at allocating opportunities without the need to rely on any explicit exculpation.

In addition, to strengthen the validity of the corporate opportunity charter provision, a parent company contemplating a partial spin-off or carve-out IPO should ensure that the provision is adopted prior to the sale of any shares, while the subsidiary is still wholly owned by the parent. In that context, the parent company's fiduciary duties should not be implicated.25 Proper disclosure in any offering document, as well as a deemed notice provision in the charter — whereby any person acquiring shares in the company will be deemed to have notice of, and to consent to, the corporate opportunity provisions — should provide further insulation against liability. Where adoption of the corporate opportunity provision in the pre-IPO charter is not possible, as in the case of a private equity fund's investment in a public company, consideration should be given to having the provision adopted as a condition to the closing of the transaction, when negotiations are occurring on an arms' length basis. If subsequently adopted, the charter provision should be approved by a majority of the minority vote to avoid the possibility of judicial review of the decision under the entire fairness standard.


In view of the new powers afforded to corporations in Delaware and their relatively limited use to date, parent companies considering partial spin-offs or carve-out IPOs, and private equity and other financial investors contemplating significant investments in Delaware corporations, may well be underestimating the usefulness of corporate opportunity charter provisions. Adopting these provisions from the outset can avoid problems later if the parent wishes to compete for the same opportunities as its partially owned subsidiary or the investor wishes to make investments in competing ventures without running afoul of its fiduciary duties. While largely untested in the courts, corporate opportunity charter provisions, even broadly drafted ones, are likely to withstand judicial scrutiny so long as they avoid the use of exculpatory language and are implemented either in the initial charter or, if that is not possible, through arms' length negotiations with a potential investor or adoption by a majority of the minority shareholders.

1 Del. Code Ann. tit. 8, §122(17) (2003).

2 See, e.g., Thorpe v. CERBCO, Inc., 676 A.2d 436 (Del. 1996).

3 3 William meade fletcher, Fletcher cyclopedia of the law of corporations §861.10 (rev. vol. 2002).

4 Broz v. Cellular Info. Systems, Inc., 673 A.2d 148, 155 (Del. 1996) (citing Guth v. Loft, Inc., 5 A.2d 503, 510-11 (Del. 1939)).

5 Yiannatsis v. Stephanis, 653 A.2d 275, 279 n.2 (Del. 1995).

6 See Broz, 673 A.2d at 155.

7 See Agranoff v. Miller, 1999 Del. Ch. LEXIS 78.

8 Broz, 673 A.2d at 156.

9 Guth, 5 A.2d at 514.

10 Id.

11 Johnston v. Greene, 121 A.2d 919, 924 (Del. 1956).

12 See Guth, 5 A.2d at 514.

13 See Kaplan v. Fenton, 278 A.2d 834, 836 (Del. 1971).

14 Broz, 673 A.2d at 155; see Guth, 5 A.2d at 510-11.

15 See Broz, 673 A.2d at 157.

16 15 Del. J. Corp. L. 218 (Del. Ch. 1989).

17 Section 102(b)(7) provides, in relevant part, that the certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director for breach of fiduciary duty, provided that such provision does not eliminate or limit the liability of a director for breach of the duty of loyalty. See Del. Code Ann. tit. 8, §102(b)(7) (2003).

18 Siegman, 15 Del. J. Corp. L. at 237.

19 Legislative Synopsis, S.B. 363, Sec. 3, 140th Gen. Assem. (Del. 2000).

20 Id.

21 Id.

22 Lewis Black, "Corporate Opportunity Amendment Doesn't Lend Itself to Boilerplate Treatment," 3 Del. L. Wkly. 32 (2000).

23 Section 102(3) provides that the certificate of incorporation shall set forth the nature of the corporation's business or purposes to be conducted or promoted, which may include any lawful act or activity for which corporations may be organized, except for express limitations, if any. See Del. Code Ann. tit. 8, §102(3) (2003).

24 When evaluating claims for breaches of fiduciary duties against directors who approve conflict transactions, such as those involving the taking of a corporate opportunity, the Delaware courts have applied a standard of "entire fairness," which in effect requires the directors to establish both the procedural fairness (i.e., the fairness of the process that resulted in approval of the conflict transaction) and the substantive fairness of the transaction. The proposed conditions for approving allocations of corporate opportunities represent an attempt to establish the procedural prong of the entire fairness standard.

25 See Black and Alexander, Analysis of the 2000 Amendments to the Delaware General Corporation Law, in LXXI Corporation 15 (Aspen Law and Business ed., 2000).