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, we 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.
If you’re a director reading this because you’re concerned about a potential conflict of interest or you’ve been accused of one, our shareholder dispute solicitors can help. We’ll explain your legal duties, how to manage conflicts properly, and what your options are if a disagreement escalates.
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?
- What evidence is needed to prove that a conflict of interest exists?
- Consequences of a breach of directors’ conflict of interest duties
- How are conflict of interest disputes resolved?
- Can a claim be made if the director has already resigned?
- What are the remedies for conflict of interest disputes?
- 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.
Duty to avoid conflicts of interest
A director must avoid placing themselves in a conflict of interest situation. This duty applies to the exploitation of any property, information or opportunity presented to the company, even if the company could not, or did not want to use it. Examples of situations that might give rise to a conflict of interest include:
- a director of a company also becoming one of its major suppliers.
- a family member of a director asking for special treatment as a potential customer.
- a director opting to exploit an opportunity for personal gain rather than for the benefit of the company.
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. It is important to note that directors can’t approve their own breach of this duty.
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. 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. It is unqualified and extends to any corporate hospitality or gift. This duty is not simply breached if any hospitality or gift is accepted. Any such acceptance needs to be regarded as being likely to give rise to a conflict of interest. Many companies choose to implement policies permitting directors to accept benefits below a certain 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. 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. Additional measures or restrictions may be contained in the company’s constitutional documentation, such as that the director in question can’t 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 possible.
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. Such issues can be problematic for the board and detract from its primary purpose of running the company. 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 up with company business and ask them to review their personal and business circumstances, regularly, to identify potential conflicts and take the action required. 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.
What evidence is needed to prove that a conflict of interest exists?
As with any claim, evidence is key. The type of evidence that will be useful will depend on the specifics of each case and the nature of the conflict, but generally, you are looking for tangible evidence of a conflict. This might take many forms but emails (or other forms of communication), contracts or meeting minutes are a good starting point. Evidence that there was a failure to disclose a conflict, having had the time and opportunity to do so, will also be useful.
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.
You can read more about the consequences and legal options available when a director breaches their duties in our breach of directors' duties guide.
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.
How are conflict of interest disputes resolved?
Ratification
In some circumstances, shareholders can excuse a director’s breach by passing a resolution that ratifies the act. The director concerned isn’t allowed to vote and this is the case even if they are a shareholder or the only shareholder. Only certain acts can be ratified too. Breaches involving dishonest, fraudulent or unlawful acts can’t be ratified. Nor can any breach that threatens the solvency of the company or a loss to creditors.
Court approval
Where proceedings are issued against a director for breach of duty, the court may relieve a director of liability if they are persuaded that the director acted honestly and reasonably, and that in view of all the circumstances it is reasonable to do so. A director can also apply to the court if they anticipate a claim being made against them in the future.
Can a claim be made if the director has already resigned?
A director might be tempted to assume that they can avoid any claim for conflict of interest by resigning, but this is not the case. 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. A director can’t get around their duties by resigning from the board and subsequently exploiting an opportunity. 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 resign from a company and set up a competing business. 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 they became aware whilst in office, and a director’s conduct both pre and post resignation will be examined. Taking preparatory steps to establish a competing business will only be problematic if the director doesn’t act in the best interests of the company.
What are the remedies for conflict of interest disputes?
This will depend on the circumstances of each case, but generally, you are looking at damages to put the company back in the position it would have been in if the harm hadn’t occurred. An injunction to prevent ongoing or further breaches is also an option. Other options include seeking an order to reverse any contract that is not in the company’s best interests or an order that the director account for any profits they made after resigning to take advantage of an opportunity.
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 shareholder dispute 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.
