Directors Duties – Conflicts of Interest

18 November, 2008

CONFLICT OF INTERESTS AND THE RELATED AUTHORISATION PROCESS

 

This article looks at how directors should approach actual or potential conflicts of interests having regard to the provisions of the Companies Act 2006.

 

INTRODUCTION

 

On the 1 October 2008 a new duty was placed on company directors to avoid situations in which they have, or could have, a direct or indirect interest which conflicts with, or might possibly conflict with, the interests of the company. 

 

This statutory duty is broadly similar to the previous common law duty to avoid conflict of interests although the wording of the new duty is arguably wider than the previous common law duty.

 

This article summarises the new law on directors’ conflict of interests and is designed to assist company directors in identifying actual and potential conflicts of interest for disclosure to, and potential authorisation by, the company’s board.  The article is divided into the following four sections:

Part A – The Law
Part B – Helping Directors to identify conflict of interests and potential conflicts
Part C – Authorisation of conflict situations by non-conflicted directors
Part D – A Practical Example

 

This article is intended as general guidance only and each situation of conflict or potential conflict should be considered on its facts and, if in doubt, the directors should take legal advice to ensure that there are fulfilling their duties in relation to conflict of interests.
 

PART A – THE LAW

1. Background

 

The new directors’ duties in relation to conflicts of interest are contained in the Companies Act 2006 (the “Act”) and came into force on 1 October 2008.  The new duties are as follows:
• A duty to avoid conflicts of interest (situational conflicts) unless authorised (s.175);
• A duty to disclose any interest in a proposed transaction or arrangement with the company and a separate and independent duty to disclose any interest in an existing transaction or arrangement with the company (transactional conflicts) (s.177).

 

Compliance with the above duties is the personal responsibility of each director and not the company’s responsibility.  Only directors will ultimately be aware of any actual or potential situational conflicts.  Each director should therefore ensure that he keeps these duties under review and informs the company Secretary on an ongoing basis of any change in his circumstances.

 

2. Duty to avoid conflicts of interest (situational conflicts)

 

From 1 October 2008 directors have a duty to avoid a situation in which either: there is, or may be, a conflict between the interests of the company and the direct or indirect interests of the director; or between the director’s duties to the company and those to another person. This is a change to the previous legal position because it means that a director has an obligation not to let an unauthorised conflict situation arise in the first place.

 

The Act has introduced a new statutory power for a board to authorise such situational conflicts to protect directors from breaching the relevant provisions. Although the company will need to ensure that this power is also included in the company’s articles of association or (if the company is a private company) the shareholders have passed a resolution giving them that power. As a result, the company will now be required to operate more formal procedures regarding conflicts of interest. 

 

Only non-conflicted directors will be able to count in the quorum of a board meeting and vote to pre-authorise a director’s conflict(s). Please see Part C of this article for further details on the role of a non-conflicted director voting on whether or not to authorise another director’s conflict.

 

3. Duty to disclose any interest in a proposed or existing transaction or arrangement with the company (transactional conflict)

 

Directors are required to declare the nature and extent of any interest they have in a proposed transaction or arrangement with the company and also in an existing transaction or arrangement with the company. Their interest may be direct or indirect and interests of their connected persons (e.g. adult child or spouse) may also be captured (see below in Part B for further information in relation to indirect interests). These duties are broadly similar to the requirements of the previous law.

 

The interested director cannot be counted in the quorum or vote on a board resolution relating to the relevant transaction or arrangement. 

 

Failure to declare an interest in an existing transaction or arrangement with the company is a criminal offence (a breach of the other duties could only give rise to civil claims against a director).

 

If a director becomes aware that he has a direct or indirect interest in an existing or proposed transaction or arrangement with the company, he should notify the board of the nature of the interest at the next board meeting or by a written declaration. Interests in proposed transactions should be notified before the transaction is entered into and each director has an ongoing duty to update any changes in these interests.

 

PART B – HELPING DIRECTORS TO IDENTIFY CONFLICTS OF INTEREST AND POTENTIAL CONFLICTS

 

There is no statutory definition of a conflict of interest.  However a useful test is to regard an “interest” as a very broad term that includes anything or any connection which could potentially divert a director’s mind from giving sole consideration to promoting the company’s success. 

 

Ten questions to help identify a conflict:

 

1. Are you a director of or a significant shareholder of a company which is:
• A significant shareholder in the company?
• In partnership with the company?
• In a joint venture with the company?

2. Are you a significant shareholder of the company in your own right?

3. Does any external body you are associated with have any of the following relationships with the company?
• Supplier
• Customer
• Competitor
• Banking
• Distribution
• Any other ongoing, but material relationship

Examples include where the relevant body is bidding for a contract against/with the company OR acts in any way as agent for the company OR provides financing to the company (or any of its subsidiaries).

4. Are you associated with any adviser to the company (e.g. audit, tax, legal, investment banking, pensions or investments, management consultancy)?

