DIRECTORS’ DUTIES: CONFLICT OF INTEREST DUTIES

12

Directors’ duties: Conflict of interest duties

AIMS AND OBJECTIVES

After reading this chapter you should be able to:

  Distinguish:

  a director contracting (or having an interest in a contract) with his company

  other conflict of interest situations

  Understand the scope and operation of the two general conflict of interest duties:

  duty to avoid conflicts of interest (s 175)

  duty not to accept benefits from third parties (s 176)

  Identify director/company transactions for which shareholder approval is required

  Identify when a director is required to declare his interest in a transaction to the board of directors

  Recognise that the acts of a director may constitute breach of more than one duty

  Analyse a fact situation and identify:

  the behaviour of each director involved

  the directors’ duties that may have been breached by each director

  any statutory provisions governing company contracts with directors or persons connected with directors that may have been contravened

12.1 Introduction

As indicated in the introduction to Chapter 11, this chapter covers two essential parts of our study of directors’ duties and the key statutory provisions governing company contracts with directors and persons connected with directors. The overall scheme of our study is as follows:

  legislative reform (Chapter 11);

  to whom the duties are owed (Chapter 11);

  management duties (Chapter 11);

  conflict of interest duties (Chapter 12);

  statutory provisions governing company contracts with directors and persons connected with directors (Chapter 12);

  remedies and relief for breaches and contraventions (Chapter 13);

‘Conflict of interest duties’, as that term is used in this book, are the duties imposed on directors primarily to discourage them from acting not only in their own self-interest but also in the interest of any person other than the company, including a person to whom they may also owe a duty. Arguably the duty in s 173 to exercise independent judgment, considered in Chapter 11, would be better placed in this chapter, as a conflict of interest duty, based on its role in regulating a director faced with duties both to the company and a third party (often the director’s nominating shareholder). Its inclusion in the previous chapter, as a management duty, emphasises its role in requiring a director to actually exercise his judgment in the course of management, rather than abdicating responsibility.

The dual function of the duty simply highlights the fact that management duties and conflict of interest duties are not mutually exclusive categories. Where a director acts in his own self-interest or in the interest of another person to whom he owes a duty, he will very often also be in breach of a management duty. He may have exercised a power for an improper purpose (in breach of s 171) and he is very likely to have failed to act in the way he considers, in good faith, would be most likely to promote the success of the company. The same is not true in reverse, however; there is not the same likelihood that a breach of management duty will also entail a breach of a conflict of interest duty.

Duties regulating self-interested actions by directors fall into two categories: duties in relation to conflicts of interests and duties in relation to contracting with the company. Each category contains general duties. Additional statutory provisions govern specific types of contracts directors enter into with their companies. An overview of conflict of interest duties and key statutory provisions governing company contracts with directors and persons connected with directors can be seen in Figure 12.1. In this chapter we deal with the two general duties governing directors’ conflicts of interest that do not involve company contracts before turning to the duty imposed on directors to disclose interests in company contracts and specifically regulated company contracts.

12.2 Directors’ conflicts of interest

Directors’ conflicts of interests are governed by two general duties, the duty to avoid conflicts of interest (s 175) and the duty not to accept benefits from third parties (s 176).

12.2.1 Duty to avoid conflicts of interest

SECTION

Section 175(6) governs the conditions of effective director authorisation. Any requirement as to the quorum at the meeting at which the matter is considered must be met without counting the director in question or any other interested director, and the matter must be agreed to without their voting or it must be the case that it would have been agreed to if their votes had not been counted. Note also that authorisation must be obtained in advance of acting in what would otherwise be a conflict of interest matter. When deciding whether or not to authorise a conflict, a director must, of course, act in accordance with all of the duties he owes to the company. He will be in breach of s 172, for example, if he votes to authorise a conflict if he does not consider, in good faith, that the authorisation would be most likely to promote the success of the company.

