Conflict of Interest
A director’s duty to disclose
We’ve been hearing the term “Conflict of Interest” bandied about quite a bit lately, especially in some of the – erm – interesting news items coming from across the Pond.
It’s a serious matter and not just for Presidents and their families, UK company directors are subject to some very strict regulations regarding how they manage their various roles and interests. These laws can apply to members of their immediate families too, spouses, parents and offspring.
We thought it might be worth providing a closer look at this topic as consequences for breaching the laws can even amount to criminal prosecution yet many directors and their family members are not really that au fait with the detail and what they must, by law, disclose and seek authorisation from their board for.
The principle behind the law
The Companies Act (2006) defines the general duties and responsibilities of company directors as follows:
Duty to act within powers conferred by the company's Memorandum and Articles of association, and to only exercise those powers for the purpose for which they were conferred.
Duty to promote the success of the company
Duty to exercise independent judgment
Duty to exercise reasonable care, skill and diligence
Duty to avoid conflicts of interest
Duty to declare interest in proposed transaction or arrangement
The key thing to understand is that your role as a director imposes an obligation on you to “promote the success of the company”. Now, that might seem obvious to a rookie director launching their first venture and dedicated to it with all their heart and soul. But as life goes on it is very common for successful business people to operate as directors and/or owners in a variety of different ventures, frequently concurrently.
Having the interests of a different company who is a competitor, client or supplier to the firm in question in play can easily be seen to pose a potential interference with a director’s ability to exercise independent judgement or to be fully focused on the success of the company.
Hence there are clauses in the Act which lay out how you must balance your directorial responsibilities with your other commitments.
Understand the 2 types of conflict
There are in fact two different types of Conflict of Interest: Situational and Transactional. If you understand them both clearly you are in a far better position not to wander inadvertently into a breach of the Act or to find yourself in a position where a family member has.
There are provisions that make it possible for everyone concerned to do business without excessive restrictions but procedures and reporting protocols must be adhered to.
What is a Situational Conflict of Interest?
A company director is deemed to be in a situational conflict of interest if s/he:
- is operating as a competitor through another business.
- is a major shareholder of the company.
- is a potential customer of, or supplier to the company.
- owns property adjacent to the company premises which could be affected by the activities of the business.
- has an advisory relationship – for instance financial or legal – with either the company or one of its competitors
is a director of the company’s pension trustee firm.
- takes up an opportunity which has previously been offered to the company even though they declined it.
- is in a position to make a profit from a third party as a result of his directorship (or because s/he does something or omits to do something in his capacity as director) – it doesn’t matter whether or not he discloses this to the company.
- is a director of another company to which any of the above situations apply.
A situational conflict of interest is only permitted if it is authorised in the company’s Articles of Association or specifically, by vote of a majority of other non-conflicted directors.
What constitutes a Transactional Conflict of Interest
Transactional conflicts of interest are a little more straightforward. They arise when a director has a personal interest in an existing transaction, or one that a company plans to enter into and therefore might benefit from that transaction. Benefits that must be disclosed include gifts or hospitality as well as financial remuneration.
Conflicts can arise for directors even in they themselves are not the party directly affected if their family members are involved.
Imagine a situation with a small chain of hairdressing salons as an example. They are looking for an interior outfitter to provide a completely new look for all their salons. The husband of one of the directors is a director of a very good interior outfitter in the area and a very likely candidate to win the contract.
This would pose a conflict of interest for the director in question just as much as if she herself were a director of the interiors company. She would need to disclose this to the board before the decision was made on who the contractor should be. The salon chain could still be at liberty to choose the outfitter but it is essential that the interest is disclosed just as it would be if she were also a director or agent of the outfitting firm.
The duty to disclose
There are several options for dealing with conflicts of interest either on the part of the director or their family member. The director can sit out the meeting or the vote on the decision or still vote but with their interest recorded.
Usually a board meeting will need to be held so that the directors not involved in the conflict can discuss the potential conflict and decide what should be done. In some situations a director will need to resign from the board but in most cases a less drastic solution will be able to be found.
And note, the size of the transaction is immaterial – it’s the duty to disclose that is key and which, if breached can even result in criminal proceedings. If the decision was about a few hundred pounds a year to be spent on a particular range of haircare products, rather than a 6-figure construction project, it would still be just as important for the director to declare their interest and for a board decision to be taken on how they should participate or not in the decision on the award of business. But actually, even if the director has no particular influence on the decision, the duty to declare a conflicting interest is still legally binding.
Also important to note – it is the director’s personal obligation to identify actual or potential conflicts of interest and take immediate steps to disclose them to his board, not the company’s. The regulations are strict and failure to comply can result in criminal action. So the rule must be: if in doubt, disclose.
Avoiding Conflicts of Interest
Don’t assume everyone on your board knows what they should be doing about conflicts of interest or understands the full weight of the legal implications. Both new and existing directors should be briefed and it’s a good idea to schedule a regular item in the board’s meeting agenda to review member’s interests in relation to the company’s activities and plans.
The regulations are complex – this article only gives an overview. For much fuller detail you may like to download and read the GC100 guidance notes on directors’ conflicts of interest.
Draw up a company policy regarding conflict of interest and require all directors to read it.
Review existing policies and bring them up to date.
Make sure your minute-taking is completely up to scratch so that when you follow disclosure procedures you have a proper court-proof record of it.
Tiger Law can help you to ensure that your company’s policies and procedures are in line with the Companies Act provisions on Conflict of Interest or advise on a specific situation. Initial consultations are free of charge so don’t put off calling us if you are in any doubt.
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