How can conflicts of interest be managed?
In the first part of this article, we looked at typical scenarios where conflicts of interest can occur and their possible consequences. In this post, we examine practical strategies for managing them.
There are three steps to ensure conflicts are properly managed and undesirable consequences avoided.
Identify the conflict
Individual board members must be aware of what type of conflicts could occur and they must declare them. The organisation should have a Conflicts of Interest Policy and should arrange training or induction for board members. Declaration can be done verbally at the start of meetings through a standard agenda item, by notice in writing to other board members, or more generally by the board secretary keeping a register of outside interests. If a board member is unsure, it is better to err on the side of caution and openness and discuss the matter with the Chair.
Prevent the conflict from affecting the decision
Remember the Board has an overriding fiduciary duty to act in the best interests of the organisation. They must consider how they can prevent the conflict from affecting proper decision-making. Their approach is likely to depend on how serious the issue is. In very serious cases, the Board may take the view that the conflicted board member must resign. If a substantial number of board members are conflicted, it may necessary to appoint more neutral board members to allow valid decisions to be taken. Alternatives would be not to pursue the course of action or to proceed in a different way.
If the conflict is not completely removed in this way and it is not a fundamental one, the Board will have to follow any specific procedure for managing a conflict set out in the organisation’s constitution. The Articles or governing document typically require that conflicted board members must declare their interest, retire from the meeting and not participate in the voting or form part of the quorum for the meeting to be valid.
If the constitution allows it, the remaining non-conflicted board members may proceed to debate the issues and specifically authorise the proposed action in spite of the conflict. However, even if the constitution of the organisation contains machinery to authorise a conflict, it may be that the matter is so serious that the Board could still not in good conscience proceed to authorise because it would never be in the best interests of the organisation and they would not be discharging their overriding fiduciary duty by doing so.
For companies, Section 175 (3) of the Act states “This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company if, or to the extent that, the company’s articles allow that duty to be so disapplied, which they may do only in relation to the descriptions of transaction or arrangement specified in the company’s articles.”
So for example, Article 14 of the Model Articles for private companies says that a director who is interested in an actual or proposed transaction or arrangement with the company can be still be counted in the quorum and voting if:
- the members pass an ordinary resolution to disapply the ban (calling a members meeting may not always be practical, of course. But certain transactions always need the shareholder/ members’ approval, such as large loans to a director, directors buying or selling significant assets to/ from the company, service contracts for directors with a notice period exceeding 2 years and ex gratia severance payments); or
- the director’s interest cannot reasonably be regarded as likely to give rise to a conflict (a common sense test, which can be difficult to apply in practice, of course); or
- the matter concerns a guarantee to be given by or to a director in relation to the company, the subscription for shares by the director, or which concerns employee benefits for current or former staff.
Where there is doubt about the eligibility of a director to participate, the Chairman’s ruling is final.
On the other hand in the Charity Commission’s model articles for a charitable company, there is a comprehensive and very strict scheme in Articles 7 to 9 regulating conflict situations. In summary, Article 7 permits limited benefits for directors (and their ‘connected persons’) if: they are themselves beneficiaries of the charity; if they are receiving rent for premises let to the charity, or interest on money lent (provided the level is reasonable); participation in normal fundraising and trading activities; or if they are supplying services or goods to the charity and specific conditions are satisfied (namely, there is a written agreement, the remuneration is reasonable, the directors are satisfied it would be in the charity’s best interests to use that particular supplier, persons receiving remuneration are always in a minority and there is no specific prohibition of the payment elsewhere in the constitution). Also to supply goods, the director affected must not take part in the meeting, voting or quorum, and the reason for the decision are clearly minuted. The exemptions apply also to the same type of dealings with a charity’s trading subsidiary.
Similarly, under Article 9, the unconflicted directors of a charitable company may specifically authorise a conflict of loyalties, provided the conflicted director absents himself from that part of the meeting, does not vote or form part of the quorum and the remaining directors consider it is in the best interests of the charity to authorise, and the person does not derive any personal benefit from their involvement with the outside body.
If the constitution does not contain a procedure to authorise low level conflicts, it would be prudent to considering amending it to include one. In cases of doubt, the Board should take external advice on how to proceed. A court or regulator would be less likely to criticise a board which had acted on professional advice.
In extreme cases, the board may consider making an application to the court for authorisation to proceed, however this could be an expensive solution. In the case of charities, the trustees can seek guidance and authorisation from the Charity Commission under special procedures.
Keep proper records
The minutes of meetings should formally record any conflicts of interest and how they were handled. If a transaction or decision is later challenged in litigation or regulatory proceedings, the minutes form an important record to demonstrate that the Board gave the matter appropriate attention and reached a decision within their margin of discretion. The Board would be in a much better position to defend itself than if there were no paperwork or audit trail.
Remember also that certain types of organisation may be required to disclose ‘related party transactions’ or benefits paid to Board members in their accounts. Consider how it would look to external stakeholders when these details enter the public domain?
The proper identification and management of conflicts of interest is essential to maintain stakeholder confidence and protect the organisation’s reputation. Government and regulators have become very vigilant towards abuses, particularly where public money is involved. For example, in academy schools, the Education Select Committee recently investigated relationships between some academy sponsors and their commercial arms, who may supply paid for back office and curriculum support services into their schools. Similarly in the health sector, Parliament has legislated to regulate conflicts of interest between Clinical Commissioning Groups and their member GP practices who may supply services to them. With the right constitution and procedures in place and appropriate training and support for the Board it is possible to avoid the pitfalls.
Mark Johnson is an experienced solicitor and company secretary working with charities, social enterprises, SMEs and public sector spin-outs to manage risk and ensure sound governance arrangements. More at elderflowerlegal.co.uk
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