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Directors face liability, reputation damage

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Failure to declare real or perceived conflicts of interest to the board may result in civil or criminal prosecution for the director, as well as immeasurable reputational harm to their organisation.

This is the crux of the message conveyed at Institute of Directors in Southern Africa’s (IoDSA) launch of a position paper on directors’ conflict of interest. Issued by the IoDSA’s Corporate Governance Network (CGN) in association with PwC, the paper makes clear that directors are well advised to promptly deal with areas of conflict.

The most significant protection for directors – the business judgement rule – requires that directors manage conflicts of interest in accordance with the Companies Act 2008.

It is therefore important to identify conflicts, both real and perceived, early on, so that they can be assessed and dealt with in the most appropriate manner. While the concept of materiality in relation to conflicts is crucial, it needs to be remembered that a conflict that is not material or not actual it may still give rise to perceptions that may in turn cause reputational harm. Thus this aspect provides an added dimension worthy of consideration.

Speaking at the launch of the paper, attorney Michael Katz pointed out that many people, when contemplating the Companies Act, see it as an exercise in interpretation whilst losing sight of the bigger context.

“There are, in truth, two separate components to conflicts of interest. The first component is the substance of the law, while the second is the procedural rules,” he said.

Substantive law is governed by Section 76 of the Act and deals with the fact that the heart of company law arises from the separation of ownership and control. “It means that directors’ duties are designed by the principles of company law to protect owners from any delinquency on the part of its directors, being the controllers of the company,” said Katz. One of the single most important duties of directors therefore, is to avoid conflict of interest. “It is for this reason that the courts come down so heavily on a company’s controllers when there is a major corporate malfunction, as evidenced by the outcome of the Enron situation,” he noted.

Procedural rules are governed by Section 75 of the Act and outline the need for directors to declare their interest in a particular matter, answer any questions the board may have and then recuse themselves so that they cannot influence the debate that follows, Katz added.

While examples of conflict are legion – from board members receiving gifts from contractors to directors proposing the appointment of family members – the existence of conflict is not necessarily an indication of impropriety. Nonetheless, good practice demands that directors disclose all cases of potential conflict and obtain board advice on such matters.

Furthermore, King III states that certain conflicts of interest are fundamental and should be avoided. An example of a fundamental conflict is where a director sits on the board of a rival company. In such a case, the director would need to resign from one of the boards. Other conflicts , in an instance where it is a once-off decision, such as the company making a donation to a sports club of which the director’s child is a member, the director need only be recused from the decision-making relating to this subject.

Teri Solomon, from Marsh Africa, suggested thorough documentation in any instance of a potential conflict of interest. “Then, provided you have properly followed Section 75, you should be protected, or at least have a reasonable defence if you are called out on the matter,” she said.

“This would be the case in an instance where there is a management buyout by the directors. The mere fact that a conflict exists doesn’t necessarily mean that the directors have breached their fiduciary duties. The key here lies in ensuring everything is properly declared and recorded.”