Understanding directors' duty to avoid conflict of interest

Keith Tully explains the legal responsibilities of a director to disclose and avoid potential conflicts of interest.

Conflicts of interest, whether actual or potential, are an important consideration for company directors. Non-disclosure can result in criminal action, which is why it’s important to understand your duties in this area.

It’s a good idea to approach the issue with a wide view of what could be regarded as a conflict. This should cover most scenarios, and along with following the correct procedures for pre-authorisation, will help you to comply with the legislation.

So, what is a conflict of interest?

There are two types of conflict:

  • situational
  • transactional

These can be further sub-divided into actual and potential conflicts, and direct and indirect interests. Additionally, the Companies Act states that directors must not accept benefits from third parties.

So what, in practice, could be seen as a conflict of interest?

  • If you are a company director, and also a trustee of the same company’s pension scheme, or about to become a trustee, this may be viewed as a situational conflict.
  • If you, or a ‘connected party’, such as a family member, hold shares in a company with which the company that you're a director of does business, or may do business with in the future, it could be seen as a transactional conflict of interest.

Why do you need to avoid these types of conflict?

Under the Companies Act 2006, it is a legal obligation for company directors to avoid conflicts of interest, and to follow specific pre-authorisation procedures for any potential conflicts.  

Liability for this lies personally with each director, and not with the company. Non-compliance is seen as a serious breach of director duties, and criminal action could follow.

For this reason, you should regularly review your personal and business circumstances to capture all possible conflicts – erring on the side of caution will prove to be the safest route for directors.

Compliance: what you need to do

Private companies formed before 1 October 2008 must include in their company’s articles of association the power for directors to pre-authorise conflicts of interest.

For those incorporated after this date it is automatically implied, but you can still choose to include some detail within the articles on the processes to be used. This may be how a conflict is to be declared, for example, or who is able to vote on the issue and the process for doing so.

In general terms, a board meeting will be held during which non-conflicted directors make judgement as to whether a conflict has arisen, and also whether the director in question is breaching their duty to consider the best interests of the company as a whole.

Not all decisions are clear-cut, and there is scope for certain conditions to be applied if directors think a conflict may arise further down the line. Shareholders can also authorise an actual or potential conflict by way of an ordinary resolution.

Conflicts already in existence can be ratified by shareholders, but the conflicted director, and any party connected to them, will be unable to vote in this instance.

About the author

Keith Tully is an insolvency expert and partner at Begbies Traynor Group.