Director rules: personal struggle

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:

• A professional adviser to the company, for example, an accountant,
  solicitor or financial adviser, who is asked to serve as a non-executive
  director.

• A non-executive director with specific industry expertise serving on the
  boards of two or more companies in the same industry sector.

• Where a director of a subsidiary is also a director of the main board.

• A director, or whose family or family trust, owns a significant shareholding
  in the company.

• A director who is nominated by a major shareholder or private equity
  investor.

• Where a director of a joint venture company is appointed directly by one of
  the parties to the joint venture.

• A director who is also a trustee of the company’s pension scheme, or who
  serves as a director of the company’s pension trustee company.

• Where a director or his family has any business interest which competes in
  any way with the company.

• Where a director or his family is a potential supplier to, or significant
  customer of, the company or might enter into commercial arrangements with it.
  This also applies to any company associated with the director and his family.

• If a director wants to make personal use of any information he has learnt as
  a director, or any property of the company or any business opportunity which the
  company has declined.

• Where a director or his family owns property adjacent or near to the
  company’s premises, which might be affected by the company’s activities. Again,
  property owned by companies associated with the director and his family should
  also be considered.

• If a director is approached by a possible bidder for the company, and
  offered the prospect of a role after the company is taken over.

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