Harmony in conflict management
The new law on company directors' conflict of interest, and how it affects governance procedures, particularly as respects company pension schemes
The provisions of the Companies Act 2006 ("the Act") concerning directors’ duties in relation to conflicts of interest came into force on 1 October 2008. The new legislation clarifies a historically confusing area of legislation. The legislative change has overlapped with the Pensions Regulator (tPR) issuing new guidance (see "Useful Links", below) on conflicts of interest. tPR’s aim is to offer educational support with a view to sharing good practice and raising standards through drawing up guidance for trustees who may have conflicts of interest.
Directors could potentially be caught up in conflict situations in a number of different ways. This article considers how the legislation affects directors and governance procedures, and also how the broader tPR guidance will impact on directors with pension scheme appointments.
The Act defines two different types of conflict of interest:
- transactional conflicts; and
- situational conflicts.
Each requires a different response from directors.
A transactional conflict arises where a director, or connected person, has an interest in a transaction or arrangement with the company.
The Act at s 177(1) says: "If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors."
This is much the same as the previous position: such interests must be declared to the board. Chapter 4 of Part 10 of the Act imposes additional requirements for shareholder approval in the case of some types of transaction between a company and its directors, such as loans or substantial property transactions.
Where a transactional conflict is declared in writing to the directors, this item should be on the agenda of the next board meeting, and be carefully minuted.
Section 175(1) defines a situational conflict as: "a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company".
GC100 (see "Useful Links", below) offers this plain English description of a situational conflict: “anything or any connection which could potentially divert a director’s mind from giving sole consideration to promoting the success [of the company]”.
The Act requires that directors avoid conflict situations. This more restrictive regime confers a positive duty on directors to avoid possible conflict situations, rather than simply show that there are procedures in place to manage actual and potential conflicts. Indirect conflicts can arise, in particular, through a broader definition of connected persons, which now includes parents, civil partners, children and stepchildren under 18.
Breach of company law from conflict situations can be avoided by prior authorisation. This can be obtained in one of three ways:
1. Authorisation by the company board
For public companies authorisation by the board must be facilitated by the articles of association. Quorum requirements at a board meeting to approve conflicts must be met ignoring the conflicted director. In private companies incorporated after 1 October 2008, the board can authorise conflicts unless this is expressly disallowed in the articles. For private companies incorporated before that date there must either be power included in the articles for the board to authorise conflicts or the shareholders need to pass a resolution to permit board authorisation going forward.
In approving any conflict, the directors are bound to act in good faith to promote the success of the company. Authorisation by the company board may be the approach taken where, for example, a finance director is to be appointed to the trustee board of the company pension scheme. There is clear potential for conflict to arise whenever the board of the company discuss any matter that could affect the ability of the company to fund the scheme.
2. Authorisation through the articles
For efficiency in governance processes it makes sense for companies to make allowance in their articles for common conflict situations. A "safe harbour" provision exists ensuring that anything done or not done by directors in compliance with the articles does not constitute a breach of duty under the Act. This route to authorisation could be favoured for example within groups where a director may hold directorships in several subsidiaries. The articles of many companies which form part of large groups now provide that any conflict arising out of a directorship of other companies in that group is approved.
Also, consider a situation where e.g. Banking Co Ltd has a joint venture with Supermarket Ltd: Supermarket Financial Services Ltd, to distribute financial products. A director of Banking Co Ltd who is also a director of Supermarket Financial Services Ltd representing the interests of Banking Co Ltd, could have his situation recognised in the articles.
3. Authorisation by shareholder resolution
For companies with a small number of shareholders, or in unusual situations where all of the directors have potential conflicts, this is a practical route to securing the required authorisation. This could also be used where the directors have concern as to whether authorising the conflict would promote the success of the company.
No authorisation is required where the situation cannot reasonably be regarded as likely to give rise to a conflict of interest. However, there is currently no clear guidance or case law for this reasonableness test so this path should be followed with care.
Existing situational conflicts
The new legislation covers situational conflicts arising after 1 October 2008; however, best practice would encourage companies to keep a register of conflict situations which emerged before this, along with records of how these situations are being managed. In the case of particularly significant or delicate existing situational conflicts there is certainly no downside in securing authorisation, although it is not strictly required, under the new requirements.
