A company’s board of directors are responsible for the day-to-day management of the business. Their duties include making key strategic and operational decisions, giving commercial advice and appointing senior management. A director’s role is a powerful one, but it is not unfettered. In recognition of the significant power they hold, the law imposes certain duties on company directors. One such duty is to avoid placing themselves in a position where their personal interests conflict with those of the company.
Here, our business dispute solicitors explain what a director’s conflict of interest means, how a company might avoid its directors breaching their conflict of interest duties, and how a breach might be resolved.
Contents:
- What is a director’s conflict of interest?
- What are the different types of conflicts of interest?
- How a company can avoid a conflict of interest
- What happens if a director has a conflict of interest?
- Consequences of a breach of directors’ conflict of interest duties
- Can a conflict of interest be resolved?
- Resignation of directors
- Summary
What is a director’s conflict of interest?
Simply put, a director’s conflict of interest is a situation in which a company director has an interest, either direct or indirect, that conflicts, or may conflict, with those of the company. It is a very broad duty, encompassing actual and potential situations.
What are the different types of conflicts of interest?
The Companies Act 2006 imposes on directors three general duties relating to conflicts of interest. They are as follows:
Duty to avoid conflicts of interest
A director must avoid placing themselves in a conflict of interest situation. This duty applies, in particular, to exploiting any property, information or opportunity presented to the company, even if the company could not, or did not want to use it. An example of a situation that might give rise to a conflict of interest is a director of a company also becoming one of its major suppliers.
The duty to avoid conflicts of interest continues after the individual ceases to be a director of the company in respect of property, information or opportunities that the director became aware of during their time as a director.
Directors will not breach their statutory duty to avoid conflicts of interest if they obtain authorisation in advance from either the company’s directors or shareholders.
Duty not to accept benefits from third parties
Accepting bribes is clearly improper and constitutes a breach of a director’s duty not to accept benefits from third parties. However, the scope of the duty is wider than straightforward bribery. Directors must not accept any benefit offered by virtue of their position as a director, or for doing, or not doing, something in their role as director.
This prohibition clearly covers situations such as a director accepting a bribe from a contractor in return for granting a contract. However, it is unqualified and so extends to any corporate hospitality or gift. Accordingly, some companies implement policies permitting directors to only accept benefits below a specific level.
Only the company’s shareholders can authorise a director to accept benefits from third parties; the directors do not possess the requisite power.
Duty to declare interest in a transaction or arrangement
This duty addresses situations where a director is involved on both sides of a proposed transaction. For example, a company might wish to purchase goods from one of its directors. The sale is in both parties’ interests; the director wants to sell the items and the company wants to buy them. However, the director is faced with a clear dilemma. On the one hand, they want to make as much money from the sale as possible. On the other hand, they are obliged to act in the best interests of the company, which will presumably involve seeking the lowest possible purchase price.
Unlike the duties discussed above, the law does not prohibit these types of ‘transactional conflicts’. Rather, directors must declare the nature and extent of their interest in the transaction to the board of directors before the company proceeds. The board’s authorisation is not required; once the director has declared their interest, they have fulfilled their duty. However, additional measures or restrictions may be contained in the company’s constitutional documentation, such as that the director in question cannot vote on any resolution regarding the transaction.
A separate duty applies to transactions already entered into by the company. The director may not have realised they had an interest in the transaction before it was finalised or may have joined the board after the event. In these cases, the director must declare their interest as soon as reasonably practicable.
How a company can avoid a conflict of interest
Liability for breaching the legal duties relating to directors’ conflicts of interest lies with the individual director, not the company. However, such issues can be problematic for the board and detract from its primary purpose of running the company. Accordingly, it is sensible to take proactive steps to avoid conflicts of interest.
Examples of the types of measures that the board might take include the following:
- Inform new directors, and periodically remind others, of their duties to avoid conflicts of interest. Explain that they should keep abreast of company business to identify potential conflicts and take the action required in respect of them. This is of particular importance to non-executive directors who do not have an active role in the day-to-day management of the company. To simplify matters, a written note detailing the director’s duties might be useful, along with a questionnaire focussing the director’s mind on potential conflicts.
- Put in place policies governing how and when directors should notify the board of any potential conflicts, and how the board will decide whether or not to authorise them. Such policies will ensure that all directors understand their obligations and carry them out in a uniform manner.
- Ensure the board carefully consider any requests for pre-authorisation of a conflict, having regard to each director’s duty to act in the company’s best interests.
