corporate clips

Directors’ Conflicts of Interest and the Companies Act 2006

June 2008

The New Legislation

From 1 October 2008, a director of a company will have a statutory duty under section 175 of the Companies Act 2006 (the “2006 Act”) to avoid a situation in which he has an actual or potential interest that actually or possibly conflicts with the interests of the company. The 2006 Act also introduces a mechanism which allows the non-interested directors on the board of a Company to authorise a director’s conflict of interest, a power which was previously reserved for shareholders.

This edition of Corporate Clips briefly outlines the scope of section 175, illustrates some examples of conflict situations and discusses how boards may want to approach directors’ conflicts of interest going forward.

Conflicts of Interest – Examples

Situations where a director of Company A has or could have a conflict of interest could arise for example if the director:

is also major shareholder in / potential customer of / supplier to Company A;
competes with Company A / is a director of a company competing with Company A;
has an advisory relationship with Company A or a competitor; or
is in a situation where he can make a profit as a result of his directorship (whether or not he discloses this to Company A).

An indirect conflicting interest can also be caught – e.g. where a director represents a major shareholder, and that shareholder’s interests conflict with the interests of the company. It is also irrelevant whether the company itself would have taken advantage of any property, information or opportunity that is being exploited by a director.

Authorisation of Conflict Situations

Under the existing regime, a director who has a conflict of interest has to stay away from board discussions of the matter or step down from the board altogether, unless shareholders expressly sanction the conflict. By contrast, under the 2006 Act, a director has a broader duty not to let the situation of a conflict arise in the first place, but, importantly, it will also be open to the non-conflicted members of the board to authorise a conflict of interest.

The board of a public company will only be able to authorise conflicts if it has express power to do so under the company’s articles. The starting point for private companies is that the board can authorise conflict situations as long as the company’s articles do not prohibit authorisation. Private companies incorporated before 1 October 2008 will first need to pass an ordinary resolution to approve authorisation of conflict situations under section 175.

Most public companies will therefore want to amend their articles to include powers to authorise conflicts. Private companies should also consider (even if they are not forced to change their articles) a review of the existing articles to ensure that adequate conflicts provisions are in place.

Changes to Articles

To take full advantage of the provisions of section 175, a company should include in its articles a general power of the board to authorise conflicts. In addition, a company may want to consider how its articles should deal with:

how conflict situations are communicated to the board and the process for authorisation;
the quorum requirements to authorise a conflict;
the terms that apply to the conflict authorisation (e.g. exclusion of the conflicted director from relevant meetings or decisions).

“Safe Harbour” Provisions

Although a director may be authorised by the board in relation to a particular conflict situation, it is important to bear in mind that he will always be subject to his general statutory duty under the 2006 Act to promote the success of the company.

A company may therefore want to include safe harbour provisions in its articles, which could, for example:

make it clear that a director who obtains information that is confidential to a third party is not in breach of a general duty if he does not disclose that information to the company or use it for the company’s benefit, or
deal with directors’ roles in other group companies or joint venture companies.

Board Review of Actual or Potential Conflicts before 1 October 2008

In addition to amending articles, boards may want to review each director’s position before 1 October 2008 for situations of actual or potential conflicts of interest that require board authorisation to ensure that breaches of the duty in section 175 are avoided. After that date, a director will be in breach of duty if he is in a situation that involves (or could involve) a conflict, unless:

this has previously been authorised by the board;
the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or
he acted in accordance with provisions in the articles dealing with conflicts.

Directors should be asked to draw up a list of other positions held and all other conflict situations that may need to be authorised by the board.

When board members review a director’s conflict situation and consider authorisation, they must take account of the director’s and their own general statutory duty to promote the success of the company. A board should be able to approve a matter if on balance the directors think it is in the interests of the company for the company to retain (or appoint) that director.

The board resolution approving a director’s actual or possible conflict should:

set out the matter that has been authorised;
state the duration of the authority and that it can be revoked at any time; set out any circumstances in which the director must revert to the board for the authority to be reviewed;
include provisions stating that the director may not receive information relating to the conflict or participate in board discussions where the conflict is relevant; and
include, where appropriate, provisions releasing a director from his obligation to disclose to the company confidential information obtained by virtue of his position with another entity.

As an administrative matter going forward, companies may wish to keep a list of authorisations granted to directors, setting out the date a conflict was authorised as well as the scope and expiry date of such authority.

Further Information

If you have any questions or would like to discuss anything in this article in more detail, please contact Charles Claisse at Kemp Little LLP on 020 7600 8080.