New potential situational conflicts should be dealt with as they arise, but all directors should be reminded to regularly review and update any situational conflicts. Particular care should be taken with new directors to secure authorisation of situational conflicts, ideally before the date of their appointment.
Transacting into a situation
It is possible that transactions/arrangements which are covered by the transactional conflicts provision (s 177 of the Act) may also fall under s 175 relating to situational conflicts. This would invoke a duty to avoid such situations. Directors have no positive obligation to avoid transactional conflicts.
For example, a director of Widget Co, who is also a director of Outsource Co, has a transactional conflict during negotiations between the companies for a new outsourcing arrangement. Once the contract is up and running an ongoing commercial relationship has been formed and this could be a situational conflict falling under s 175 which requires separate disclosure and authorisation.
In the case of a transaction or arrangement with a director covered by Part 10, Chapter 4 of the Act, (for example substantial property transactions or loans to directors) where shareholder approval is either required and secured, or not required in terms of that chapter, it is not necessary also to comply with the provisions relating to s 175 situational conflicts.
What is notable for directors about the legislation and associated GC100 guidance is that the approach to conflict management engendered has broad similarity to tPR's newly issued guidance on how trustees should identify, monitor, and manage conflicts of interest in the stewardship of pension schemes.
The Pensions Regulator
Avoiding a breach of company law still leaves trustees with a need to avoid breaches of trust law. After broad consultation, tPR published guidance on 1 October 2008 with a view to sharing best practice and raising standards in the area of conflicts management.
In the current economic environment the tension between the sponsoring employer’s commercial goals and the trust law protection afforded to beneficiaries is brought sharply into focus. Even the mere threat of a conflict situation could give scope for the courts to set aside the action of an affected trustee.
tPR has taken a pragmatic approach regarding senior employees who are directors and also trustees of the pension scheme. Despite the clear potential conflict, such a scheme trustee brings invaluable experience to their role and enhances communication between the company and the scheme. Just as the Act facilitates such an appointment in the face of the obvious situational conflict through authorisation, tPR favours careful management of such conflicts, through its five key principles of conflict management, rather than avoidance.
There are striking parallels between these principles and the GC100 guidance on directors’ conflicts of interests:
GC 100 Guidance on the Act
|1. Understanding the importance of conflicts of interest
||Encourages company secretary to write to directors explaining the new regime
|2. Identifying conflicts of interest
||Highlights the need for the board to consider each director’s actual and potential conflicts through the use of a questionnaire
|3. Evaluation, management or avoidance of conflicts
||Encourages directors to list positions/situations held to secure authorisation, and regularly update the board of changes
|4. Managing adviser conflicts
||Encourages the board to anticipate how to deal with confidentiality issues where a director also has a role with a company adviser
|5. Maintaining a conflicts of interest policy
||Gives specific guidance on processes required to demonstrate compliance with the Act, e.g. maintenance of conflicts register, new appointments procedure
tPR’s issuance of this guidance heralds an increased emphasis on conflicts of interest. This comes at a time when the responsibilities that rest with trustees have been growing steadily for several years, including for example the effect of the recent Transfer Value Amendment Regulations 2008. It is also wholly consistent with tPR’s recent approach to dealing with "problem schemes", as illustrated in the case of Telent: independent trustees can bring the necessary expertise, without the potential baggage of conflicts.
tPR has suggested that some or all of the following measures may help trustees to manage active conflicts:
2. establish a subcommittee
3. appoint an independent trustee
4. resignation/non-appointment of trustees
Having suggested these management tools, tPR warns that inadequate management of conflict situations will result in regulatory action which could include the appointment of an independent trustee.
Through the provisions of the Act, and/or guidance from tPR, many directors will now be required to have increased awareness of possible and actual conflicts of interest. Early identification and effective management through enhanced governance processes may leave affected individuals free to discharge their other responsibilities. Directors with concerns about compliance with company law, trust law or tPR’s requirements should seek independent legal advice.
Louise Aitchison is a Trainee Solicitor at Dundas & Wilson CS LLP.
GC100 brings together senior legal officers and company secretaries from 90 past and present FTSE 100 companies to provide a forum where members can share best practice in relation to legal, risk management, compliance and other areas of common interest.