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You must not allow your own interests to conflict with those of the company.
This is the seventh in a series of articles in which we explore the role of a director from various angles, some of them slightly unconventional. Each article identifies a fact of which directors need to be aware - whether concerning their duties, their relationship with other key players or their responsibilities under the Companies Act 2006 - and uses it as a starting-point to illuminate a particular aspect of their role.
This article discusses the duty imposed on directors to avoid situations of conflicts of interest.
As important as a director's core duty to act in such a way as to promote the success of the company undoubtedly is, it is not the only duty which he owes to his company. Indeed, from a compliance perspective, some of the other duties may raise more issues from a compliance perspective. Whilst a director will be meeting his obligations under the success duty as long as he is acting in what he believes are the company's interests, each of the other duties incorporates an objective component and so may be breached even if the director is acting in good faith.
The full list of statutory duties is as follows:
Each of the duties is, in its own way, important, but some are more likely to cause problems for directors than others. The duty to avoid situations of conflicts of interest is of particularly wide application, and so merits special consideration.
The duty to avoid conflicts of interest
The duty to avoid conflicts of interest is set out in section 175 of the Act, which states that a director "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" (section 175(1)), and adds that this rule "applies in particular to the exploitation of any property, information or opportunity" (section 175(2)).
It will be apparent from the wording of section 175(1) that the duty has an extremely wide scope. It covers both direct and indirect interests, and both actual and potential conflicts. Thus, whilst a director might expect a conflicts duty to prevent him from taking up a board position with a rival company, he might not necessarily expect that he would be in breach of duty if his only involvement with the rival company was through his wife, who happened to own shares in it. That is, however, the effect of section 175(1), and on the whole it probably makes sense to draw the rule's scope so widely. After all, just as the director's loyalty to his company would be compromised if he were to be directly involved in the management of a rival, so too it would be threatened if he were conscious that his efforts to ensure its success would adversely affect his wife's financial interests (on the basis that if his company flourished, inevitably the rival company's prospects would be damaged).
The reference in section 175 to the exploitation of any opportunity, etc is designed to ensure that a director does not take advantage of an opportunity that properly belongs to the company. The potential difficulty in this area concerns the identification of those opportunities which are regarded as belonging to the company. Some cases will be clear-cut. For example, where a director of a fast-food restaurant is approached by an entrepreneur with a proposal to fund the opening of a takeaway outlet under the restaurant's name in a nearby shopping centre, plainly the business opportunity belongs to the company, and the director will be in breach of section 175 if he persuades the entrepreneur to open the outlet with him in his personal capacity rather than with the company. Other cases may seem to fall into a grey area. What would be the position, for example, if the company's board had recently rejected a similar proposal from another entrepreneur on the basis that it was planning to move out of the fast-food business and into the world of fine dining? Would the new opportunity to open a takeaway outlet still be regarded as belonging to the company? In fact, this is not a particularly grey area. The courts take a strict approach to this aspect of the law on directors' duties (see, for example, Bhullar v Bhullar  EWCA Civ 424), and an opportunity is likely to be regarded as belonging to the company if it might in any way be of interest to it, even if, in practice, it is unlikely to want to take advantage of it. In our scenario, then, since the opportunity to open a takeaway outlet would certainly be of interest to the company (whether or not it chose, ultimately, to accept the entrepreneur's offer), it would be categorised as belonging to the company.
A draconian duty?
The conflicts duty is certainly very wide in scope, and can easily trip up a director who is not fully aware of the nature and extent of his duties under the Act. On the whole, though, it would be unfair to describe it as draconian.
In the first place, it serves a crucial function. A director's obligation of loyalty lies at the heart of his relationship with his company, and section 175 is designed to do nothing more than ensure that a director is able to give his company his undivided loyalty.
What is more, the potentially harsh effects of the rule are softened by section 175(4)(a), which provides that it will not be infringed "if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest".
Finally, the prohibition against entering into situations of conflict is not, in any case, absolute, in the sense that an act which would otherwise constitute a breach can be authorised in advance. Take the case of our director of a fast-food restaurant which is planning to move out of the fast-food sector. Whilst he will, as noted above, be in breach of section 175 if he secretly diverts the opportunity to open a takeaway outlet to himself, there is nothing to prevent him from placing the entrepreneur's proposal before the board and, if the board rejects it, seeking his fellow directors' permission to take advantage of it himself.
Directors need to be alert to the fact that they may fall foul of section 175 even if they act at all times in what they believe are the company's best interests.
Having said that, a director who is fully aware of the scope of the duty should not find it an unduly difficult obligation with which to comply. In fact, the duty's broad scope may actually operate in a director's favour from a compliance perspective, since the only question he needs to ask himself when considering whether a particular action might breach the duty is whether, as a matter of common sense, there is a realistic possibility that the action might place him in a situation in which his interests might conflict with those of the company. If there is, his options are clear: either he must drop any thought of taking the action, or he must obtain authorisation from the board or the shareholders.
The duty may have a surprisingly wide scope, but at least it leaves little room for the sorts of grey areas which can cause directors real difficulties. That being the case, a director who breaches section 175 generally has no one to blame but himself.
Nigel Banerjee can be contacted at email@example.com.
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