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Directors’ conflicts of interest
Under Section 177 of the Companies Act 2006 any director who is in any way, directly or indirectly, interested in a proposed transaction or arrangement with a company, has a duty to declare the nature and extent of that interest to the other directors (unless it cannot reasonably be regarded as likely to give rise to a conflict of interest).
Purpose of the director’s duty to declare an interest
The purpose of duty is to ensure that the other directors are aware of a director’s interest and have the necessary information to enable them to properly assess whether the proposed transaction should be approved.
Main features of the duty to declare an interest
The duty is owed by the director to the company, which means that only the company has the right to enforce that duty. It is an internal matter and therefore does not constitute a criminal offence.
The duty is interpreted strictly, meaning that it is a director’s absolute duty to declare their interest. Consequently, a breach of s.177 may be technical, without the need for any deliberate wrongdoing.
When does the director have an interest in a proposed transaction?
At the most basic level, a director will be interested in a transaction if, for example, they are the counter-party to a contract with the company, or if they are buying an asset from or selling one to the company.
However, the duty to declare also applies to indirect interests, which may include the company:
- dealing with the director’s spouse or family;
- dealing with another company in which the director has a stake;
- buying or selling an asset which affects something owned by the director (for example land adjoining land owned by the director).
The duty to declare an interest arises whenever the director is interested in a proposed “transaction or arrangement” with the company. This wording is extremely broad and will include more than simple contractual dealings.
Exceptions
A director is not obliged to declare an interest where:
- the director is not aware (or should not reasonably be aware) that they have an interest, or are unaware that the transaction has been proposed or even exists;
- they do have an interest, but where it cannot be reasonably regarded as likely to give rise to a conflict of interest;
- if the other directors are, or ought reasonably to be, aware;
- the shareholders have approved the conflict of interest (with informed consent).
How does the director comply with the duty?
The director must disclose his/her interest to the other directors. Only full and frank disclosure will be adequate to a company with the duty to declare. Disclosure may be made in writing or verbally, but full records must be kept.
Effect of declaring an interest
Declaring an interest protects the company and the director against some action by shareholders. However, it does not override the directors’ general duty to consider whether entering into the proposed transaction is in the company’s interests, nor does it override anything in the company’s articles of association regarding decision-making (for example, the articles may provide that conflicted directors may not vote at board meetings on the matter in question).
Failure to declare an interest
If the director has not declared an interest, then the company could seek to rescind any contract (i.e. declare it void) as against the director.
In addition, the company may have a claim against the director for breach of their fiduciary duty to the company, giving rise to a right to compensation.
In extremis, the company might have a claim against the director for commercial fraud (although, as noted above, a failure to declare an interest is not a criminal matter).
There is also the possibility of a claim by shareholders for unfair prejudice, or by the Registrar of Companies for an order seeking disqualification of the individual from acting as a company director.
Ratification by shareholders
If a director has failed to declare an interest, the matter may be ratified (i.e. approved) by the shareholders after the event.
Conclusion
The duty to declare an interest in any proposed transaction or arrangement with a company is important and far-reaching, and the risks of failure to comply are substantial for the director personally. Directors should remain alert to the possibility of any conflict of interest and be prudent in deciding whether or not to inform the other directors of a potential conflict.
Further Information
If you have any questions regarding the above, or require any assistance, please do not hesitate to contact Dixcart Legal on: hello@dixcartuk.com
