In this post we explore how to identify and manage conflicts of interest
An effective system of corporate governance for any organisation must be underpinned by the three pillars of transparency, accountability and integrity. The public’s faith in corporate institutions has been repeatedly shaken by wrongdoing, impaired judgements and undue influence. Perceptions can be just as damaging as events actually occurring in practice. At the heart of these questions of trust often lies a failure properly to identify and manage conflicts of interest.
What is a conflict of interest?
A conflict of interest occurs where an individual’s ability to exercise independent judgement, or to perform a role objectively, is, could be, or could be seen to be impaired or otherwise influenced by their involvement in another role or relationship. The individual does not actually need to exploit his or her position or obtain an actual benefit, financial or otherwise, for a conflict of interest to occur. There are two types of conflicts of interest:
- Personal benefit conflict – the person could enjoy a potential financial or measurable benefit directly, or through a connected person (for example, a close relative, or a business in which they have a material stake). They may stand to gain personally from decisions made, or may exploit the knowledge gained from their role for personal gain;
- Conflicts of loyalty – the person’s duty to the organisation may compete with a duty or loyalty they owe to another organisation or person (for example, where a director has been appointed to a board of a joint venture company by one of the joint venture partners by whom she is employed, or where she sits on the board of other organisations or serves as an elected member or officer of a public body). This may prevent her from acting properly or independently, in the best interests of the organisation.
Common examples of conflicts of interest situations include:
- a board member sits on the board of another organisation which may be awarded a contract by this organisation, or which is in dispute with this organisation
- a board member may wish to sell to, or purchase assets or property from the organisation
- a decision is to be made on a contract or payment to a board member for their services
- a proposal to employ a board member’s spouse or child in the organisation
- paying a person or business closely connected with a board member for delivering services to the organisation
- making a payment or awarding benefits to a person who is a close relative of the board member
Why are conflicts of interest so important?
The law takes a dim view of persons who place themselves in a situation where their interests conflict with those whom they are appointed to represent. The duty to avoid a conflict of interest derives from the duty of undivided loyalty which applies to someone acting in a fiduciary capacity. A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a special relationship of trust and confidence. Company directors act in a fiduciary capacity when they take decisions and act on behalf of their company, charity trustees are fiduciaries, as are executors and trustees of a will, as well as investment managers, pension fund trustees, and solicitors and accountants in their dealings with clients.
The Courts have laid down clear rules for fiduciaries. ‘A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal’. (Bristol & West v Mothew 1998, Lord Justice Millett). These principles are supplemented by specific legislation which applies to particular types or organisations, backed up by a range of sanctions for behaviour which contravenes them.
Special Rules for Company Directors
Directors of any company (whether it be limited by shares, limited by guarantee, an academy trust or a community interest company) have specific statutory duties under the Companies Act 2006. These include a duty to promote the success of the company (s 172), a duty to exercise independent judgment (s 173), a duty not to accept benefits from third parties (s 176) and at section 175 we find: “A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”. The section goes on to state that this includes a situation where a director exploits property or information belonging to the company after he has left, even if the company itself could not make use of the material itself.
A breach of any fiduciary duty could have the following consequences:
- The company, fellow directors or an aggrieved shareholder or member may begin court action for a breach of statutory duty and seek damages for any loss caused by events or actions which breach the duty.
- Transactions entered into in breach of the duty may be set aside as void (for example, the transfer of property may have to be unwound or a contract may become unenforceable).
- A director who benefits from the transaction may be ordered to repay the company its loss, or account for any profits he has made.
- The other directors who authorised a transaction in breach of the duty, when they did not have the power to do so, can also be held liable.
- A director’s failure to declare an interest in an existing contract or arrangement is a criminal offence making the director liable to prosecution and a fine.
- The incident or transaction could attract the attention and intervention of regulators.
- The breach could seriously damage the reputation of the organisation and erode the confidence of key stakeholders, including employees, customers and funders.
- Serious breaches of duties can lead to a director being disqualified from holding office for up to 15 years.
Special Rules for Charity trustees
Charity trustees have a strict legal duty to act only in the best interests of their charity. They must not put themselves in a position where their duties as trustee may conflict with any personal interest they may have. In addition, charity trustees can only receive a personal benefit from their charity if there is explicit authority, obtained in advance. This authority can only come from one of four sources: a provision in the charity’s governing document, a power in the Charities Act, permission from the Charity Commission or an order of the High Court. ‘Benefit’ has a wide meaning here, including any payments, property, loans, goods or services received from the charity, but does not include genuine reasonable ‘out of pocket expenses’, which are excluded.
Special Rules for Charitable Incorporated Organisations
Specific rules have been developed for trustees of CIOs. Section 222 of the Charities Act 2011 says: “A Charity trustee of a CIO may not benefit personally from an arrangement or transaction entered into by the CIO if, before the arrangement or transaction was entered into, the charity trustee did not disclose to all the charity trustees of the CIO any material interest (whether direct or indirect) which the trustee had in it or any other person or body party to it.”
Regulation 36 of the CIO Regulations says that a trustee who would benefit from a transaction or arrangement which the CIO is proposing to enter into must not take part in the decision-making and cannot form part of the quorum for that decision.
In the second part of this article, we will examine how to manage conflicts of interest.
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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