Dealing with ‘Situational Conflicts’ of Interest
The inherent risk for companies and directors when there is a conflict of interests is the potential for an unfair prejudice petition by shareholders. But what is the position where the petitioner has effectively accepted a ‘situational conflict’ on the part of a director?
The message for shareholders following a recent ruling1 is that if you do not complain at the time, you will probably not be granted relief for unfair prejudice. And directors are reminded of the importance of complying with their legal duties when a situational conflict arises - or risk a claim.
What is a ‘situational conflict’?
Directors are under a clear legal duty under company law to avoid situations that could lead to a conflict of interest. Typical examples include circumstances where the director and or members of their family are majority shareholders in a competitor business. Situational conflict is to be distinguished from conflicts that arise out of a transaction or an arrangement.
Where a situational conflict exists, there is no breach of duty if the non-conflicting directors approve and authorise it - subject to any clause in the company’s constitution to the contrary.
What is unfair prejudice?
Unfair prejudice arises out of acts which have led to a reduction in the value of your shares, for example, failing to consult shareholders, paying directors excessive salaries whilst awarding no dividends.
What situational conflict arose in this case?
Five brothers and sisters inherited the shares in their parents’ construction company. There was also a corporate shareholder. P was the majority shareholder and managing director; A was a minority shareholder and a director, and G was a minority shareholder and company secretary. M was a minority shareholder but not actively involved in the company.
P decided to set up a new company and bought, in the name of the new company, the assets of a separate company that had gone into administration. Those assets were then hired out to the construction company, at a price. However, even though A and G knew what was going on within a very short time of these events, they and M brought proceedings against P on the basis of breach of fiduciary duty and alleging unfair prejudice.
The High Court found that P had put himself into a situational conflict because his interests conflicted with those of the company and this had not been authorised. P honestly believed that buying the assets in the name of his new company was in the original company’s best interests. In fact, the Court agreed that this was the reality – but that was not relevant as to whether or not he had breached his duty.
The Court also agreed that his breaches were unfairly prejudicial conduct in relation to the other shareholders. So what relief was granted to those shareholders? The answer is: none.
What was directly relevant was the fact that the other shareholders knew of P’s actions but had failed to act. They were happy to allow the events to continue without any complaint, and this amounted to consenting to P’s breach of duty. For this reason, they were not entitled to relief.
What does this mean?
Directors must avoid situational conflicts if they can, otherwise they should seek authorisation from the other directors – otherwise there could be a risk of a claim for unfair prejudice. However, if the other shareholders know about the conflict and fail to complain or take any action, they will be unlikely to expect any remedy for unfair prejudice.
Also, what is clear is that even where the company benefits out of the director’s actions which are in breach of duty, this does not excuse or invalidate that breach.
1Waldron & Ors v Waldron & Anor [2019] EWHC 115
If you would like us to cover an issue in the next NGM Tax Law Newsletter, we would be pleased to hear from you