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We often come across companies whose board of directors contain individuals holding more than one directorship in different companies. It is easy for the board to overlook potential issues that could arise from this and, particularly where relationships sour or a particular director feels hard done by, we have seen that this can cause significant issues.
It is important for directors not to get caught out by taking some simple steps.
When does a conflict arise?
Company directors have many duties imposed on the by the Companies Act 2006. The relevant duties in relation to a director’s conflict of interest are:
Situational conflicts
A director has a duty to avoid a situation in which the director has a conflict, or possible conflict, between the duties they owe to their company and any other interest (a personal interest or other duties they owe to a third party).
An obvious example of a situational conflict would arise if a director intentionally sets up a directly competing business and tries to undercut the company. However, other examples include where a director owns property adjacent to the company’s property, the value of which could be affected by the activities of the company, or where a director has an advisory relationship (such as financial or legal) with the company.
Holding directorship of two companies in the same sector may also be a situational conflict as there is a possible conflict between the director’s duties to each company, particularly if an opportunity arises which both companies may wish to explore.
Transactional conflicts
A director has a duty to declare any direct or indirect interests in a proposed transaction or arrangement with the company. This will include arrangements between the company and a person who is “connected” to the director, such as a spouse, civil partner or connected firm or partnership.
For example, a transactional conflict may arise where the company is bidding for an opportunity with a customer of which one of the directors holds a significant shareholding, or is also a director.
There is an additional duty for a director to declare an interest in an existing transaction or arrangement with the company, where for any reason he or she has not already declared such interest.
A key point for boards to take from these duties is that, even if the director’s involvement in another business is in good faith, a conflict and breach of duty may still arise merely as a result of the scenario arising and the director in question not properly considering whether a conflict exists and taking the necessary steps to authorise the conflict.
Some transactions also require the further approval of the company’s shareholders. These include service contracts with a guaranteed term of over two years, payments for a director’s loss of office, substantial property transactions (where the value exceeds £100,000 or 10% of the company’s asset value) and loans to directors, amongst others.
How to protect your board in practice
A director will not be in breach of their duties where a situational conflict has been properly authorised by the rest of the board, or where they have properly declared their interests in transactional conflicts. It is therefore important for companies to keep accurate minutes of board meetings where directors’ conflicts are properly considered and recorded, as well as clear resolutions authorising any conflicts.
Directors may complete a general interest form declaring any interests held in other entities which can act as a general disclosure for any future transactions between the company and such entities. If a director is unsure whether to disclose an interest or not, it is best practice to make the disclosure in order to avoid a potential breach of his or her duties.
Directors should make a habit of properly considering whether there are any additional, specific directors’ interests (in addition to the general disclosure) that need to be disclosed at each board meeting. Any general interest form or central register of directors’ interests should also be kept up-to-date if a director’s circumstances change in any way.
Directors should carefully consider the provisions of the company’s articles of association and any relevant shareholders’ agreement, to check what they say about conflicts and how to authorise them. This may, for example, be by way of approval of the board or by resolution of the shareholders, subject to restrictions as to voting rights of the conflicted director. The Model Articles for private limited companies provides that where a director is in a conflict position or has an interest in a transaction, they may remain a director of the company but cannot vote or count towards the quorum in board meetings where such conflict or transaction is considered. Directors should therefore consider whether to amend their articles to allow for a director to vote and count towards the quorum in board meetings where they have declared a conflict or an interest in a proposed transaction.
The answer to avoiding the risk of running into problems is by no means difficult and is a case of boards making it a habit to consider and reflect on interests and potential conflicts of their board members regularly.
Consequences for failing to record conflicts
Failure to properly record conflicts or to comply with the procedure for authorising conflicts may result in:
- the conflicted director being in breach of his or her duties which could result in a fine or, in serious cases, grounds for disqualification as a director
- the director accounting to the company for profits made as a result of the conflict
- paying damages or compensation to the company for any loss suffered
- the option for the company to render the transaction in question void.
The main consequence for a board failing to manage conflicts properly is that this can become another weapon in the arsenal of a disgruntled individual if relationships sour or the business gets into financial trouble.
Whilst it can be difficult to bring a formal claim for breach of directors’ duties, failure to properly manage conflicts of interest can bring other aspects of a company’s governance and management into question and ultimately cause a headache for the board in dealing with them. Avoiding the problem in the first place is going to be easier than dealing with the fallout.
How can we help?
We advise on all aspect of directors’ duties including conflicts of interests, from providing draft minutes and resolutions for board meetings to delivering bespoke training for boards of directors and company secretaries. If you have any queries, please contact Adam Quint, Solicitor in our Corporate Team.
This article is for general information only and does not, and is not intended to, amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.
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