Directors’ duty to avoid (situational) conflicts of interest (section 175 of the Companies Act 2006)
A director must avoid a situation in which they have, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company. This duty applies whether or not the director has any influence over the situation and even if the conflict in question is trivial in nature. The scope of this duty is, therefore, very wide and could include where a director is on the board of, or is a significant shareholder in, or is themselves:
- A competitor of the company
- A significant shareholder of the company
- A customer of or supplier to the company
- An advisor to the company
- A trustee of the company’s pension scheme.
An independent director can authorise a potential situational conflict, so communication between directors is key in this situation to authorise a conflict before it is too late.
Some examples include:
- Multiple directorships – for example, where a director of company A is also a director of company B, which potentially competes with company A. Also another example is where a person is a director of various other subsidiaries in a corporate group
- Pursuing opportunities personally declined by the company – for example, where a director wishes personally to take up an opportunity that has been offered to, but declined by, his or her company
- Persons connected – for example, where the director’s spouse is a key employee in a competitor
- Being a nominee of a significant shareholder – which relates to section 173 of the Companies Act 2006 (the CA 2006) duty to exercise independent judgement, which was discussed in part 2 of this mini-series and can be found here.
If a director recognises a situational conflict, they would be well advised to seek authorisation (or ratification if the duty has already been breached) of the conflict under section 175 (5)-(6) of the CA 2006.
The board resolution approving a director’s actual or possible conflict situation should:
- Set out the matter that is being authorised
- State the duration of the authority
- Set out any circumstances when the director must revert to the board for the authority to be reviewed
- Include, where appropriate, provisions stating that the director may not receive information relating to the conflict or participate in board discussions where the conflict is relevant
- Include, again where appropriate, provisions stating that where the director receives confidential information as a result of their conflict position, that they will not be obliged to disclose this information to the company or use the information in relation to the company’s affairs if it would breach this confidence.
If the requirements for board authorisation are not made out, the directors can look to the company’s shareholders to authorise / ratify the conflict. Ratification is traditionally a common law process whereby the shareholders could authorise the actions of the board by an ordinary resolution. However, breaches involving a failure by a director to act in good faith cannot be ratified, for example, deliberately misappropriating company assets.
Duty not to accept benefits from third parties (section 176 of the CA 2006)
Directors are under a duty not to accept a benefit from a third party that is conferred because they are a director; or they have done (or not done) anything as a director. There is no definition of what constitutes a ‘benefit’, although it is widely accepted to include bribes and is thought to have a broad meaning that covers body corporate benefits of any description, including non-financial benefits.
The duty of a director not to accept a benefit from a third party is not infringed if the acceptance of the benefit cannot reasonably be regarded as being likely to give rise to a conflict of interest. For example, the acceptance of reasonable and proportionate corporate hospitality will not usually breach this duty, but a director should give proper consideration to the acceptance of each offer of hospitality and ensure that it could not be reasonably regarded as being likely to give rise to a conflict of interest.
The directors do not have the power to authorise the receipt of a benefit by a director from a third party, but the shareholders of the company may do so. They may also be able to ratify the breach of duty after the event of the receipt of a benefit.
Duty to declare any interest in proposed transaction or arrangement with the company (sections 177 and 182 of the CA 2006)
A director who is in any way interested in a proposed transaction or arrangement with the company has a duty to declare the nature and extent of that interest to the other directors before the company enters into the transaction or arrangement, except where:
- The director is not aware of their interest or the transaction
- The interest cannot reasonably be regarded as being likely to give rise to a conflict of interest;
- The other directors are already aware of the interest
- It concerns the terms of their service contract that are to be considered by a meeting of the directors or a committee of the directors.
The declaration of interest must be made as soon as reasonably practicable after the director becomes aware of the interest. If the company only has one director (and it is permitted by the company’s articles of association to have only one director), that sole director does not need to declare an interest in a proposed transaction or arrangement.
Directors have to declare indirect interests (such as the interests of persons connected with them) as well as direct interests, and it is not necessary that the director is a party to the relevant transaction or arrangement.
How do you declare an interest?
A declaration of an interest in a proposed transaction or arrangement with the company must be made to the other directors in any way, including:
- At a meeting of the directors – making sure the declaration is properly minuted as being a declaration made pursuant to either section 177 or 182 of the CA 2006
- By notice in writing – which is deemed to form part of the proceedings at the next meeting of the directors after the notice is given, and is to be recorded in the minutes as if the interest was declared at the meeting, in accordance with section 184 of the CA 2006
- By general notice – stating the nature and extent of the director’s interest in the body corporate or firm or the nature of their connection with the person in accordance with section 185 of the CA 2006.
It is vitally important that directors understand the formalities of making a declaration because, if a valid declaration is not made, the transaction is voidable and the director with an interest may be required to repay any profit made to the company.
In part 4 the final part of this series, we will look in more detail at the other duties of directors, the consequences of breaching any duties and some general guidance to directors on how to protect themselves from liabilities.
If you have any questions about the topics raised in this article, please get in touch.