Directors' conflicts of interest (section 175 of the Act)
On 1 October 2008 the remaining directors' statutory duties come into effect. One of these - the duty to avoid a conflict of interest – could have practical implications for many companies.
Statutory duty to avoid a conflict of interests
A director must “avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”.
While there is no definition of “interest” in the 2006 Act, the duty is expressed to apply, in particular, to the exploitation of any property, information or opportunity and it is immaterial whether the company could have taken advantage of such property, information or opportunity.
So, for example, a conflict situation may arise where:
- a director holds other directorships for example, the director sits on the board of a supplier or customer; or
- a director is appointed to the board by a major shareholder in, for example, a joint venture arrangement.
Although it is not expressly stated in section 175, a director should also consider the interests of a person connected with him in deciding whether or not there is a conflict situation. The definition of “connected” in the 2006 Act is wide and covers amongst others a director’s parents, spouse, children, step-children and a civil partner.
Exemptions
The are three exemptions to the duty to avoid a conflict of interests. The duty is not infringed:
- if the conflict arises in relation to a transaction or arrangement with the company (in which case the director is obliged to disclose his interest);
- if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or
- if the matter has been authorised by the independent directors without the conflicted director either counting towards the quorum or voting on the resolution.
Board authorisation of conflicts
Under current law, if a director finds himself in a conflict situation only the shareholders may authorise the conflict.
There is a substantial relaxation of this common law rule in the Companies Act 2006, which takes effect on 1 October 2008.
In the case of private companies formed on or after 1 October 2008, the board may authorise a conflict of interest unless this power is invalidated by the company’s articles.
For private companies formed before 1 October 2008, the directors are not automatically given the power to approve conflicts. Instead the company must either pass a resolution or amend their articles to give the directors this authority.
Section 175 clearly states that the directors' authority is only valid if the director who is in the conflict situation does not count in the quorum or vote on the resolution giving the authority.
If the company's articles allow a director to vote and count on a quorum on a matter in which he is interested, it is unclear whether the authority will be upheld by the courts given the wording of section 175.
The cautious view, therefore, is that the procedure in section 175 for giving director's approval of a conflict should be followed, and if this means that no directors qualify to constitute a quorum then the shareholders should be asked to approve the conflict instead.
Position of the authorising directors
When deciding whether to authorise a conflict of interest, the directors of private companies must:
- comply with their other statutory duties under the 2006 Act, including the duty to promote the success of the company;
- ensure that the meeting is quorate and the resolution passed without the conflicted director voting;
- consider whether any qualifications should be imposed, for example time limits or a requirement to revert to the board for further authorisation in certain specified circumstances; and
- consider what actions to take if an actual conflict arises, for example excluding the conflicted director from participating in board discussions.
Conflicts in existence on 1 October 2008
Section 175 applies where the situation giving rise to the conflict arises on or after 1 October 2008. It is generally felt that section 175 cannot be used to retrospectively authorise or ratify existing conflicts. However, companies may still wish to give their board the authority to authorise conflicts arising in the future.
What should companies be doing?
- All companies should review the conflict of interest provisions in their articles of association to check that they are up to date.
- Private companies formed prior to 1 October 2008 should consider amending their articles to give the board the authority to approve future conflicts in accordance with this statutory procedure.
- Companies and directors should also review the indemnity provisions in their articles. If indemnity provisions are poorly drafted they can be invalid and companies with older articles may only provide limited indemnities to directors. Now is a good time to review these provisions alongside the conflict provisions.
For assistance on reviewing your articles to give the board authority to approve conflicts and to update your indemnity provisions, please contact Helen Goose on 0117 918 1322 or email her at helen_goose@jordans.co.uk.
