Duty to avoid conflicts of interest
A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company (s.175(1)).
Some points to note:
There is no definition of “interest” or “conflict of interest”, although a reference to a conflict of interest includes a conflict of interest and duty and a conflict of duties (s.175(7)).
The conflicting interest can be direct or indirect.
The duty applies in particular to the exploitation of any property, information or opportunity, whether or not the company could itself take advantage of it (s.175(2)).
The prohibition refers to a “situation” in which the director has or can have an interest that conflicts or possibly may conflict with the interests of the company. However, the duty is not infringed if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest (s.175(4)(a)).
It appears that it is not necessary for a director to have any influence over a particular situation for a conflict to arise.
The duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company (s.175(3)). Conflicts arising in these circumstances are covered by two separate provisions of the Act:
under s.177, a director has a duty to declare an interest in a proposed transaction or arrangement with the company; and
under s.182, a director must declare an interest in an existing transaction or arrangement with the company – in this case, failure to comply is a criminal offence.
This duty is not infringed if the matter has been authorised by the directors (s.175(4)(b)). Authorisation may be given by the directors:
where the company is a private company and nothing in the company’s constitution invalidates such authorisation, by the matter being proposed to and authorised by the directors; or
where the company is a public company and its constitution includes provision enabling the directors to authorise the matter, by the matter being proposed to and authorised by them in accordance with the constitution (s.175(5)).
The prohibition applies to a “situation” whereas it is a “matter” that can be authorised. It appears from statements made during the Bill’s passage through Parliament that the words should be construed similarly (see for example, the remarks of Lord Goldsmith on 6 February 2006, Hansard GC290)
The authorisation is effective only if:
any requirements as to the quorum at the meeting at which the matter is considered is met without counting the director in question or any other interested director, and
the matter was agreed to without their voting or would have been agreed to if their votes had not been counted (s.175(6)).
Some possible examples of situations which might fall within s.175:
If a director of Company A is a competitor in some respects of Company A.
If a director of Company A is a major shareholder in Company A.
If a director of Company A owns property adjacent to Company A’s property, the value of which could be affected by the activities of Company A.
If, in each of the above situations, the director is a director of another company which has the relevant relationship with Company A.
If a director of Company A is a director of an investment bank which may have a relationship with Company A, or a competitor.
If a director of Company A is also a director of Company A’s pension trust company
Is this a change in the law?
“The clause reflects current law and is derived from the expression of the rule by Lord Cranworth …” (Solicitor General, Hansard 20 May 2006 col. 613)
No fiduciary “shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict with the interests of those whom he is bound to protect” per Cranworth LC in Aberdeen Railway & Blaikie Brothers (1854) 1 Mac 461 at 471-472.
“This section imposes a positive duty to avoid conflicts of interests and departs from the common law which merely imposed a “disability” in a situation of conflict, but did not impose a duty to avoid a conflict”. (Hannigan and Prentice, The Companies Act 2006 – A Commentary p.34).
It is clear that the director’s authorisation process is a change in the law.
Authorisation of conflicts – power to do so
Section 175 comes into force October 2008.
Public companies will require provisions in their articles if directors are to be able to authorise conflicts.
So will private companies incorporated before 1 October 2008.
Consider including a provision in the articles that any authorisation may exempt a director from disclosing confidential information to the company which he has received otherwise than through his position as director.
What assurances, if any, will shareholders wish to see before agreeing to provisions in articles?
Boards will need to have procedures in place to:
Identify existing conflicts or potential conflicts as at October 2008.
Ensure that any conflict is properly presented to the board.
Consider the extent to which those conflicts should be authorised.
Clarify the circumstances when authorisation can be withdrawn.
Ensure that all future conflicts are reviewed:
on appointment
on a regular basis (say, as part of the annual board review)
when circumstances change
Decide which body is to conduct reviews, e.g.
whole board
Nominations committee
Chairman
Decide which body should be authorised to amend or withdraw authorisations.
Agree how to ensure that provisions relating to third party confidential information are mutual.
Possibly, to identify how to give shareholders assurance that the powers of authorisation are being used appropriately, e.g.
through explaining policy and procedures in Corporate Governance report (likely to become the norm?)
disclosing authorisations (cumbersome, confidentiality issues?)
Two points to note on section 175 authorisation:
authorisation cannot be retrospective; and
authorisation does not apply to other breaches of duty, e.g. s.172.
Some particular examples:
Scenario 1
Company A wishes to appoint X as a non-executive director. X is a director of an investment bank, B.
Some issues to consider:
Could the mere situation of the cross-directorship leadto an interest that conflicts, or possibly may conflict, withthe interests of the company?
If so, should the situation be authorised now?
What should be the extent of that authorisation?
Should it be clear that information which X receives through his position as a director of Bank B should not have to be disclosed to Company A?
Should the authorisation recognise that Bank B could act in a way which conflicts with the interests of Company A (for example in acting for a bidder for Company A)?
In such situation, what limitations should be put on the conduct of X – for example, should he be prevented from being involved in the team acting for the bidder and/or be exempted from taking part in defence discussions?
Should his duties of confidentiality to Company A be clarified?
How should the authorisation be recorded?
Scenario 2
Company A wishes to appoint X as a non-executive director. X is a director of Company B, a major shareholder in Company A.
Some issues to consider:
Could the mere situation of the cross-directorship lead to an interest that conflicts, or possibly may conflict, with the interests of the company?
What limitation, if any, should be imposed on X relating to the use of information confidential to Company A?
What should happen if Company B received an approach from a potential bidder for Company A?
Scenario 3
Company A wishes to propose X, one of its directors, to be appointed to the board of its pension trustee company.
Some issues to consider:
Could the mere situation of the cross-directorship lead to an interest that conflicts, or possibly may conflict, with the interests of the company?
If so, should the situation be authorised now?
What should be the extent of that authorisation?
Should it be clear that information which X receives through his position as a director of the Trustee should not have to be disclosed to Company A
Should his duties of confidentiality to Company A be clarified?
How should the director act when pension funding is being discussed?
How should the authorisation be recorded?
Duties not to accept benefits from third parties
A director must not accept a benefit from a third party conferred by reason of his being a director (s.176(1)).
The duty is not infringed if the acceptance of the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest (s.176(4)).
Some points to note:
The exemption applies an objective test – there is no provision for authorisation in the articles.
Companies should, however, review their policies on receipt of gifts, hospitality, etc.
Duty to declare interest in proposed transaction or arrangement
If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors (s.177(1)).
The declaration can be made at a meeting or by notice.
A director can give a general notice to the effect that, because of his interest or connection with a third party, he should be regarded as interested in any transaction or arrangement with that third party (s.177(2) and s.185).
Declarations which become inaccurate or incomplete must be updated (s.177(4).
A director does not have to declare an interest:
which cannot reasonably be regarded as likely to give rise to a conflict of interest;
if the other directors are already aware of it; or
if it concerns the terms of his service contract which have been or are to be considered by the board or a committee (s.177(6)).
Duty of interest in existing transaction or arrangement
Where a director is in any way, directly or indirectly, interested in a transaction or arrangement that has been entered into by the company, he must declare the nature and extent of the interest to the other directors (s.182).
Broadly similar principles apply as applied to s.177.
In this instance, failure to comply is a criminal offence.
