21 January 2009

Conflict of interest: duties of directors to disclose interests in company contracts

Directors have a legal duty to act at all times in the best interests of their companies. Naturally, a conflict arises where a director has an interest, either directly or indirectly, in any transaction that is being concluded with his company. Where these conflicts arise, there are a number of legal requirements relating to consent and disclosure that have to be met by directors to render their conduct lawful and the resultant contracts valid.

Broadly speaking, two distinct but related rules govern these matters:

  • Firstly, directors may not act for or on behalf of their company in the negotiation and conclusion of a contract in
    • which they may have a conflicting interest. This is known as the rule against "self-dealing". The reason for this rule
    • is fairly self-evident - a director of a company is obliged to obtain the best terms possible for that company when
    • concluding a contract whilst his personal interest in that contract may motivate him to do just the opposite. The
    • only exception to this rule is where the director has obtained the consent of the members of the company in a
    • general meeting.
  • The second rule is known as the "fair-dealing" rule and essentially compels a director to make full disclosure of his
    • interest in the contract and of all other relevant material facts. Unless the company's articles of association stipulate
    • otherwise, disclosure must be made to the members of a company at a general meeting. Interestingly, once full
    • disclosure is made, a director who is also a member may even vote for the approval of the relevant contract at a
    • general meeting.

A company's articles of association will often, for the sake of convenience, give the board of directors the authority to consider and approve contracts in which a particular director has a personal interest.

The Companies Act, 1973 prescribes the manner in which disclosure must take place but not the content of the disclosure, and this will depend on the circumstances of each case. At the very least, a director should disclose the nature of his interest, any profits he may make and any other facts that would have a bearing on the company's decision to enter into the contract.

If a director contravenes either the self dealing rule or the fair dealing rule, the contract is voidable at the insistence of the company no matter how fair or reasonable the transaction. However, if the contract was concluded with a third party that did not know, or could not reasonably have been expected to know, of the conflict of interest, the company is bound to the terms of the contract. In those circumstances, the company has a right to claim back from the relevant director any profits he may have made from the transaction. In addition, the director may well be held liable for any damages sustained by the company arising from the non-disclosure.

Brigit Rubinstein and Tash Steinberg

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