What is a director’s conflict of interest?
The Companies Act 2006 introduced a number of duties to which all company directors are subject. In particular, some of the statutory duties relate to conflicts of interest that directors may face in their duties owed to the company of which they are an officer and their personal interests. A director’s conflict of interest refers to a situation in which a director’s personal interests or the interests of other persons to whom the director owes duties are, or may be, at odds with the duties owed by the director to his or her company.
What are the statutory conflicts duties?
- Duty to avoid conflicts of interest
- Duty not to accept benefits from third parties
- Duty to declare interest in a proposed transaction or arrangement (transactional conflicts)
- Duty to declare interest in an existing transaction or arrangement
Duty to avoid situational conflicts of interest
A director is required to 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.
Examples of situational conflicts which might be caught under this section include where a director of company A is also a director of company B which potentially competes with company A, or where a director wishes personally to take up an opportunity that has been offered to, but declined by, his or her company.
However, this duty does not apply to the extent that a situational conflict relates to an interest which a director has in a proposed transaction or arrangement with the company. Separate duties apply in that case, as outlined below.
Key features of the duty to avoid situational conflicts:
- It extends to the exploitation of any property, information or opportunity even if the company could not have taken advantage of such property, information or opportunity itself.
- It continues to apply to a person who ceases to be a director as regards the exploitation of any property, information or opportunity of which he became aware whilst he was still a director.
- There is a safe harbour for directors in relation to situations which cannot reasonably be regarded as likely to give rise to a conflict of interest. For example, a small shareholding (less than one per cent) held by a director of a company which is a key supplier may not be caught. However, what can or cannot reasonably be regarded as likely to give rise to a conflict of interest will depend upon the facts of the case.
Directors are permitted to have conflict situations which would otherwise breach this duty if those situations have been authorised by the shareholders or by the directors.
Board authorisation of conflicts
When a director identifies a situational conflict, the other directors may be able to authorise it (subject to what the constitution provides). Any such authorisation given by the non-conflicted directors is only effective if the conflicted director(s) is/are excluded from the voting and quorum requirements at the meeting in which authorisation is given. This cannot be overridden by anything in the company’s constitution
Duty not to accept benefits from a third party
A director must not accept a benefit from a third party conferred by reason of his being a director, or his doing (or not doing) anything as a director.
Key features of the duty not to accept benefits from a third party:
- It covers benefits of any kind, including non-financial benefits.
- It does not cover benefits received from group companies or a company by whom the director's services are supplied to the company.
- Benefits are not defined and so this duty is open to a potentially wide interpretation. In particular, there is no specific financial threshold below which benefits would not be caught. However, there is a safe harbour for directors in relation to benefits which cannot reasonably be regarded as likely to give rise to a conflict of interest, and this will depend upon the facts of the case.
- It continues to apply to a person who ceases to be a director as regards benefits conferred by reason of things done or omitted by him before he ceased to be a director.
- Unlike the duty to avoid situational conflicts, the directors cannot be empowered to authorise benefits which would otherwise fall foul of this duty; such authorisation can only be given by the shareholders.
Duty to declare transactional conflicts
There are separate duties, relating to proposed transactions and arrangements and existing transactions and arrangements respectively:
A director who is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, must declare the nature and extent of that interest to the other directors.
Where a director of the company 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.
Key features of the transactional conflicts duties:
- In each case the director is required to declare the "nature and extent" of his or her interest, and there is a requirement to update a declaration as necessary to ensure that it remains accurate and complete.
- A director is only required to declare an interest to the extent that he or she is aware of it; (and will be treated as being aware of matters of which he or she ought reasonably to be aware).
- There are various safe harbours for a director. A director need not declare an interest if it cannot reasonably be regarded as likely to give rise to a conflict of interests; to the extent that the other directors are aware of it (and they are treated as being aware of anything of which they ought reasonably to be aware); or to the extent that it concerns the terms of his service contract.
- Any declaration can be made at a board meeting or by written notice. If made by written notice it is deemed to form part of the proceedings at the next board meeting and the minutes of that meeting must reflect this fact. It is also possible to give a general notice (for example, that a director is interested in his capacity as a member of another company and therefore is to be regarded as interested in any future transaction or arrangement entered with into that body corporate).
- In the case of a proposed transaction or arrangement, the declaration must be made before that transaction or arrangement is entered into. In relation to an existing transaction or arrangement, the requirement is to make such disclosure as soon as is reasonably practicable.
- Any declarations required must be made to the non-conflicted directors. If the company has a sole director, a declaration is not required.
- Having made the requisite declaration, the Companies Act does not require any further approvals to be obtained. However, any additional requirements set out in the company's articles (in particular the ability of a director to vote and/or count in the quorum at a meeting at which the transaction or arrangement is considered) need to be observed.
- Although the duty to avoid situational conflicts does not apply to transactional conflicts, there may be situations which need board authorisation under the duty to avoid situational conflicts, as well as needing to be declared. For example, if the director is also a customer of the company, any proposed contract with the company would need to be declared; however the underlying relationship between the director, as customer, and the company may fall within the scope of the duty to avoid situational conflicts and so additionally require authorisation.
Consequences of a breach
In relation to the duty to avoid situational conflicts, duty not to accept benefits from third parties and duty to declare interest in a proposed transaction or arrangement) breach will give rise to civil remedies. Depending upon the circumstances of the breach, this could include compensation, damages, an account of profits, restoration of property or rescission of a contract.
A breach of the duty to declare an interest in an existing transaction or arrangement will not give rise to civil liability but will constitute a criminal offence, punishable by a fine.
However, if a director fails to declare an interest in a proposed transaction with the company and, following that transaction being entered into, persists in failing to declare his interest in that transaction, he will be in breach of both of these duties and so potentially expose himself to civil and criminal liability.
What steps should directors take in order to comply with their duties?
- Directors should ensure that they keep themselves informed of the business of the board so as to be able to identify potential situations of conflicts and obtain the necessary authorisations/make the necessary declarations in advance, as required by the legislation. This is particularly important for non-executive directors who are not likely to be involved in day to day management.
- Where the board/shareholders propose to authorise a particular conflict, consideration should be given as to the scope of the approval and, in particular, whether such approval is to be given subject to any limitations or conditions, and taking into account any specific provisions in the articles. (The GC100 guidance on conflicts gives useful practical advice and guidance in this respect.) It is important to remember that, when considering whether to authorise conflicts, the independent directors are required to comply with their general duties, in particular to promote the success of the company. It is advisable for relevant board minute documentation to evidence that due consideration to these duties has been given.
- Consider whether it is appropriate to put any guidelines in place regarding the acceptance of benefits by directors. Such guidelines may need shareholder approval, depending on their scope.
The information contained in this guide is intended to be a general introductory summary of the subject matters covered only. It does not purport to be exhaustive, or to provide legal advice, and should not be used as a substitute for such advice.
© Stevens & Bolton LLP 2020