4.5 Conflict of interests

On this page 4.5.1 What are conflict of interests? 4.5.2 Identifying, declaring and managing conflict of interests 4.5.3 Ad hoc conflict of interests committee 4.5.4 Interests register 4.5.5 When is a director interested under the Companies Act 1993? 4.5.6 Providing other services to the company

• A conflict of interests occurs when a director has two or more interests, one of which will or may affect the way in which they are motivated to act in relation to the other.
• Directors must be vigilant about conflict of interests, for themselves and others.
• The board should have procedures in place to deal with conflict of interests.

 

4.5.1 What are conflict of interests?

A conflict of interests can often be an unidentified or overlooked risk for directors. Put simply, a conflict occurs where a director is in a position where they have two or more interests which may not be compatible. In a conflict situation one interest may actually or potentially affect the director’s incentives/motivation in relation to the other. This creates a risk of bias in professional judgement and compromised objectivity, and of a breach of the director’s duties.

For example:

• if a company proposes to guarantee a debt of one of its directors, that director has a clear conflict between their personal interest in having their debt guaranteed and their duty as a director to act in the company’s interests
• if a company proposes to buy an asset from another company, and there is someone who is a director of both companies, that director has a clear conflict (technically a conflict of duties) between their duty to act in the interests of the purchasing company and their duty to act in the interests of the selling company.

Importantly, whether there is a conflict does not depend on a transaction being, in some objective sense, in the interests of the company or companies. The conflict exists simply because the director is in the position of wearing two hats, giving them an incentive to act otherwise than in the company’s interests, whether or not, in fact, they do (or think they are).

Managing conflict of interests is about more than just understanding legislation. Even where there is no statutory requirement to disclose interests, if the associated risks and implications are not managed, they can lead to significant consequences, including reputational damage and loss of shareholder and stakeholder value. The existence of a conflict of interests does not necessarily mean that the director concerned has done anything wrong. What it means is that the conflict needs to be managed.

Essentially, an apparent or actual conflict of interests exists where a reasonable person would think a director’s judgement is potentially compromised by some other interest or role they have. A potential conflict of interests involves a situation that may develop into an actual conflict of interests. There can be many causes of conflict. Interests can be business or personal. Common reasons a conflict is not identified are proximity to the issues and failure to properly assess the circumstances. The earlier references to motivated blindness in section 2.2 on ethics and organisational culture apply here too. A conflict of interests can be a case of not seeing the wood for the trees.

A fundamental obligation of directors, enshrined in the directors’ duties provisions of the Companies Act 1993, is that directors must act in good faith and in what they consider to be the best interests of their company. To act when a conflict of interests exists can result in a director breaching their fiduciary duties. New Zealand has a relatively interconnected and cohesive business community. This means there is a high likelihood a director’s obligations could at some point conflict or potentially conflict with one or more of their other interests.

A board that makes the best possible decisions is characterised by a culture of capability, accountability, independence, trust, diligence and candour. A conflict of interests needs to be handled within this context of candour and trust. In deciding whether a conflict is present in any given situation the determinant should be whether a reasonably informed objective observer would infer from the circumstances that the conflicted director’s judgement is potentially compromised by the other interest to the detriment of the company’s best interests. Ask: what would a reasonable person think? Note that an actual conflict is not required to be established before treating it as a situation deserving of attention. Potential or perceived conflict of interests should also be addressed.

4.5.2 Identifying, declaring and managing conflict of interests

Shareholders should be left in no doubt as to whether directors are appropriately motivated. Even the appearance of a conflict is to be avoided – if in doubt, declare. The potential damage to the organisation can be profound where a conflict is not properly managed.

The usual process for handling a conflict of interests consists of three steps:

1. Identify: The conflicted director identifies that they have (or may have) conflicting interests.
2. Declare: The conflict is (sometimes following a conversation with the chair, where this can occur promptly) declared to the board and recorded in the company’s interests register.
3. Manage: The board collectively agrees on how the conflict should be managed – for example, by the conflicted director abstaining from voting or being absent while the matter is discussed and determined.

While the identification and disclosure of the conflict is the director’s primary responsibility, the board is responsible for the decision about any action to be taken to mitigate risk and avoid harm.