5. Are you a member of a committee or of a commission or do you have a material position with a regulator, any department of government, a trade body, a professional body or a Charitable Organisation (e.g. where the relevant organisation influences government policy, influences accounting standards or is preparing industry guidance)?

6. Are you a trustee of the company’s pension trust (or a director of the corporate trustee of the pension trust)?

7. Do you hold a material position with any pension fund that could itself maintain a material shareholding in the company?

8. Are you associated with an investment organisation of any nature (e.g. venture capital/private equity, hedge fund, investment trust/fund, an organisation taking material positions in shares or securities)?

9. Are you in a position that you (or a company you are a director or material shareholder of) could make a profit as a result of your directorship of the company?

10. Do you know of any other circumstances that could give rise to a potential or actual conflict of interest or duties?

 

Further guidance once a potential conflict situation is identified

 

There is no breach of duty when a situation cannot reasonably be regarded as likely to give rise to a conflict of interest or of duties.  To identify situational conflicts, a director may find it helpful to ask himself the following questions:

• Is my role/connection with another company likely to prevent me, when acting as a director of the company, from giving sole consideration to the interests of the company?
• Is my role/connection with the other party likely to involve consideration of actions that could be adverse to the company’s interests or to put me in a position where information that I know as a result of being a director of the company would be relevant to the decision to be taken?
• Am I part of the decision making process of the other party?
• Particularly in relation to any perceived conflict, what is the justification for the company to authorise it?
• Do the interests of the two companies compete, either in their product markets or in relation to strategic opportunities?
• Would the activities undertaken in one role be likely to have a material impact on the other?

 

Indirect interests – connected persons

 

Directors should note that the duty to avoid a conflict arises where a director has an indirect interest. Therefore directors should check with all their connected persons (e.g. adult child or spouse) regarding any possible relationships they might have with the company (e.g. where a connected person works for an adviser to one of the company’s competitors). This duty however is not infringed if the situation is unlikely to give rise to a conflict and a director only need to disclose a conflict once he becomes aware of it.
 

 

PART C – AUTHORISATION OF CONFLICT SITUATIONS BY NON-CONFLICTED DIRECTORS

 

Only non-conflicted directors will be able to count in the quorum and vote to consider and if appropriate to pre-authorise a director’s conflict(s) and in doing so they will need to act in accordance with their general duties, including the duty to promote the success of the company for the benefit of its members as whole.

 

Where a director is asked as a non-conflicted director to approve a potential conflicting position that brings clear benefits to the company, for example access to industry or sector expertise, it will usually not be an issue in deciding that the director in question is acting in the interests of the company in approving the conflict. The board should be able to approve a matter if, on balance, the directors think it is in the best interests of the company for the company to retain (or appoint) that director. A board should consider whether the matter they are approving would affect the relevant director’s ability to act in accordance with his wider duties.

 

The board may impose conditions upon conflict authorisations where there is scope for a matter that does not give rise to a conflict at the outset to develop into one as circumstances progress (an example would be where a director has material involvement with a regulatory body, an approval of the conflict might be given subject to his not acting on any matter concerning the company).

 

The board resolution approving a director’s actual or possible conflict should:
• set out the matter that has been authorised;
• state the duration of the authority (it is suggested sufficient time, e.g. 12 months, for it to be reviewed annually) and that it can be revoked at any time;
• set out any circumstances when the director must revert to the board for the authority to be reviewed;
• include, where appropriate, provisions stating that the director may not receive information relating to the conflict or participate in board discussions where the conflict is relevant.

 

The board also needs to consider what should happen if a real conflict arises post authorisation and the director has clearly conflicting interests. The options are:
• exclude the director from the relevant information and debate;
• exclude the director from the board (suspension);
• require the director to resign.
 

 

PART D – A PRACTICAL EXAMPLE

 

We will assume for the purposes of this example that the company’s articles of association give the board the power to sanction the conflict situation.

 • In this example a director, we shall call him Chris, is involved with a marketing agency and the company has used this agency in the past to prepare and launch its advertising campaigns. This general relationship is a potential conflict situation for Chris.

• Chris should notify this potential conflict situation to the board of the company so that he is not in breach of Section 175 of the Companies Act 2006 (duty to avoid a conflict of interest).

• The board should then meet to vote on whether or not to pre-authorise Chris’ potential conflict situation. The board will need to act in accordance with their general duties, including the duty to promote the success of the company for the benefit of its members as whole. Chris cannot be counted in the quorum of this meeting or vote on the matter.

• The board may decide to approve the general relationship but will not want Chris to be able to disclose “company” information to the marketing agency or to use it for the marketing agency’s benefit. The board also will not want him to be involved in board discussions concerning the relationship.

• Note that the actual entering into of any contract between the company and the marketing agency is a transactional conflict and not a situational conflict. Notwithstanding any authorisation by the board of the potential conflict, Chris will still need to declare his interest in relation to any contracts entered into by the company with the marketing agency after 1 October 2008.

Reviewed in 2015