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Company Law Reform Bill

11th July 2006

Duty to avoid conflict of interests.

Mr. Djanogly: This is a complicated clause, in what is clearly the controversial part of the Bill. It replaces the existing no conflict common law rule and covers all conflicts between the interests of the director and the company. A significant change in subsection (4) is that independent directors can authorise another director's conflict. In the case of a public company, such authorisation must be allowed by the company's constitution. In the case of a private company, authorisation can be given by the directors so long as nothing in the company's articles invalidates such authorisation. By virtue of clause 156(2)(a), this duty is extended to former directors in relation to

"the exploitation of...property, information or opportunity of which he became aware at a time when he was a director".

The Law Society, among others, has pointed out that there is a significant difference between the common law rule on conflicts of interest and the wording of clause 161. Notably, the common law rule maintains a negative position, whereas the clause imposes a positive duty. That is a key concern that has been raised by many stakeholders. There is a fear that this positive duty might impact on the ability of a director to assume multiple directorships, which is a feature of the UK company system and provides a number of benefits to companies of all sizes. I should like to quote from a briefing that we have received from the City law firm, Allen and Overy. It states:

"At present, a director may comply with the duty to avoid conflicts of interest by taking appropriate action to ensure that a company is not disadvantaged by any conflict of interest the director may have i.e. by not taking part in a particular matter. Based on the current formulation, which is widely expressed to avoid a situation where there is, or may be, a potential conflict, there is arguably no place for multiple directorships."

We believe that it will be more difficult for directors to hold multiple directorships, and that could affect the pool of non-executive directors, which is itself a current problem. This is of particular concern to the private equity and venture capital industries, where executives of private equity firms routinely hold multiple non-executive directorships. The British Venture Capital Association made the point clear in a letter of 12 January to Lord Sainsbury of Turville. It stated that the clause

"may result in individuals refusing to hold multiple directorships. If this happens, it will affect the private equity industry's ability to attract non-executive directors who can sit, or may want to sit, on multiple boards."

It continues by saying that is it important that the clause

"is amended to avoid any uncertainty in relation to this issue.

It is standard practice within the UK private equity industry for a private equity fund to have the right to appoint one or more non-executive directors ('NEDs') to each company that the fund is providing investment to. Invariably, the private equity firm that has organised the company's investment by the private equity fund will select the NEDs and these will either be executives of the private equity house or independent experts who may have industry-specific knowledge. The effect of this kind of industry arrangement is that often these executives or independent experts will hold non-executive directorships in a number of companies associated with the private equity firm and the funds of which the private equity firm manages."

The letter then says that the clause

"places an absolute obligation on a director of a company to avoid a situation in which the director has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. In practice, taking on any additional directorship is likely to give rise to difficulty under this provision as almost any additional directorship 'possibly may' conflict. Although this duty will not be infringed if the situation cannot 'reasonably be regarded as likely' to give rise to a conflict of interest...it will not always be easy for a director to be able to rely confidently on this safe harbour when accepting an additional directorship."

The letter goes on to state that the other safe harbour provided in subsection (4)(b)

"which allows the other directors to authorise the 'matter', would appear to require specific permission to be given to each additional directorship at the time it is taken on. This would, in effect, amount to a need for an NED to seek permission each and every time he wants to accept an additional NED post, which is not practicable. It needs to be clear at the outset that the NED can take on other directorships, subject only to having to disclose them."

5.45 pm

The letter continues:

"If a person holds more than one non-executive directorship and a conflict arises but the person cannot explain the reason for the conflict (e.g. because the information giving rise to is confidential or price sensitive), it seems that the director's only option will be to resign rather than to absent himself of herself from decision making as would be the case at present."

The letter urges that the clause should be amended

"to provide a mechanism for a person to be able to take on multiple directorships and for a person who holds multiple directorships to be able to deal with conflicts in the same way as they can now."

It goes on to say that it

"should state that a director of a company (the 'first' company) should be able to accept an additional directorship with another company (the 'second' company) if at that time of his or her appointment as a director of the second company, there is no actual conflict with the interests of the first company. If a conflict arises after the director has been appointed as a director of the second company, the director should be able to absent himself or herself from decision making or obtain authorisation from the directors of the relevant companies as envisaged by"

subsection (4)(b).

Those concerns should not be taken lightly. Private equity and venture capital are growing industries in the UK, and more and more of our successful companies are being financed by private equity. The industry has been a valuable driver of business growth. We should not put barriers in the way of those who want to invest in UK companies, particularly the small start-ups that are often the target of venture capital investment.

Those who practise law in this area have also raised concerns with us. As a City lawyer said to me, the key issue is that, currently, a director in the conflict position can manage the problem by removing himself from the company's decision-making process when a conflict arises. The draft new law seems to go much further, imposing a duty to avoid the possibility ofa conflict in the first place. If that is not the Government's intention, an explanation should be provided as to how directors of more than one company can manage a situation in which duties to those companies will conflict. As the Government have not been forthcoming with an explanation, we tabled the amendments to rectify the problem. Amendment No. 167 would meet the concerns by stating that if there is no disadvantage to the interests of the company, a director may hold multiple directorships.

Amendment No. 257 would allow directors to exercise their subjective judgment as to whether a situation is likely to give rise to a conflict. We should show UK company directors that we have faith in their judgment, but the Government seem not to be doing that with this clause.

