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Directors’ conflicts of interest

30 October 2016 by Lorraine Young

Directors’ conflicts of interest - read more

The key message for the board on conflicts of interest is disclosure

The law regarding directors’ conflicts of interest came into force in October 2008 as part of the Companies Act 2006. As it has now been around for some time, implementing it can become routine and it is tempting to assume everyone knows what they should be doing. However, there is still a need to brief new directors and to remind existing directors of what the actual rules and obligations are, rather than what they remember.

Common law

In addition to the provisions about conflicts of interest, directors should be aware of their other duties under the Act, which include promoting the success of the company and exercising independent judgement. They also have common law duties which include a duty not to make a secret profit, and duties of loyalty (to the company) and confidentiality. These are all relevant when considering the area of conflicts of interest.

The Act

The CA 2006 provisions on conflicts of interest can be summarised as:

  • A director must avoid a situation in which they have, or can have, a direct or indirect interest that conflicts, or may conflict with the interests of the company (s175)
  • Directors must not accept benefits from third parties by reason of their office or of doing or not doing anything as a director (s176)
  • Directors must declare to the board their interests in any existing or proposed transactions to which the company is a party (ss177 and 182). The nature and extent of their interest should be disclosed.

None of these duties will be infringed if the situation, interest or benefit is such that it cannot reasonably be regarded as likely to give rise to a conflict or if it is authorised by the other directors.

Authorisation

Directors may authorise any actual or potential conflicts of interest provided that:

  • For public companies – the articles permit it. 
  • For private companies formed before 1 October 2008 − an ordinary resolution of members has been passed to permit the board to use the power to authorise conflicts. This resolution has to be filed at Companies House. It is possible that for many dormant or wholly-owned subsidiaries this exercise did not happen. If the status of those companies changes and they become more active then this point should be checked. 
  • For private companies formed after 1 October 2008 − there is nothing in the articles which prevents this.

Where the other directors authorise an actual or potential conflict, the quorum requirements for the meeting must be met without the conflicted director being included.

The practicalities

Disclosure

The key message for the board is disclosure. Directors must declare actual and potential conflicts of interest and there is a separate requirement to disclose interests in any transactions with the company. The latter are probably best dealt with on a case-by-case basis. Having a standard agenda item for declarations of interest at the start of the board meeting agenda can be a helpful reminder for this.

Directors also have a duty to make prompt notifications of any changes to their interests. I find that circulating a list of directors’ interests once a quarter is a useful exercise and can prompt directors to scribble on it at the meeting and pass it across with an update or two.

In an ideal world they would tell you as soon as the change occurs, but this at least acts as a fail safe. Once an interest has been disclosed, it is not necessary to repeat the disclosure at every meeting. The directors should be aware of it from the original disclosure.

It is obviously useful to keep a record of directors’ interests. Although this need not be complicated, it should not simply be a list of other directorships. Other business interests should be included, such as interests in partnerships, advisory roles and shareholdings in entities where influence is held. Equally, it is not helpful if the list is overly long, so past directorships or details of someone’s full investment portfolio are not necessary.

Outside interests which do not relate to business may or may not need to be disclosed. For example, being a charity trustee may not be relevant unless the company is supporting that charity. The record of interests should note whether any conflict exists, whether it has been authorised and any conditions attaching
to that authorisation.

Connected persons

There is no specific reference to the interests of a director’s connected persons (CA 2006 ss252–255 provide the definition) however, this should be borne in mind − a director is treated as being aware of matters of which they ought reasonably to be aware. It will be a matter of judgement as to whether there is an actual or potential conflict and whether authorisation is required. If a director’s spouse works for a major competitor there is likely to be some disquiet around the board table, even if, in theory, there is no conflict for the director themselves.

Procedure during meetings

The articles will give some guidance on what to do if an actual or potential conflict arises. Judgement will be needed and appropriate action will depend on the size and materiality of the conflict.

The director may be asked to step out of the meeting for the item of business where the conflict arises and they may receive edited minutes, with any reference to the matter removed. It would make sense in such circumstances for the relevant board paper to be withheld. It may sometimes be acceptable for the director to remain in the meeting but not to speak or vote on the matter.

In yet other cases it may be permissible for them to speak and vote (provided the articles allow this). If the matter is material and/or goes on for some time, then the issue can become more difficult to manage and the only option may be for the director to resign. The company secretary, as well as the chair, should be mindful of these issues and each situation needs to be monitored.

Minutes

Minutes drafted to approve a particular transaction often contain a standard paragraph about directors’ disclosing their interests. There are some instances where this may be important, for example if a board is approving a placing and some of the directors may be large shareholders. However, for regular board meetings, the danger with standard wording being inserted every time, is that people are lulled into a false sense of security that this wording magically fixes any issues and they forget what it is they should actually be doing and thinking about.

The recent ICSA guidance on minute taking refers to conflicts of interest in section 5.2.2 and 5.3.6. It recommends that where a conflict of interest exists the meeting minutes should:

  • Identify the director concerned
  • Record the nature of the conflict, the decision as to whether or not the director should attend that part of the meeting where they are conflicted and any other action taken by the board to address the conflict 
  • Make it clear that the director took no part in that part of the meeting (whether or not they left the room)
  • Where applicable, could confirm that the meeting remained quorate.
Accepting benefits

The provisions of the Act regarding not accepting benefits can usually be managed by directors following an appropriate gifts and hospitality policy. Again disclosure is key. The Bribery Act, which came into force some time after the CA 2006 provisions, is also relevant. This should be covered in a director’s induction and there should be regular updates on it to the board, both in terms of their personal obligations as well as the company’s compliance.

Under CA 2006 there is no minimum level of benefits permitted and directors are not able to authorise them for each other. However, the CA 2006 duty will only be infringed if accepting the benefit results in a conflict of interest − the provisions are not designed to prevent normal corporate hospitality. Rules are likely to be stricter in public bodies and regulated sectors.

New board members

As part of a director’s induction, the company secretary should ensure they obtain a list of the new director’s other interests, explaining to them what they need to disclose, and arrange for these interests to be noted at the next board meeting. The new board member should also be briefed on the relevant company policies and procedures.

Penalties

There are criminal penalties for directors who do not disclose their interest in a transaction with the company. There may also be an issue with them breaching their common law duty not to make a secret profit.

Towers v Premier Waste Management Limited [2011] EWCA Civ 923 is a notable case where the amounts involved were not large, and the circumstances rather unusual, but the director concerned was still found guilty and ordered to pay an amount back to the company. The judge took a strict view on the facts and the lack of disclosure was the key misdemeanour, rather than any benefit received.

What next?

It is worth considering if a review of the company’s policies on directors’ conflicts of interest or gifts and hospitality is worthwhile. It may be that no changes are needed, but at least the fact of the review can be noted and it will be a useful reminder of the rules for those who have been on the board for some time.

Useful reference sources

Lorraine Young is Company Secretarial Director at Shakespeare Martineau

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