Dealpoint - Avoiding Conflict
From
this Wednesday 1 October 2008 directors of UK registered
companies come under a new positive duty to avoid situations
in which they have (or can have) a direct or indirect
interest that conflicts with (or possibly may conflict
with) their company's interests.
This
new duty is broadly similar to the existing common law
duties directors have to avoid placing themselves in positions
of conflict. However, the wording of the new duty is arguably
wider than the previous common law duty. This and the
fact that the duty is now set out in black and white in
primary legislation means that directors will be more
minded than ever to avoid inadvertently breaching this
duty to avoid 'Situational Conflicts'.
Breach of the duty might result in the company having
a right of action against the director, with possible
remedies including the setting aside of transactions,
damages and injunctions. Allegations of breach are most
likely to arise in circumstances where companies are in
financial difficulty or a formal insolvency process such
as liquidation or administration.
What
is a Situational Conflict?
The
legislation does not set out what situations will be caught,
which will depend upon the specific circumstances in any
case. However, common day-to-day examples might include:
-
Directors being involved in some way with a business that
might compete with their company.
- Directors
being trustees of the company's pension scheme or directors
of the company's pension trustee company.
- Directors
being involved with customers of, or suppliers to their
company.
-
Directors owning property or assets unconnected to their
company, but the value of which might be affected by the
activities of their company.
It is important to note that for the duty to be infringed
there does not have to be an actual conflict of interests,
only a situation that might result in a conflict.
This duty does not however apply to a conflict of interest
arising from a transaction or arrangement between
a director and the company which is governed by the longstanding
requirement for the director to declare such interests.
The duty may well be relevant in corporate transactions
where possible Situational Conflicts might arise:
- Where
directors are negotiating the potential sale of their
company. Often in the context of a disposal directors
will be engaged in a wide variety of discussions which
might result in them having a conflict of interest. For
example, the director might be involved in negotiations
regarding the provision by him of consultancy services
to the proposed acquirer; share options or other benefits
he might receive as a result of the sale; a severance
package he will receive as part of the transaction; or
a new salary package if he will continue to be employed
by the company. Given the numerous potential conflicts
that can arise in this situation, directors of companies
being marketed for sale might consider that from the point
that the consideration of such a disposal commences they
are faced with a Situational Conflict.
- In
a Management Buy Out. MBOs often present difficulties
for those involved due to the potential divergence of
interests faced by management who are both running the
business and taking steps to acquire it. It is highly
likely that, from the point that management determine
they wish to buy their company or its assets, they will
be in a Situational Conflict. It may be that at this point
the management team have not yet declared their intent
to the shareholders and other directors. Our opinion is
that management teams should seek approval for their involvement
in the buy out from any directors who are not part of
the proposed MBO team at the earliest possible stage.
It is likely that any such approval would be subject to
certain conditions and some examples are considered below.
- Where
Directors are also trustees of their company's pension
scheme. Directors are probably facing a Situational Conflict
merely by virtue of holding both positions. However, this
is particularly likely to be the case if the company is
considering a corporate transaction which might be prejudicial
the scheme in some respect. The Pensions Regulator imposes
similar conflict rules.
- Via
connected persons. Suppose a company is considering a
disposal of a division of its business. Once the marketing
process is underway, it transpires that a director's brother
is an investment manager with a firm of venture capitalists
which has expressed an interest in acquiring the division.
Here, there may be not actual conflict but the director
may well have a Situational Conflict.
How
to avoid breach of duty
Thankfully, given the wide nature of the duty, the legislation
introduces for the first time the ability for conflict
situations to be sanctioned at board level. Situational
Conflicts will not amount to a breach of duty if authorisation
for the continued existence of the situation has been
given by the independent directors of the company's board.
However,
for the board to have the power to give such authorisations:
-
Public companies' articles of association must expressly
give them that power.
- All
existing private companies incorporated before 1 October
2008 must have passed a shareholder resolution giving
them that power.
Boards
of private companies incorporated after 1 October 2008
will automatically have the power unless their articles
expressly prohibit them. If the situation is not authorised
by the board there remains the possibility of it being
sanctioned by prior or subsequent shareholder approval.
The change in law should be of particular concern to companies
(whether public or private) with a diverse shareholder
base.
We are advising boards of directors to:
- Amend
their articles or seek the necessary resolutions to give
them the power to sanction Situational Conflicts.
- Carefully
consider any other positions they hold or other situations
which they think may need authorising and consider whether
any of their connected persons are in such a position.
Should
boards authorise Situational Conflicts?
Why
should the independent directors on a board authorise
the existence of a Situational Conflict? The answer is
that it might be in the company's best interest for the
situation to exist. When considering whether or not to
authorise, each director will need to have regard to his
own duties including the duty to act in a way he considers,
in good faith, will be most likely to promote the success
of his company. Where the directors are asked to approve
a situation that brings clear benefits to the company,
for example access to industry or sector expertise, they
should usually be able to determine that they are acting
in the interests of the company in approving the situation.
Directors should be able to approve a matter if, on balance,
they think it is in the interests of the company to retain
(or appoint) that particular director. However, the directors
should always consider what effect the matter they are
approving would have on the relevant director's ability
to act in accordance with his wider duties.
Crucially, directors also need to consider how far any
authorisation should go. They may wish to sanction a situation,
but not wish to sanction all the consequences that flow
from it. They may also wish to give themselves the power
to revoke any authorisation at any point in the future
For example, in the scenarios set out above:
- In
an MBO, the independent directors (if any) may wish to
allow the MBO team to proceed with trying to raise finance
for the proposed buy-out subject to certain conditions,
for example: restrictions regarding to whom they are able
pass confidential information; the requirement that they
must make certain information available to the company
(for example any potential rival offer); and the obvious
requirement that they do nothing with a view to reducing
the value of the company and hence the price they are
paying. Directors in an MBO scenario have always been,
and remain, under a positive duty to act in their company's
best interests irrespective of any conflicts presented
by the MBO. However, unless considered properly there
might now be the danger that the independent directors
inadvertently sanction certain unacceptable conduct at
the point they approve the situation generally.
- In
a scenario where no actual conflict presently exists,
but the potential is anticipated, such as the example
in which the director is related to the interested VC,
the independent directors may wish to authorise the situation
subject to the condition that the authorisation is only
given up to the point where the VC is selected as the
preferred acquirer, and from that point the authorisation
is withdrawn and the director must absent himself from
any discussions regarding the sale.
This change in law clearly requires some detailed thought
on the part of directors. If directors require any further
advice in respect of the new duty, or their duties at
law generally, please contact Richard Wrigley on 0870
763 1586.
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