In dealing with conflict of interests, actual or potential, regard should be had to:

• the Companies Act 1993 (or relevant legislation governing the entity)
• best business practice and convention.

Procedures for participating in board decisions where directors have a personal interest should ensure the protection of the legal and ethical positions of those involved while preserving, to the extent practicable, the general principle that a company should be entitled to the collective wisdom of all its directors.

If directors are unsure whether a conflict of interests exists, they should discuss the matter with the chair. If necessary, legal advice should be taken. If doubt remains then the matter should usually be treated as a conflict situation.

Resources The IoD’s Conflict of Interests Practice Guide (2015) provides directors with an overview of how to recognise and manage conflict of interests in the boardroom, along with a useful lens through which to observe and model good practice. See also Managing conflict of interests: A guide for the public sector (2020), by the Office of the Auditor-General.

In the event that a conflict exists, note the following:

Disclosures of interest	The Companies Act 1993 requires directors having a conflict of interests to disclose the nature and extent of their interests to the board. (For what constitutes a conflict, and what disclosure is required, see section 4.5.5)
Interests registers	Conflicted directors of companies registered under the Companies Act 1993 must cause their interests to be noted in the company’s interests register.
Right to receive notice of meeting	Conflicted directors are entitled to be given notice of any board meeting at which the conflict matter is to be considered.
Right of attendance at meetings	This depends on the entity’s constitution and its governing legislation. The Companies Act 1993 permits conflicted directors to attend board meetings at which the conflict matter is to be considered, unless the constitution provides otherwise.
Right to be included in quorum	From a legal viewpoint, this depends on the entity’s constitution and its governing legislation. The Companies Act 1993 permits conflicted directors to be included in the quorum at board meetings at which the conflict matter is to be considered, unless the constitution provides otherwise. However, the NZX Listing Rules (rule 2.10) require that conflicted directors of listed companies may not be included in the quorum (except in some specific circumstances).
Right to participate in discussions	This depends on the entity’s constitution and its governing legislation. The Companies Act 1993 permits conflicted directors to participate in discussions, unless the constitution provides otherwise. However, it is best practice that conflicted directors do not participate except: to the extent invited by the board (for example, to state their positions, answer questions or comment on matters of fact) if the board consents, and the conflicted directors believe that the board will otherwise make an unsound decision. It is also best practice that conflicted directors should volunteer to withdraw from at least part of the meeting to facilitate full and frank discussion of the conflict matter by the non-conflicted directors.
Right to vote	Again, from a legal viewpoint this depends on the constitution and its governing legislation. The Companies Act 1993 permits conflicted directors to vote on the conflict matter, unless the constitution provides otherwise. However, it is best practice that, even if the constitution permits it, that conflicted directors not vote. Note that the NZX Listing Rules (rule 2.10) require that conflicted directors of listed companies are not to vote (except in some specific circumstances). It is also best practice that conflicted directors should volunteer to absent themselves during the vote. The meeting (through the chair) should feel free not to accept the offer unless the conflicted directors presence is likely to adversely affect the voting process. Notwithstanding the best practice on voting referred to above, conflicted directors should be entitled to vote on the conflict matter if that matter is one where directors are required to sign a certificate pursuant to the Companies Act 1993.

4.5.3 Ad hoc conflict of interests committee

Sometimes it may be helpful for conflict issues to be referred to an ad hoc board committee constituted of non-conflicted directors to recommend the best way in which the conflict should be addressed. In general, committee procedures are governed by the laws and best practices applying to board meetings.

The committee may require further particulars of the conflict from a director. If asked by the committee, and if it is in the interests of the company, conflicted directors should provide the committee with any information the committee reasonably requires after having regard to any responsibilities that directors owe to third parties.

Conversely, the rights of conflicted directors should be acknowledged. In particular, the directors are entitled to be given:

• access to the committee’s minutes at their request, and
• a copy of the committee’s report to the board.

With respect to the report to the board, the conflicted director should volunteer not to receive the report if knowledge of its contents may not be in the best interests of the company or its shareholders.

Directors with a continuing material conflict of interest should consider resigning from office.

4.5.4 Interests register

Section 189(1)(c) of the Companies Act 1993 requires that a company must establish an interests register, to record certain matters (such as conflict of interests) relating to directors.

