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CONFLICT OF INTEREST DUTIES OF DIRECTORS

Updated 9/1/10. This information is included in ss.15.3.5-15.3.8 in The Russell-Cooke Voluntary Sector Legal Handbook (VSLH3).
Duties in effect from 1 October 2008 require company directors to avoid conflicts of interest, not to accept benefits from third parties, and to declare interest in a proposed transaction or arrangement with the company (in addition to the requirement that was already in effect to declare an interest in an existing transaction) (Companies Act 2006 ss.175-177).

Prior to October 2008 it was often enough for a company director with a conflict of interest or a conflict of loyalties simply to declare the conflict, have the declaration minuted or entered in a register of directors' interests, and not take part in discussions or decisions affected by the conflict. This is no longer the case, and from 1 October 2008 new rules govern authorisation and approval in conflict of interest situations. Some of these rules are not very clear, especially where they overlap with charity law rules on conflicts of interest. If in doubt about how to deal with a particular conflict of interest, advice should be sought from the Charity Commission or from a solicitor who specialises in charities or other voluntary organisations.

The Charity Commission's Guide to the charity law rules on conflict of interest, accessible via tinyurl.com/2rquuc has not yet been updated to cover the new requirements for charitable companies, but provides a useful starting point for thinking through the issues and developing a conflict of interest policy. Issues specific to charitable companies are covered in a separate document at www.charitycommission.gov.uk/supportingcharities/qaconflicts.asp.

The Commission's view is that the provisions in most existing charitable companies' memorandum and articles are adequate to comply with the new company law rules. However, very few existing memoranda or articles contain provision on conflict of loyalties. To be sure everything is covered, it may be sensible to amend the governing document to include updated provisions on benefits for directors/trustees and connected persons, and on conflict of interest and conflict of loyalties. These could be based on the provisions in the Charity Commission's revised GD1 model articles, but see further on in this section for some concerns about the Commission's suggested articles. The Commission's prior written consent is required for any such amendment.

Transactional conflicts of interest
Where a director or a person connected with a director has or might have an interest in a transaction or arrangement with the company, this must be declared to the other directors (Companies Act 2006 s.177). There are a few exceptions, but it's best to declare everything even if it is technically covered by one of the exceptions — especially in charitable companies, where the charity law duty to declare an interest may override any company law exception. Interests in existing transactions between the company and a director must also be declared (s.182).

Register of interests. Although it is not a statutory requirement, a register of directors' and connected persons' interests should be set up if the company does not already have one. It should include business interests (including share ownership) where the company could purchase goods or services from the business or vice versa, situations where the director or a connected person could enter into a transaction with or receive a benefit from the company, directors' involvement with other organisations whose interests could, however indirectly, conflict with those of the company or where the director could be under conflicting duties to the company and the other organisation, and any other situation where the interests of the director or a connected person could be in conflict with those of the company. Procedures should be in place to ensure interests are disclosed when a person is elected or appointed as a director and whenever they become aware of a conflict or potential conflict thereafter, or at directors' meetings when an issue is discussed in which a director or connected person could have a conflict of interest. The disclosures should be recorded in the register, as well as in the minutes if they are disclosed at a meeting, and should be regularly reviewed and updated. All of this is best practice for all organisations, not only companies.

Transactions requiring approval by company members. Some transactions with a director or connected person must be authorised by the company members, either at a general meeting or through a written resolution (Companies Act 2006 s.180). These include service contracts (a contract under which the director or connected person will be remunerated for providing services or goods to the company) for more than two years; a director or connected person acquiring a substantial non-cash asset such as property from the company; and loans or credit provided to directors or connected persons (this is not an exhaustive list).

In a charitable company, such transactions can be authorised by the company members only if they are explicitly allowed under the memorandum or articles (for example a provision allowing an employee to be a director/trustee, where the employee/director has or will have an open-ended contract that will or could last more than two years) and the Charity Commission gives prior consent in writing for the members to authorise the transaction (Companies Act 2006 ss.181 & 226). Directors in charitable companies must be aware that even if a conflict of interest requiring approval by company members is allowed under the memorandum or articles, the Charity Commission must authorise the company members to approve the conflict, and the members must then approve it.

In a non-charitable company the company members can authorise such transactions even if the transaction is not explicitly authorised by the memorandum or articles. Community interest companies (CICs) are covered by the rules for non-charitable companies, but must comply with the requirements of the community interest test; guidance is available from the CIC regulator at www.cicregulator.gov.uk.

Transactions not requiring approval by company members. In a non-charitable company, transactions not requiring authorisation by the company members do not need to be authorised by the directors, but do need to be declared to them.

In a charitable company, transactions between the company and a director/trustee or connected person not requiring authorisation by the company members must either be explicitly allowed under the memorandum or articles, or require an order of the Charity Commission (Companies Act 2006 s.181(4))..

Advice should be sought from the Charity Commission before a charity's non-charitable trading subsidiary approves a transaction with a director of either the subsidiary or the parent charity, or a person connected to such a director, unless the memorandum or articles of the charity and/or the trading subsidiary contain provisions authorising such a transaction.

Situational conflicts of interest
Most people would think that a Companies Act duty on company directors "to avoid conflict of interest" (s.175) would include transactions or arrangements between the company and a director or connected person. But it does not apply. Instead, those conflicts are covered by ss.177 & 180 (see above).

S.175 covers conflict of duties, where a director does not stand to gain or lose financially but fills two roles, in which his or her duties in one role could conflict with duties in another role. This is obviously very common in voluntary organisations where staff or board members of one organisation may be directors of another organisation. The Charity Commission has been using the term conflict of loyalties to describe this situation, and in the world of housing associations it may be called duality of interest.

