All directors know they must tread carefully if there is any conflict between their own interests and the interests of their company. But changes effected by the Companies Act 2006, coming into force in October 2008, introduce even tighter rules governing directors’ conflicts.

The changes will have a wide impact: non executives may have to review their existing board appointments, groups will need to consider cross-directorships and companies will have to establish procedures for addressing conflict situations.

The most controversial area is the requirement for a director to avoid any situation in which he has, or can have, a direct or indirect interest which conflicts, or possibly may conflict, with the interests of the company.
This wording is wide enough to encompass any situation which may lead to a conflict of interest for a director at some time in the future, and he will be in breach of duty if he allows such a situation to exist, even if there is no present conflict.

Take, for example, the case of an accountant whose firm provides non-audit services to a company. The company values his strategic business insight and wide industry experience, and asks him to serve as a non-executive director.

Currently there would be nothing to prevent the accountant accepting the appointment, although he would have to take steps to manage the conflicts which would arise whenever his professional services were engaged by the company, for example by not participating in relevant board meetings.

However, under the new rules, it appears an accountant in this situation would need to ensure he had the necessary formal authorisation from the company to accept the appointment.

Until the extent of the statutory duty has been tested in the courts, companies and directors are being advised to take a cautious approach and seek authorisation in relation to any situation which might be caught by the new rules.

There are many such situations, not all of them obvious, and a number of examples are outlined in the box ('Conflict stress points').

If a director permits an unauthorised conflict situation to exist, he may face action by the company or its shareholders for breach of duty.

In addition to claims for damages and an account of profits, and the termination of any affected contracts, the damage to his reputation could be considerable. Indeed, the company as a whole would be tainted by the adverse publicity. Directors will, therefore, be seeking the appropriate authorisation and may step down if it is not forthcoming. Replacements may be hard to find, unless procedures are in place for potential conflicts to be addressed.

So how can a director ensure he has the necessary authorisation in relation to a given situation? Firstly, the company’s articles of association should be checked to see if they sanction the situation.

The default articles in Table A, for example, permit a director also to be a director of a subsidiary company. Articles are, however, a blunt instrument for sanctioning conflicts and there will be few situations which can appropriately be dealt with in this way.

Under the current rules, the only other option is to seek shareholder approval. In many cases this would be time consuming and costly, for example for listed companies, which would have to convene a general meeting and send an explanatory circular to shareholders.

From October, it will be possible for the first time for the board to give the necessary authorisation. For public companies, board authorisation will only be possible if the company’s articles have been changed to permit this. Private companies will not need to change their articles, but all existing private companies, and any new ones incorporated before October, will need to pass a shareholder resolution.

Companies should be taking action now to prepare for these changes. The articles of association should be reviewed and appropriate shareholder resolutions sought. Directors should be alerted to the new rules and prompted to identify any situations where they may face a conflict.

Consideration of conflict situations should become a regular agenda item at board meetings. Some companies may wish to change the terms of reference of, say, the nominations committee, to consider conflicts and make recommendations to the board.

Procedures should be put in place for a regular review of authorised conflicts. And finally, the conflict situations of new directors should be assessed before they are appointed.

Conflict stress points

Both direct and indirect conflicts must be authorised by the company through its articles of association. Situations which might require authorisation include:

Danielle Harris is a professional support lawyer in the corporate department at Maclay Murray & Spens LLP