  Section 175(3) provides that a conflict arising in relation to a transaction or arrangement with the company is not a conflict covered by s 175 (regulation of these transactions and the scope of s 175(3) are considered in section 12.3, see in particular the example at the end of 12.3.2).

  Section 175(1) refers to the duty to avoid a situation in which the director has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company, yet s 175(4) states that the duty does not apply if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest.

  Section 175(2) reinforces that the duty applies in particular to the exploitation of any property, information or opportunity.

  Section 175(2) goes on to state that it is immaterial whether the company could take advantage of the property, information or opportunity, yet again, it is difficult to reconcile this with the duty not applying if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest (s 175(4)).

Beyond the clues in s 175 as to when a conflict of interest will exist, it is instructive to examine pre-2006 Act conflict of interest cases to have a sense of when a director will be found to have a conflict of interest for the purposes of s 175. Many cases have concerned directors exploiting corporate opportunities themselves after they have left the company, which raises the question when do directors who leave a company cease to be subject to the duty. In other cases, the company has not been in a position to exploit the opportunity itself, or has decided not to. Each of these situations is considered in turn in the following paragraphs.

Corporate opportunities and directors who leave or are in the process of leaving the company

Section 170(2) specifically provides that a person who ceases to be a director continues to be subject to the duty in s 175, ‘as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director’. What is not always clear is whether such exploitation is, as a matter of fact, a conflict of interest. Two types of cases dealing with directors who leave companies and take up opportunities the companies consider they should not have exploited for their own benefit are where a director leaves deliberately in order to acquire an opportunity previously sought by and for the company, and where a director is forced out of a company. In relation to the first of these scenarios, the law is strictly applied.

In contrast, there may be no conflict where a director performs services for a customer of the company in competition with the company, even whilst he is a director, if he is in the process of being forced out of the company. Starting from the principle illustrated in London and Mashonaland Exploration Co Ltd v New Mashonaland Exploration Co Ltd [1891] WN 165, that there is no completely rigid rule that a director may not be involved in the business of a company which is in competition with another company of which he is a director, the Court of Appeal in Plus Group Ltd v Pyke [2002] 2 BCLC 201 (CA) considered it possible for a director’s duty to be ‘reduced to vanishing point’ on the facts because he had been squeezed out of any management role in the company. In those circumstances, a director who set up a new company to compete with the company and performed services for a major client of the company, was held not to be in breach of duty.

In Foster Bryant Surveying Ltd v Bryant & Savernake Property Consultants Ltd [2007] 2 BCLC 239 (CA), the Court of Appeal explored the duty of a director between resigning (he was effectively forced out of a company) and his resignation taking effect in the context of a customer of the company wishing to continue to secure the services of the director. Rix LJ’s judgment is worth reading for its clear review of the ‘corporate opportunity’ authorities. He focused on the need for a link between the resignation and the obtaining of the business by the director, i.e. the resignation must be part of a dishonest plan. He stated that the standards of loyalty, good faith and the no-conflict rule should be tested in each case by many factors, i.e. a fact-intensive investigation was required to determine liability for breach. Amongst the factors to be considered in that enquiry are:

  position or office held;

  nature of the corporate opportunity;

  its ripeness;

  its specificness;

  the director’s or managerial officer’s relation to it;

  the amount of knowledge possessed;

  the circumstances in which it was obtained;

  whether it was special or, indeed, even private;

  the factor of time in the continuation of fiduciary duty where the alleged breach occurs after termination of the relationship with the company;

  the circumstances under which the relationship was terminated, that is whether by retirement or resignation or discharge.

Note the willingness of the court in this case to engage in in-depth factual analysis when applying the conflict of interest rules to determine whether or not a conflict actually existed. This approach is in stark contrast with the approach in old cases asserting the necessity for fiduciary obligations to be applied strictly, regardless of whether or not the principal suffered a loss, to protect the principal, ‘as no court is equal to the examination and ascertainment of the truth in much the greater number of cases’ (per Lord Eldon LC in Ex parte James 8 Ves 337).

12.2.2 Duty not to accept benefits from third parties

SECTION