The definition of conflict of interest under s.175 also includes situations arising from a director's use, or potential use, of property, information or opportunities where the director's interests could be in conflict with the company's — even if the company does not use, or intend to use the property, information or opportunity. An example could be where a director knows that the company is interested in setting up a new shared house for its beneficiaries. The director learns about a suitable four-bedroom property down the road — but his or her family is expanding and needs a four-bedroom house.... I call this opportunistic conflict of interest, but as far as I am aware no one else does, so no one will know what you are talking about if you use this term.

The duty to avoid conflict of interest under s.175 is not absolute. In a non-charitable company formed on or after 1 October 2008, a conflict of interest can be authorised by the directors provided there is nothing in the articles prohibiting this or saying a conflict of interest of that particular type is not allowed. In a non-charitable company formed before 1 October 2008, the directors can authorise a s.175 conflict if the memorandum or articles allow them to authorise that particular type of conflict, or the company members have passed a resolution allowing them to do so.

In charitable companies (and probably in non-charitable companies that are subsidiaries of charities), regardless of when they were set up, the directors can authorise a s.175 conflict of interest only if the memorandum or articles explicitly allows them to authorise that type of conflict. Unlike a non-charitable company, the members cannot simply pass a resolution allowing the directors to authorise a conflict of interest.

Where a director in either a charitable or non-charitable company had a s.175 conflict of interest (conflict of loyalties, or access to information etc that might be of use to them) prior to s.175 coming into effect on 1 October 2008, it continues to be dealt with under the old rules. So it is not necessary for existing conflicts to be authorised as indicated above. But for any new s.175 conflict, authorisation is needed. This is most likely to apply where a person becomes a director and has a conflict of duties because of involvement with another body, or a person who is already a director becomes involved in another body where there is a conflict of duties. This is likely to affect, in due course, a very large proportion of voluntary sector company directors.

Benefits from third parties
A company director cannot accept any benefit from a third party which is given because the person is a director, or which is given because they do or do not do something as a director (Companies Act 2006 s.176). There is an exception for a benefit which cannot reasonably be regarded as giving rise to a conflict of interest. This could include, for example, a small token such as an inexpensive pen given by a printing company, or a director being taken out for a working lunch by the organisation's solicitor, accountant or professional advisor.

There is no provision in s.176 for third party benefits to be authorised by the directors or company members.

The Charity Commission's model articles (GD1)
Article 6(4) (option 2) in the Charity Commission's revised model articles of association sets out constitutional provisions under which directors/trustees and connected persons can benefit from the charity, covering transactional conflicts of interest (see above). Most charitable companies already have similar provisions in their memorandum of association. Article 6(5)(b) in the model articles sets out who is a connected person. Article 44 says that such transactional conflicts must be declared, and that a conflicted director must not be present for discussions about the transaction. But it does not make clear that the director cannot vote or be counted in the quorum on the issue. Article 44 also appears to cover access to information etc which could be of use to a director — what I am calling an "opportunistic" conflict.

Article 45 allows the directors to authorise a conflict of duties/loyalties, where a person's duty to the charitable company conflicts with a duty owed to another person or organisation. Like article 44 it says that the conflicted director cannot be present for discussions of transactions or arrangements with that other person or organisation. Unlike article 44, however, article 45 does not explicitly require the conflict of interest to be declared. And also unlike article 44, it explicitly states that the conflicted director cannot vote or count towards the quorum.

I am not clear why articles 44 and 45 are not consistent. In any case, in relation to both transactions/arrangements with the company and conflicts of loyalty, it may be preferable for a conflicted director to be present for and take part in discussions, if the other directors wish, provided they are not present for the decision.

All in all I remain concerned about some of the Commission's articles, and I know that some voluntary sector specialist solicitors also are. So companies may not want to be panicked into making hasty amendments. Instead company directors should read and understand their current constitutional provisions on conflict of interest, ensure they scrupulously comply with them, ensure they explicitly authorise directors' and connected persons' transactions with the company (and minute their authorisation), ensure they authorise new conflicts of loyalty (even though there may not yet be constitutional provision allowing such authorisation), and consider whether the conflict of interest provisions are consistent with the new Companies Act requirements.

The directors should consider whether to amend the articles now in line with the Charity Commission's GD1, despite its apparent imperfections; wait for the Charity Law Association model articles to see if they are better; take specialist advice about the organisation's specific requirements; or wait and hope it will all go away (probably not recommended).

Provided the company complies with its articles and charity law, failure to comply with the strict letter of the company law conflict of interest duties will probably not become an issue. Failure to comply with company law can be enforced against the directors only by the company itself (which seems pretty unlikely, if the company itself has failed to pass the necessary amendment), or by a disgruntled company member or members getting court consent to bring a derivative claim against the directors (and it seems to me unlikely the court would give consent for this, unless there was a gross conflict of interest that really should not have been approved). The Charity Commission enforces charity law, not company law, and is unlikely to come down heavy on a charitable company that does not strictly comply with Companies Act procedures, provided the conflict has been declared and is being properly dealt with under the articles and charity law.

Please note that I am not a solicitor. The above section is my personal view. It is not intended as advice and should not be acted upon without taking specialist legal advice about your organisation's specific situation.

If the conflict of interest clauses in the articles are to be amended, it should be as part of a general review of Charities Act and Companies Act constitutional provisions — see s.7.7 in The Russell-Cooke Voluntary Sector Legal Handbook.

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