- Record all authorisations in a central record, detailing the basis upon which they were agreed to, and any conditions attached.
- Implement sensible policies regarding corporate hospitality and gifts and ensure all directors are familiar with them.
What happens if a director has a conflict of interest?
As soon as a director becomes aware of a conflict, or potential conflict, of interest, they should declare it to their fellow directors openly and honestly, providing as much information as the board needs to understand the nature and extent of the conflict.
If the conflict can be pre-approved by the directors or shareholders, such approval should be sought, and the interested director should distance themselves from any discussions relating to the issue. If the conflict is authorised, the director must follow any conditions imposed on the authorisation, which might include refraining from taking part in any meetings or decisions regarding the situation giving rise to the conflict.
When considering whether to pre-authorise a conflict of interest, the non-conflicted directors must carefully consider what would be in the company’s best interests, having regard to their own duties. If they decide that the proposed act is in the company’s best interests but compromises the conflicted director’s position, that director may need to seek shareholder approval or, in extreme cases, resign from the board.
Consequences of a breach of directors’ conflict of interest duties
The consequences of a director breaching their conflict of interest duties vary depending on the duty breached.
A breach of the duty to avoid conflict, the duty not to accept benefits or the duty to declare any interest in a proposed transaction are civil offences and result in civil remedies. A breach of the duty to declare an interest in an existing transaction is a criminal offence, resulting in criminal remedies.
A director is personally liable for any breach of their conflict of interest duties. Since the duties are owed to the company, only the company can enforce them. If the company chooses to do so and succeeds, the director may be ordered to account to the company for the profit made from the breach or to compensate the company for any losses it suffered as a result. The director may be forced to return any misappropriated company property, and any contract with the company they failed to disclose an interest in may be rendered null and void.
If the breach constitutes a criminal offence, it is punishable by a fine. The director in breach will not only face financial punishment, but also the stigma of a criminal record which might make future directorships unlikely.
Whilst legal liability for a director’s breach of duty lies with the director personally, the consequences for the company can be similarly severe. A breach of the conflict of interest duties is regarded as a serious issue, and can damage one of the company’s most valuable assets: its reputation. This can expose the company to increased public scrutiny, making it more difficult to secure finance and attract investors.
Can a conflict of interest be resolved?
In some circumstances, the shareholders can excuse a director’s breach of their conflict of interest duties by passing a shareholder’s resolution ratifying the act that gave rise to the breach.
Whether or not a specific act can be ratified depends on the circumstances of the breach. Breaches involving dishonesty, fraud or unlawful acts cannot be ratified.
Resignation of directors
A director’s duties to avoid conflicts of interest continue when they are no longer a director in respect of information, property or opportunities of which they became aware whilst in office. Accordingly, a director cannot get around their duties by resigning from the board and subsequently exploiting an opportunity. Crucially, this ongoing liability has been held by the Court to apply even if the director’s subsequent use of the information played no part in their decision to resign.
Most claims in this area are brought against directors who have resigned from the company, set up a competing business and used knowledge and opportunities of which they became aware whilst in office. To establish a claim of this nature, the company needs to prove, on the balance of probabilities, that the director has used information or exploited opportunities of which he became aware whilst on the board of the company.
If you are concerned that your proposed use of information or opportunities of which you gained knowledge whilst a director of another company might constitute a breach of your duty to avoid conflicts of interest, speak to us. Our experienced business dispute solicitors have extensive experience acting for directors in this position. They will consider your proposed course of action against the context in which you gained the relevant information and advise on the likelihood of you breaching your duties should you proceed.
Summary
The law governing directors’ conflicts of interest is complex and difficult to navigate. When considering whether to authorise a conflict, the board must act in accordance with their own statutory duties and the company’s constitution, and any decision must be justifiable as being in the company’s best interests. Not all decisions are clear cut and require the non-conflicted directors to undertake a delicate balancing act to identify what course of action will likely benefit the company and its shareholders the most. Often, this involves attaching conditions to any authorisation and periodically reviewing the situation.
A director’s duties to avoid conflicts of interest are crucial to ensuring those responsible for the success of a company – the board – act in the company’s best interests, as opposed to their own. If you are faced with a situation in which a co-director has breached their duties in this regard, our expert dispute resolution solicitors can help. They will review the director’s conduct and advise whether a conflict has arisen and, if so, the appropriate remedies. They will pursue the claim on the company’s behalf, acting swiftly and decisively to protect its position and obtain the relief to which it is entitled.