Amendment No. 255 was drafted for us by the Law Society. A similar amendment was rejected by Lord Goldsmith in the other place, and both the Conservative party and the Law Society sincerely hope that the Government will reconsider their position. The Law Society is clear on this point. In its June 2006 Commons briefing, it states:

"As a matter of principle, we do not think that a director should be at risk of being in breach of duty in a case where he may be unable to prevent the breach arising, because the breach arises as a result of an action by a company of which he is a director, rather than because of an action that he has taken himself...We are very concerned that the effect of Clause 161 will be to make it almost impossible for a director of more than one company to manage conflicts which may arise between the interests of the companies of which he is a director. At present, it is normal for a director who finds himself in such a position to manage the conflict by absenting himself from meetings at which the matter giving rise to the conflict is discussed. Only in the most extreme cases would a director be expected to resign. It is by no means clear that such an approach will be possible in future. As a result, it is likely not only that directors will be required to resign from multiple boards more frequently, but also that individuals will be very reluctant to put themselves forward to take up non-executive posts."

We tabled amendment No. 322 to make the clause slightly less onerous. The clause could be used against directors' future conflicts of interests, or in relation to conflicts of which they were not aware. The amendment would limit the scope of the clause to the period when the director seeks authorisation. Similarly, we have tabled amendment No. 323 to remove wording that could be used to threaten directors with possible future conflicts of interest. That would be an onerous requirement for a director to take account of and is not commercially realistic.

Amendment No. 256 has been tabled to allow directors to take all reasonable steps to avoid a conflict of interest. That is a fair allowance for directors who will be running a day-to-day business and should not be unfairly pressured to research every possible conflict of interest that might arise. In his response to amendments to clause 161 in the Lords Grand Committee, Lord Goldsmith said that a director who obtains his board's consent to another appointment will be entitled to assume that that consent "franks" any subsequent conflict that arises in practice. In our view, and that of most experts, it is far from clear that that will be the case. If that is what the Government believe, however, we would like them to clarify it inthe Bill.

The clause refers throughout to authorisation of "the matter" by the board. It is hard to imagine that, when a specific conflict has arisen between two directorships, a court will take "the matter" to mean the director's original appointment to the directorship giving rise to the conflict, rather than the circumstances of the conflict. If our concerns are correct, it is unlikely that board approval would be a realistic option in many cases, given the confidentiality obligations to which the director is likely to be subject. In real life, the director will owe duties of confidentiality to each company of which he is a director. In such a case, we fear that the only course open to him in practice will be to resign.

The change may have a significant effect on the availability of suitable non-executive directors for company boards. The introduction of words that specifically provide for general consent will go some way towards alleviating that difficulty. The Minister has heard arguments from legal practitioners with many years' experience, the Law Society and the venture capital industry. Lord Goldsmith said that he thought he was steering the right course between placing burdens and restrictions on enterprise and looking after the interests of shareholders, but we suggest that he has veered too far in the direction of restrictions. A great number of highly successful businesses will be affected by the provision, and because of it, many smaller businesses may not receive the funding and expertise that they so greatly need.

The Government fail to appreciate, first, that companies often want non-executive directors who are successful in another company in the same sector to enjoy the benefit of their experience, and secondly that such directors will have much to learn and benefit from by seeing other companies in action. The clause could threaten that.

The United Kingdom Shareholders Association and others have objected to subsection (4)(b), which allows directors to authorise the conflict of interest situation without even informing shareholders. The UKSA recommends that such authorisation should at least appear in the company's next annual report. Under the provision, directors can still authorise the conflict of interest situation without informing shareholders, if the company constitution allows. Any conflict should be reported in the company's annual report in the case of public companies, but the requirement might be a burden for smaller private companies.

Norton Rose in its report also had something to say on the matter:

"The new clause permits a company's rights to be waived by the prior consent of the board, provided in the case of a public company, that such board approval is permitted by its constitution. The company can nevertheless provide in its articles of association that shareholder approval is required. In practice, smaller private companies are likely to welcome the ability to sanction a transaction involving a possible conflict by board resolution."

Will the Government please explain why, if they are committed to encouraging people to become non-executive directors, they do not support our position on that issue?


Mr. Djanogly: The Solicitor-General's full response is appreciated. It will need careful review. However, he Column number: 620started by saying that there is no problem with people holding multiple directorships. That is simply not the case. People have been telling us that there will be exactly that problem. It is yet to be seen whether what he just said will satisfy stakeholders, but I doubt it. He has not helped to allay my concerns that a director will have a real problem avoiding a situation that, possibly, may conflict. If, for instance, I were an electronics expert and a director of an electronics company looking for a non-executive directorship in the electronics field, it could be argued that, if I took up such a post in a field similar to the company in which I was a director, future conflict would be likely—through competition, one company buying another or any number of other possibilities. I would know that that situation could arise, but as things stand it would not present a problem because people declare interests when they need to do so. That point was made clearly by my hon. Friend the Member for Grantham and Stamford, who spoke with an authority that comes from experience. He explained how he has found conflict situations work in practice. For the most part the existing system works pretty well.

We are some way from the Government's position and we wish to express our concerns on the practical implications of the clause. On that basis, I shall ask the Committee to divide on amendment No. 257. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

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