Tag Archives: conflict of interest

COMMON LAW DIRECTOR DUTIES II


We discussed two common law duties in the last post, today we cover the remaining duties.

The next key duty of directors is that they should exercise unfettered and independent discretion and judgement.

Directors should exercise objective and unbiased judgement on the affairs of the company independently from management and any shareholders, but with sufficient information to enable a proper and objective assessment to be made. The director should not be influenced by any other party interested in the outcome of the decision. Put another way the director should be making his own decisions rather than simply implementing the instructions/commands from stakeholders. This flows from the concept that it is the director who is both personally and criminally liable for performance of the duty of care and good faith to the company. I have seen many fall foul of this common law duty in Board rooms. Some directors try to flow with anything that the Group CEO or the most powerful principle wants. This may be due to the fact that they want to stay on the Board and fear jeopardizing their income or they derive some social value form regarded as a compliant director.

 A corollary of this is that even when directors depend on information from experts, consultants and other members of the company for information, they still need to exercise their minds and make unfettered decisions.  The directors have to be very familiar with the governing documents and business model of the organization

The other common law duty is that directors should avoid having their persona interests conflict with those of the organization. A related duty is the disclosure and management of any potential conflicts. The personal interests of a director; or of people closely associated with that director, should not take precedence over the interests of the company.

 This implies that in their responsibilities to the company they should not put their own interests before the organization. This can happen, for example, in State Owned Entities where directors can vote to pay themselves very high board sitting fees when the entity is loss making. Similarly directors should not in any way misappropriate corporate opportunities due to the company as well as improperly competing with the company.

Similarly a director should not make any secret profits or possible incidental profits at the expense of the company or accept profit from third parties using their position as directors.

These common law duties are quite onerous and should be carefully considered before and during Board services. They can be detrimental to your wealth creation if you are found liable personally for violating them. Many people in NGO voluntary corporate Boards usually take these casually not realizing that they are still responsible legally even if they are not paid.

I hope this discussion has been enlightening and helps you in your fiduciary duties.

CONFLICT OF INTEREST


All corporate board members have fiduciary duties and a duty of loyalty (care and skill) to the corporations they oversee. If one of the directors chooses to take action that benefits them at the detriment of the firm, they are harming the company with a conflict of interest.

A conflict of interest involves a person or entity that has two relationships competing with each other for the person’s loyalty, such that serving one interest results in working against the other interest. The person’s vested interests raise a question of whether their actions, judgment, and/or decision-making can be unbiased. In a conflict of interest a director chooses personal gain over duties to the organization in which they are a director, or exploits their position for personal gain in some way.

Directors need to manage conflict of interests as these can lead to the transactions and decisions being nullified. It may even lead to prosecution.

Some conflict of interest is fundamental ad pervasive and therefore has to be avoided by a resignation e.g. if a director holds significant shares in a competitor, the conflict of interests will persist making his duty impossible. In that case the a director decides whether to dispose of the equity or to resign form the Board.

In some cases the conflict is temporal and so can be managed. For example if a director holds shares in a company bidding for a once off contract, the director can manage the conflict of interest by declaring his interest and recusing himself from the decision- making process for this contract.

Within the Companies Act (2008) Section 75 there are some specific conflict of interest situations which must be addressed and managed in accordance to the Act. A director must be knowledgeable of these situations and manage himself accordingly.

A conflict of interest must be declared when the matter comes up on the Agenda. The affected directors should make a full disclosure and contribute to the matter without lobbying. Immediately after that he should leave the meeting that will deliberate on the matter.

Some people erroneously believe that by simply declaring the interest they have fulfilled the obligation to manage the conflict of interest. I was once acquainted with an organization in which most of the service contracts awarded by the Company were to the Group CEO’s siblings. The belief in the organization was that since the GCEO had informed everyone of the interest, then everything was okay.

Some conflict of interest matters may not be material enough to be a problem statutorily but they may case a perception challenge that can damage the company’s reputation. For example if an executive director disposes shares that he owned just before a massive loss of stock prize based on an options contract that was due, this may be legitimate but it still cases reputational risks. A disinterested observer would be concerned.

Directors have a fiduciary responsibility to disclose conflicts of interest and to act with unfettered discretion. Where directors breach this duty they stand to attract civil and criminal sanction. Conflicts of interest have the potential to damage the company as any board decision taken in which a director has an undisclosed personal financial interest is void.

corporate directors’ challenges


Business by definition requires taking up risk in order to exploit opportunities for growth. This creates another challenge of estimating the risk that can be taken within a growth strategy to increases value.

I remember one Board on which I sat struggling to decide whether to assume the risk of investing in an industry that we had no core competencies. It looked lucrative but the Board after much discussion; decided that we had no risk appetite for this kind of investment. subsequent events proved that our decision then was wise. But at the point of making the decision we also had an apprehension that we could be missing a great opportunity.

The balance between risk appetite which is normally driven by the executives to grow the business and risk tolerance which is normally fronted by the Board needs to be struck. The Board should not unnecessarily be too conservative and still expect returns on investment. and yet it should not be too risky that it destroys value.

Related to the previous dilemma is the fact that one chooses to either have organizational performance and growth or choose compliance with corporate governance codes and regulatory requirements through form filling. Compliance has to be balanced with performance. Some Boards are too focused on complying with boundaries imposed by regulators and codes that they dare not take any risks to growth the business. Acting in the best interests of the organization-which is one of the key roles of the Board – means that the Board should take appropriate risks to ensure sustainability and viability of the corporation. Viable sustainability and business continuity are critical aspects that require mindful consideration rather than just form filling to ensure compliance.

Governing bodies have to manage the often conflicting interests of the stakeholders. Often the interests of the equity shareholders and of other stakeholders may conflict. These will need to be managed. While equity providers are keen to see returns on investment, other stakeholders like the surrounding communities are keen to see meaningful investment in the community. After all the community is the ultimate licensor of the business. If the community withdraws its support and license the organization cannot be sustainable in that area. A more challenging dilemma for governing bodies is when the interests of the shareholders like a desire for dividend declaration, conflicts with the interests of the corporate. In cases like this directors have a legal obligation to serve the interests of the corporation. The moral hazard is that by choosing the interests of the organization, the governing body risks the censure of the shareholders since they serve at the pleasure of the shareholders.

The final challenge is that of speaking up and expressing a contrarian view without being perceived as toxic. It’s easy to drift into groupthink because members want to fit in. The desire to please others can cause a member to suppress their divergent view which would have been beneficial to the organization. It’s important for the governing body to allow for robust discussion and to entertain divergent views. It’s better to have a diversity of opinion rather than to have uniformity at all times. Learning to disagree and expressing a divergent point of view without being disagreeable is critical.

Despite all these challenges it is fulfilling to see an organization grow and thrive as the governing body works closely with management.