An interests register usually has a straightforward format. It records basic information including the name, entity, particular interest and the date the interest was entered into the register. While there is no specific legal format for the register it should obviously capture the information required by the Companies Act 1993. At each board meeting the interests register will be updated as necessary.

See also A4 Resources in the appendices for a sample interests register.

4.5.5 When is a director interested under the Companies Act 1993?

The Companies Act 1993 contains a number of sections setting out when a director has an interest to which specific requirements apply, outlined as follows.

COMPANIES ACT 1993 SECTION:	REQUIREMENTS
Section 139 and 140	A director is interested in a transaction or potential transaction to which the company is party if they: are a party to, or will or may derive a material financial benefit from the transaction have a material financial interest in another party to the transaction are a director, officer, or trustee of another party to, or person who will or may derive a material financial benefit from the transaction are the parent, child or spouse of another party to, or person who will or may derive a material financial benefit from the transaction are otherwise directly or indirectly materially interested in the transaction. A director who is interested in a (potential) transaction must disclose this to the board and enter in the interests register the nature and monetary value (or, if that value cannot be quantified, the extent) of the interest. However, this does not apply if the transaction is between the director and the company in the ordinary course of the company’s business and on usual terms and conditions. Alternatively, a director may also enter in the interests register and disclose to the board a general notice that they are a shareholder, director, officer or trustee of another company or person and are to be regarded as interested in any transaction with them. That general notice will constitute sufficient disclosure of interest by the director of that interest. No further disclosure for any particular transaction with that company or person will be required.
Section 145	As discussed in section 4.2 Directors’ duties, a director of a company who gains information by virtue of being a director may not use or disclose that information except as follows: for the purposes of the company as required by law unless prohibited by the board, disclosure to a person whose interests the director represents unless prohibited by the board, disclosure to a person in accordance with whose directions or instructions the director acts, whose name is entered in the interests register the use or disclosure is permitted by the board, is not likely to prejudice the company, and is entered in the interests register.
Section 148	As discussed in section 4.4 Director shareholdings and insider trading, a director of a company who acquires or disposes of a relevant interest in shares issued by the company must: disclose this to the board, and ensure the particulars are entered into the interests register.
Section 161	The board must ensure, upon approving payments or benefits to a director, that the particulars of the payment or benefit are entered into the interests register.
Section 162(7)	The board must ensure that particulars of any indemnity given to, or insurance effected for, any director or employee of the company or a related company are entered in the interests register.

 

4.5.6 Providing other services to the company

Directors must protect the interests of shareholders and monitor the behaviour of management. When non-executive directors also provide business or other professional services to their companies there can be concerns that their independence is being compromised. These directors are referred to in this section as director/services providers.

It is not uncommon for a provider of services to be invited to become a member of the board, not least because the person has become familiar with the company and its business. However, if these directors or their organisations continue to provide services to the company they could be influenced (or perceived to be influenced) by the intention of protecting the relationship or increasing business or the profitability of such business.

As opposed to one-off, specific assignments, ongoing involvement by director/services providers is more likely to create a perception of bias. From a shareholder’s perspective, director/services providers who provide services of any significance to the company cannot be considered to be completely independent as directors. The general rule in respect of providing services to your company is to tread judiciously and consider exempting yourself from decision-making on key issues where there might be a conflict component.

When providing services to the company the director/services provider has, in some respects, divided loyalties. They may be significantly more vulnerable to management influence than directors who are truly independent. Board and management may feel more constrained in judging the services provided (for example, in contesting a fee account). In these situations the directors involved may also be constrained in contributing to the board’s affairs.

However, if director/services providers were to be excluded from office, the company (and indirectly its shareholders) could be unnecessarily penalised by being unable to take advantage of the best services available at the best available prices.

Offer to withdraw on potential conflict issues

A director/services provider should offer to withdraw on occasion to ensure the other directors have reasonable opportunities to freely discuss the director/services provider’s services and the terms on which they are provided, as well as obtaining management’s assessment of the relationship. In no event should director/services providers allow the provision of services to the company to colour their judgement when acting as directors. The best interests of the company are paramount. Director/services providers who are unable to accept this position should either cease to provide the service or resign from their directorship.