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Company Law Reform: Conflicts of Interest

24 September 2008

As highlighted in earlier updates, one of the most significant developments in the Companies Act 2006 (the Act) has been the codification of directors' duties, with four of the seven general duties set out in the Act now in place for a year.

Implementation of the remaining three has been delayed to allow companies to make necessary preparations and adopt important procedures for effective compliance.

Those three duties, which will now come into force on 1 October 2008, are:

• to avoid conflicts of interest
• not to accept benefits from third parties
• to declare interests in proposed transaction or arrangements

The duty to avoid conflicts of interest

Under the new provisions, a director must avoid situations in which he or she has, or can have, a direct or indirect interest that conflicts with, or possibly may conflict with, the company's interests. The potential for conflict situations to arise is wide, applying particularly (but not exclusively) to the exploitation of property, information or opportunities and applies whether or not the company takes advantage of it.

The conflict of interest duty is not new, but under the Act it is arguably wider. However, the major change from the old common law duty has been the introduction of a new procedure for directors to authorise conflicts. Directors independent of the conflict may, if the company's articles allow, authorise the conflict situation thus removing, in many cases, the need to obtain approval from the shareholders.

Companies should be preparing for this new regime in a number of ways:

• changing articles of association/passing shareholder resolutions to permit future director authorisation: For public companies the articles must specifically permit the directors to authorise the conflict. In the case of private companies, provided there is no specific provision restricting director authorisation then it is permitted, but those private companies incorporated before 1 October 2008 will need to pass a resolution to that effect. In addition, it is recommended that articles of association of both public and private companies are amended to include procedural provisions on how the directors must deal with authorisation; and
  
• establishing new board procedures: including briefing all existing and new directors on the duties under the Act; requesting existing directors disclose potential conflict situations so that they may be authorised from 1 October 2008; establishing procedures for disclosure of potential conflicts from new directors; and generally setting up procedures for identifying and dealing with conflicts on an on-going basis.

The duty not to accept benefits from third parties

The common law rule that a director must not exploit his position for commercial benefit has now been codified under a duty not to accept any benefit from a third party which is conferred because of his or her being a director or doing, or not doing, any act as a director. This duty has been separated out from the conflicts of interest duty since, while itself a conflict, it is not a matter which the directors themselves can authorise.

The Act does not give any guidance on what might constitute a 'benefit'. Some 'benefits' are easily identifiable as giving rise to a conflict of interest but there is much discussion over the extent to which the giving or receipt of corporate hospitality could be caught by this duty.

Companies should be preparing for implementation of this statutory duty by reviewing (and keeping under review) policies on the giving and receipt of corporate hospitality and ensuring that directors are briefed on what is and is not permissible in relation to benefits received from third parties.

The duty to declare interests in proposed transactions or arrangements

Under this duty, directors must declare to the board the nature and extent of any interest, direct or indirect, in a proposed transaction or arrangement with the company. Such declaration will need to be updated by a new declaration where circumstances render it inaccurate or incomplete and all such declarations must be made before the company enters into the transaction.

In addition, although not a 'duty', directors are required to declare the nature and extent of any direct or indirect interest in an existing transaction or arrangement (to the extent not already declared in relation to a proposed transaction). Unlike the seven 'duties', which attract civil consequences of contravention, failure to comply with this requirement is a criminal offence.

Again, companies should be preparing for the introduction of these provisions by ensuring that directors are fully briefed on their obligations and by establishing effective procedures for recording declarations of interests.

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Nigel Thorne

Partner
T: 08700 86 8821
I: +44 (0)118 965 8821
E: nigel.thorne@shoosmiths.co.uk