knowledge | 29 May 2018 |
Directors’ Conflicts of Interest: Avoid or Manage
A director occupies a position of trust in a company and must therefore avoid situations in which the director’s own interests conflict with those of the company. This is enshrined in the Companies Act 2014 (the “Act”) as the duty to avoid conflict unless the company releases the director from that duty. This briefing looks at some points to consider when faced with conflicts and how they can be either avoided or mitigated and managed.
The director’s duty to avoid conflicts of interest is linked to the duty not to make a personal profit from his or her position. It also applies to the duties to act in the interests of the company, to act honestly and responsibly, to act in accordance with the company’s constitution and for the director to exercise an independent judgement.
Questions of Conflict
Does the director have a financial, business or familial relationship with a party to the arrangement that would reasonably undermine the director’s impartiality to the company’s detriment? This is a helpful question to ask because the main types of conflict arise when the director:
- does not disclose an interest or potential interest in an arrangement with the company; or
- votes on an arrangement between the company and a person connected with the director (such as a spouse, a business partner or a company that he or she controls).
How to Avoid Conflict?
A director should seek to avoid situations in which a conflict of interest is likely to occur. Depending on the potential for conflicts, the director should consider whether it is appropriate to hold the office at all. Alternatively, the director could disclose his or her interest immediately and/or not participate in discussions about, or vote on, the arrangement. Directors of certain financial institutions and State-owned companies are subject to more onerous requirements on conflicts of interest. These are set out in the Code of Practice for the Governance of State Bodies 2016 and, for example, the Corporate Governance Requirements for Credit Institutions 2015 which require that directors will not participate in discussions where a reasonably perceived potential conflict of interest exists.
If there is a group of companies, avoid having common directors between parent and subsidiary companies because this can cause problems where the subsidiary’s interests conflict with those of the parent.
Must the Director Always Avoid Conflict?
The duty to avoid conflict and to disclose personal interests can be varied or dis-applied by the company. A company will often foresee conflicts arising and excuse a director from his or her duties in certain respects, in its constitution. The Act provides for some scenarios in which the company can pre-empt them by excusing the director, by providing that “save to the extent that the company’s constitution provides otherwise”, he or she can:
- vote in favour of a contract in which the director has an interest;
- hold an office or place of profit in the company;
- be counted in the quorum for a meeting involving the conflict, notwithstanding his or her interest; or
- be an officer of a company promoted by the director’s company.
Disclosure and Consent
The Act provides that it is the duty of a director who is in any way, whether directly or indirectly, interested in a contract or proposed contract with the company, to declare the nature of his or her interest at a meeting of the directors of the company. However, this does not apply in relation to an interest that cannot reasonably be regarded as likely to give rise to a conflict of interest.
If there is a conflict or a potential conflict and it is not one from which the director has been excused already (such as in the constitution), then the director must disclose it to the company. It is then open to the director, if appropriate, to seek a resolution releasing him or her from this duty. This can be done in general meeting or by written resolution of the members. It is vital that the director discloses fully all material facts about the proposed arrangement. The facts should be sought in the same way as from a third party. In this way, the other directors are fully aware of the conflict or potential conflict and, where appropriate, the company can make an informed decision whether or not to so release the director from that duty.
Company Information on Conflict
If a director has signed a service agreement, he or she should have agreed to comply with policies and procedures which deal with actual or potential conflicts of interest. If it is not possible to avoid such conflicts, the company should employ a clear and effective authorisation process. Policies and processes should, where relevant, extend to subsidiary companies. This is particularly the case with policies relating to conflicts, major transactions and related party transactions, borrowing and the provision of guarantees.
Proper recording of declarations of interest of directors at board meetings is vital to discharge the duty of disclosure owed by the directors to the company. Transparency in decisions concerning conflicts is crucial and limits should be imposed on any further actual or potential conflicts by having clear parameters around releases by the company from that duty. The Act requires that a company establishes and maintains a register of directors’ interests in contracts to include copies of declarations made or notices given by directors that they are interested in certain contracts made with the company.
A director is permitted under the Act to give a general notice stating that he or she is:
- a member of a specific company and should be regarded as interested in any contract which may be made with that company; or
- to be regarded as interested in any contract which may be made with a specified person who is connected with him or her.
Any such notice must be included on this register which is open to inspection, without charge, by any director, secretary, statutory auditor, member of the company or, upon request, by the Director of Corporate Enforcement.
Application and Extent of the Duty
These directors’ duties in the Act apply to every person who is occupying the position of a director, whether or not appointed formally as such (so, to “de facto directors”, and to “shadow directors”, ie those who are unduly influential with a company’s board (but excluding professional advisers acting as such)) and to executive and non-executive directors alike.
The duty to avoid conflicts is supplemented by provisions in the Act such as restrictions in relation to substantial property transactions between a company and a director or a connected person and restrictions on loans and credit transactions from a company to a director or connected person. These transactions and arrangements require prior written consent from the members of the company and not merely disclosure.
Conflicts of interest can undermine the trustworthiness of a director and also compromise the director’s independence, credibility and his or her effectiveness. It is essential that directors are aware of the extent of their duties to avoid conflicts, are familiar with the company’s constitution and with those policies and procedures of the company in respect of avoiding or managing directors’ conflicts.
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.