Directors’ conflicts of interest: What to do

14 Sep 12

In an ideal world all directors would become members of boards with just one aim – to act objectively in the interests of the company, making decisions based solely on the business merits of the situation. Unfortunately we have all come across sole director/owners who regard the company as an extension of their selves with the potential for what the Institute of Directors terms “self interested bias in their decision making” in its Corporate guidance and Principles for Unlisted Companies in the UK.

As a company grows and more directors join the Board it becomes increasingly necessary for governance procedures to be implemented to minimise any possible ‘conflict of interest’, protecting not only the interests of the company but of other director(s) and members of staff.

The “duty to avoid conflict of interest” (Companies Act 2006 s175-177) is one of the directors’ duties that the Companies Act ‘codified’ (brought together) having evolved via common law over the years; (see Directors’ duties: Get the details right) this article refers specifically to the conflict of interest duty.

The “conflict” duties are:

• to avoid conflicts of interest (situational conflicts) unless authorised (s175);

• 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) (s177).

Situational conflicts s175

Thus under s175 a director is supposed to not let a conflict situation arise in the first place but it will be allowed if the board is told of the possibility and most importantly gives prior authorisation. The power of prior authorisation must be included in the company’s articles of association (it is at Article 14 in the model articles) otherwise the shareholders will be required to pass a resolution giving the board that power.

This tightening up of the rules automatically places a company on notice to operate more formal procedures regarding any potential conflicts of interest. The requirement is very broad to include situations where not only a director becomes a director of a similar or related company but also where an adult child or spouse works for a company’s competitor, for example.

Where conflicts do arise, the directors need to be as open as possible by disclosing the conflict, distancing themselves from any discussions and decisions being made on the issue; possibly even standing down from the board in extreme situations.

Transactional conflicts s177

Any interest in a proposed or existing transaction or arrangement (whether direct or indirect or whether the company could take advantage or not) must be declared; an example being if a director intends to sell property to the company.

Practicalities/ suggestions

• Directors who are not involved in the conflict of interest are the authorising parties – not the shareholders, unless so sanctioned in the articles.

• When a conflict situation is being considered the authorisation is only effective if that director takes no part in the discussions forming no part of the quorum; best practice would be for the director to leave the meeting where the situation is being considered.

• Directors who are specialists in a particular area of business are most likely to be asked to become directors of other similar companies via multiple directorships. Such a director needs to consider whether this would potentially cause conflict problems. Corporate governance procedures could include articles stating that all multiple directorships must have board authorisation.

• On appointment each director should consider whether there is the potential for a conflict situation through a person connected to him- or herself. If there might be one, then not only should the board be notified but so should the connected person. CA 2006 s252 lists “persons connected with a director” to include trustees, family members, partners and certain firms that are “legal persons” where the director is a partner or a partner connected to the director.

• Directors need to view their position for potential conflicts on a regular basis and consider how they would deal with any ‘that should arise. Keeping of a register to be formally presented to the board on an annual basis is good a reminder of the need for prior authorisation.

• New directors should be given a letter from the board explaining the need for authorisation and notification.

• The board resolution approving an actual or possible situational conflict should state the duration of the authority, any limitations, notice of date of renewal, if any, and if the authorisation can be revoked, if relevant. Again, such authorisations should be reviewed annually.

Final warning

Breach of any of the other director’s duties is a civil offence with a claim against the director, but failure to declare a “conflict interest” in a transaction (s177) is a criminal offence (s183). The only defense for failure to disclose is if the interest could not reasonably be regarded as likely to give rise to a conflict between the directors’ and company interests.

Notifications of conflicts can easily be overlooked as being unworkable or even of relative unimportance but a recent case disproves this in that it was decided in the Court of Appeal. In Phillip Towers v Premier Waste Management Ltd (2011), Mr Towers was a director of Premier Waste who entered into an agreement to borrow equipment from a customer; the equipment being used to renovate Mr Towers’ own property. The court ruled against Mr Towers landing him with a fine of £7,797.31 plus, of course, the stigma of a criminal record.

Jennifer Adams FCIS TEP ATT is a freelance writer and author specialising in tax and company secretarial issues, and can be contacted at Abacus Business

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