Corporate Loans to Directors and Officers

At common law, a corporation's surplus funds lawfully could be loaned to directors and officers of the corporation unless the loan fundamentally was unfair to the shareholders, concealed from the shareholders, or fraudulent. The circumstances under which a corporation permissibly may make loans to directors and officers are now governed largely by statute. The permissibility of such loans varies from state to state. Most jurisdictions have adopted some version of the Revised Model Business Corporation Act (Act). Under the Act, a corporation generally cannot make a personal loan to an officer or a director unless the loan has been approved (or subsequently ratified) by a majority of the shareholders. If an approved loan is challenged, judicial review is often focused on whether the loan was fair overall to the corporation and its shareholders.

In Delaware, a corporation is authorized by statute to lend money to, guarantee any obligation of, or otherwise assist any director, officer, or employee of the corporation or its subsidiary if any of those acts may reasonably be expected to benefit the corporation. The loan, guaranty, or assistance can be made with or without interest and does not have to be secured. This is perhaps the most permissive of all of the corporate loan statutes. As mentioned above, the conditions and circumstances under which corporate loans may be made vary from state to state. For example, some statutes provide that approval of a loan by a board or shareholders is valid only when disinterested directors or shareholders vote to approve the loan. Restrictions on corporate loans to directors do not apply when they are made to defray expenses incurred by the director in the ordinary course of the corporation's business.

With the passage of the Sarbanes-Oxley Act of 2002 (Act), the variances may be moot with respect to public companies that register securities with the Securities Exchange Commission or that are required to file reports under the Exchange Act. The Act was passed in response to a plethora of corporate scandals. Section 402 of the Act generally prohibits corporations from extending credit to a director or officer. Corporations may arrange for home loans, consumer credit loans, and credit cards for directors and officers if such is done in the ordinary course of business. However, the credit arrangements have to be made on the same terms and conditions that would apply to the general public.