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 the interest of the interested director 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 in interest
The duty is owed by the director the company, which means that only the company has the right to enforce that duty. It is not a criminal offence.
The duty is interpreted strictly, so that a director has an absolute duty to declare their interest and 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 interest 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 delaings.
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 the transaction is proposed or 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 be, aware;
- the shareholders have approved the conflict of interest (with informed consent).
How does the director comply with the duty?
The director must make the disclosure to all the other directors. Only full and frank disclosure will be adequate to 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 may be able to 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 reach 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 form 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.
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. Director’s should also be alert to the possibility of any conflict of interest and should err on the side of caution in deciding whether or not to inform the other directors of any potential conflict.