The Companies Act 2006 (“2006 Act”) introduces a new statutory directors’ duty to avoid conflicts of interest.
Section 175 of the 2006 Act, which comes into force on 1 October 2008, requires a director of a company to “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”, unless the matter cannot reasonably be regarded as likely to give rise to a conflict.
This duty is very broad and can potentially catch a very wide range of situations. It is phrased as an absolute obligation to avoid conflict situations. There are, however, certain exemptions.
We outline below the steps that companies may need to take in order to prepare for the introduction of this new duty and take advantage of the exemptions. The precise steps required in each case will depend on the nature of the company.
The GC100 has published guidance on the new conflicts duty1.
EXAMPLES OF POTENTIAL CONFLICT SITUATIONS
The GC100 guidance sets out some examples of potential conflict situations and discusses the approach that boards of companies might take with regard to them. Examples include where a director is a director of another company which becomes a competitor of his company, where he represents a major shareholder or has a position with one of the company’s advisers. Companies which are particularly likely to have potential conflict situations include:
- Listed and AIM companies – as their non-executive directors are likely to hold a number of other directorships and similar positions.
- Private equity/venture capital backed companies – as the director representing the investor(s) is likely to hold a number of other directorships and may possibly be a director of the investor.
- Joint venture companies – as the directors of the joint venture company may also be directors of one of the joint venture partners.
With effect from 1 October 2008, the directors of a public company may authorise a matter which gives rise to a conflict for a director, provided the articles of association expressly permit it and provided the matter is agreed without the conflicted director counting in the quorum or voting on the resolution.
The 2006 Act also allows a company’s articles to contain specific provisions dealing with conflicts of interest and a director acting in accordance with these will not be in breach of the duty to avoid conflicts.
What action needs to be taken?
- All public companies should amend their articles before 1 October 2008 to include the necessary conflict authorisation and management provisions
- In preparation for these changes, the boards of public companies should collate information on existing directors’ conflict situations and consider what processes they wish to put in place for authorising and dealing with conflicts.
What about existing conflicts?
There is a transitional provision of the 2006 Act which states that the law applying before 1 October 2008 continues to apply to any conflict situation arising before that date. However, it is not clear how this transitional provision will apply if there are changes after 1 October 2008 to the facts of a conflict situation which existed before that date. The GC100, in its guidance on the new conflicts duty, considers that most companies will want to use the new approval procedure for conflict situations which straddle the commencement date.
With effect from 1 October 2008, the directors of a private company will be able to authorise any matter giving rise to a conflict for a director, provided there is nothing in the articles of association that prevents them from doing so and provided the matter is agreed to without the conflicted director voting or counting in the quorum.
Again, the 2006 Act states that the articles may contain provisions dealing with conflicts of interest and a director acting in accordance with these will not be in breach of the duty to avoid conflicts.
What action needs to be taken?
- Under the transitional provisions of the 2006 Act, private companies which were incorporated before 1 October 2008 must obtain shareholder consent (i.e. via a shareholder resolution) before the directors can authorise a conflict.
- Private companies may also amend their articles to include provisions dealing with conflicts of interest, and must amend their articles to remove any provisions which would invalidate the authorisation of conflicts by directors.
- Having passed a shareholder resolution (and, if necessary, removed from its articles anything which would invalidate such authorisation) a private company can rely on the provisions of the 2006 Act allowing the directors to authorise conflicts, provided that the conflicted director does not vote and is not counted in the quorum.
- Private companies should therefore consider passing a special resolution to confer shareholder consent for the authorisation of conflicts and to amend the company’s articles by inserting conflicts management provisions into their articles before 1 October 2008. If for any reason it is considered difficult or undesirable to pass a special resolution at this time, the company may pass an ordinary resolution simply permitting the directors to authorise conflicts with effect from that date.
- In preparation for the changes, private companies should also collate information on any existing directors’ conflict situations and consider what processes they wish to put in place for authorising and dealing with conflicts.
- Companies incorporated on or after 1 October 2008 need not pass a shareholder resolution but may choose to amend their articles to include provisions dealing with conflicts of interest (and should remove from the articles any provisions which would prevent the directors from authorising conflicts).
What about existing conflicts?
The transitional provision which states that the law applying before 1 October 2008 continues to apply to any conflict situation arising before that date also applies to private companies.
TRANSACTIONS OR ARRANGEMENTS WITH THE COMPANY
It should be noted that the new duty under section 175 does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company.
Conflicts arising in these circumstances are covered by two separate provisions of the 2006 Act that will replace section 317 of the Companies Act 1985. These are:
- section 177, the duty to declare an interest in a proposed transaction with the company; and
- section 182, the obligation to declare an interest in an existing transaction with the company
This means that a situation which initially falls within the new conflicts duty may develop into one which instead falls within section 177. To cite an example from the GC100 guidance, if a director of Company A is also on Company A’s list of preferred suppliers, the general relationship may fall within section 175, but the entering into of any supply contract between Company A and the director would fall within section 177.
All companies, whether public or private, should review their procedures for transactions between directors and the company and ensure that they comply with the 2006 Act and that, from 1 October 2008, board minutes and board papers refer to the correct provisions of the 2006 Act.