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Companies Act 2006
CONFLICT OF INTEREST DUTIES OF DIRECTORS

Updated 22/9/08. This information is included in ss.15.3.5-15.3.8 in The Russell-Cooke Voluntary Sector Legal Handbook (VSLH3).
From 1 October 2008 new statutory duties are added to those introduced on 1 October 2007. The new duties 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 current requirement to declare an interest in an existing transaction) (ss.175-177).

In the past 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 still unclear — especially where they overlap with charity law rules on conflicts of interest — so the information below should be taken as preliminary, and provides only an overview rather than the details of the law. I am not a solicitor, and company directors are very strongly advised to take advice from their legal advisors, and/or in charitable companies to seek advice from the Charity Commission.

The Charity Commission's Guide to conflict of interest for trustees, 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.

Transactional conflicts of interest (s.177). 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. 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).

Action: If there is not already a register of directors' and connected persons' interests, set one up. This 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, 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. Put procedures 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. Ensure the disclosures are recorded in the register and are reviewed regularly. 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 (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 (ss.181 & 226).

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.

Action: 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.

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 must be approved by the directors under the provisions in s.175 (see Situational conflicts of interest, below).

Clause 5 in the memorandum of the Charity Commission's revised GD1, Charitable companies: Model memorandum and articles of association, sets out constitutional provisions on director/trustee benefit. Clause 5(4) (option 2) authorises directors/trustees and connected persons to receive benefits as a beneficiary of the charity; directors/trustees to be paid for goods or services as allowed under the Charities Act 1993 s.73A, interest within specified limits on loans to the charity, and reasonable rent on premises let to the charity; and for the company to purchase goods or services from companies listed on a recognised stock exchange in which the director holds less than 1% of the shares. Most charitable companies already have similar provisions in their memorandum of association. Clause 5(6) in the model memorandum sets out who is a connected person, and clause 5(5) makes clear the rules on trustee benefit also apply to charities' trading subsidiaries.

GD1 also contains, in articles 39-40, procedures for declaring conflicts of interest and voting on transactions or arrangements with the company.

GD1 can be accessed via tinyurl.com/3u8mqg.

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..

Action: In charitable companies, the memorandum of association may need amending to allow certain types of transactions with directors/trustees or connected persons, and the articles may need amending to include procedures for dealing with conflicts of interest. Legal advice should be sought before doing this, and Charity Commission consent will be needed for any amendment that relates to benefits for directors/trustees.

Situational conflicts of interest (s.175). This section refers to the duty to avoid conflict of interest, and most people would think that this includes transactions between the company and a director or connected person. But it does not apply to such transactions in non-charitable companies, or in charitable companies where the transactions are allowed under the memorandum or articles — those transactions are covered by ss.177 & 180 (see above).

In charitable companies, conflict of interest as defined in s.175 covers transactions between the company and a director or connected person where that type of transaction is not authorised in the memorandum or articles, and thus has to be authorised by the directors.

In all companies, whether charitable or non-charitable, 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....

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 memorandum or 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. Clause 7 in the Charity Commission's GD1 model memorandum of association (see above) 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.

Where a director had a s.175 conflict of interest 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.

Action: In non-charitable companies (except possibly charities' trading subsidiaries), new s.175 conflicts of duties can be dealt with by a resolution of the members. This will involve either a general meeting or a written resolution.

Companies may not want to be panicked into making hasty amendments. Instead, they may want to discuss and if appropriate approve s.175 conflicts of duties arising on or after 1 October 2008, even though the memorandum or articles do not yet allow them to. Failure to comply with the strict letter of of the conflict of interest duties 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 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 s.175 procedures, provided the conflict of duties has been declared and is being properly dealt with.

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

Benefits from third parties (s.176). 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. 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.
In charitable companies, transactions or arrangements with the company, conflicts of duties, and any other conflicts of interest which cannot be authorised under the above provisions can be authorised by an order of the Charity Commission (s.181(4)).

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