Conflicts of interest under the new Companies Act
10 July 2013
In this post we deal with some pertinent issues arising from section 75 of the new Companies Act, which constitutes a partial codification of director’s duties where direct or indirect personal financial interests are involved. The scope of the section in question is wider than some people may anticipate and therefore directors (and other stakeholders) should consider their rights and obligations carefully.
The following important definitions that are contained in the Act have been paraphrased and simplified for purposes of this post:-
The implications of section 75
- "personal financial interest": a direct, material interest of a financial, monetary or economic nature, excluding interests held in unit trust and collective investment scheme vehicles (unless the latter is controlled).
- "related": in the case of individuals, if they are married, live together or are related up to the second degree; between an individual and a company, if the individual controls the company; or any second company of which the director or a related person is also a director, or a close corporation of which the director or a related person is a member.
- "control": a person controls a company or its business if: in the case of a company, it is a subsidiary; that person together with any other inter-related person has the majority of voting rights or has the right to appoint directors that have the aforegoing ability; or that person has the ability to influence the policy of the company in a manner similar to the previous scenario.
Subsection 5 provides that if a director has a personal financial interest in respect of a matter to be considered at a meeting of the board, or knows that a related person has a personal financial interest in the matter, the director:-
- must disclose the interest and any material information relating to the matter;
- may disclose any observations or pertinent insights relating to the matter if requested to do so by the other directors;
- if present at the meeting at which the matter in respect of which the director has a personal financial interest is to be discussed or voted on, must leave the meeting immediately after making any disclosure and must not take part in the consideration or voting in respect of the matter; and
- must not execute any document on behalf of the company in relation to the matter, unless specifically requested or directed to do so by the board.
- The decision must be significant to trigger the above requirements and non-financial interests of a director fall outside the scope of the definition.
Directors that are required to recuse themselves from voting are deemed to be present for purposes of the calculating the prerequisite quorum, but the remainder of the directors still have to achieve the required support for the resolution to be passed.
A director of a company may be held personally liable in accordance with the principles of the common law for any loss, damages or costs sustained by the company as a consequence of a breach of the provisions of section 75.
Any provision of an agreement, the memorandum of incorporation or rules of a company, or a resolution adopted by a company, whether express or implied, is void to the extent that it directly or indirectly purports to relieve a director of a duty contemplated in section 75.
A company must keep record of any declarations made by a director as required by section 75. In addition, if a director of a company, after a matter has been approved by the company, acquires a personal financial interest in an agreement or other matter in which the company has a material interest, or knows that a related person has acquired a personal financial interest in the matter, the director must promptly disclose such interest to the board.Practical issues
Failure to comply with the provisions of section 75 has the effect that the decision in question is voidable at the instance of the company.
A decision by the board or a transaction or agreement approved by the board is however valid despite non-disclosure of any personal financial interest as defined if:-
- it was again approved following disclosure of that interest in the manner contemplated in the section, which we read to mean that the conflicted director must not participate in the confirmatory vote as required by the section; or
- it has subsequently been ratified by an ordinary resolution of the shareholders following disclosure of that interest.
Even if the company or shareholders subsequently confirmed or ratified the decision, the fact that a director breached his or her duties in terms of section 75 would potentially remain and therefore the liability as mentioned above. The fact that such liability arises from the common law, means that the normal requirements in this regard would apply. In our view, the fact that a decision was later approved and the reasons for such approval will be material considerations.
This section does not apply to a director of a company in respect of a decision that may generally affect all of the directors of the company in their capacity as directors (which we read to refer to matters such as remuneration).
A court, on application by any interested person, may declare valid a transaction or agreement that had been approved by the board, or shareholders as the case may be, despite the failure of the director to satisfy the disclosure requirements of this section. An interested party may include a contracting party who would suffer detriment should the agreement voided.
When drafting a memorandum of incorporation and subsequently constituting a board of directors, foresight needs to be applied to anticipate the effects of section 75.
Please note that the legal topics informally discussed here are general discussions of certain aspects and therefore certainly not intended as legal advice. We look forward to discussing your particular case with you.