CORPORATE GOVERNANCE
TRAINING
MODULE 3: CONFLICTS OF
INTEREST
ADB Private Sector Development Initiative
Corporate and Financial Governance Training
Solomon Islands
Dr Ann Wardrop
La Trobe University
Session
Acknowledgments
2
These materials were produced by the Asian
Development Bank’s Pacific Private Sector
Development Initiative (PSDI). PSDI is a regional
technical assistance facility co-financed by the Asian
Development Bank, Australian Aid and the New
Zealand Aid Programme.
Session Outline: Conflicts of Interest
3

Conflicts of Interest
 Introduction
 Sources
of rules about conflicts of interest
 General law: the fiduciary relationship
 Fiduciary
duties
 Test for for conflict of interest
 Remedies for breach of fiduciary conflict duty
 Defence: fully informed consent
Session outline: Conflicts of Interest
4

The Companies Act 2009
 Section
67
 Consequences of breach of conflict provisions
 Remedies
against the director
 Can the company set aside a transaction where director has
a conflict?



Company model rules and conflicts
Public company interests register
Sum up and checklist for conflicts
Session Outline: Conflicts of Interest
5

State-Owned Enterprises

Introduction
 State-Owned
Enterprise Act Regulations concerning
conflicts
 Directors’
obligations of disclosure and no participation
 Appointments

Case study
of directors and SOEs
Introduction
6



Questions relating to conflicts of interest are central
to corporate governance.
They are therefore a key issue for the board.
A broad ethical view should be taken to the issue of
conflicts of interest rather than narrowly focussing
on what amounts to a breach of the legal
requirements relating to conflicts of interest.
Sources of rules about conflicts of
interest and directors
7

General law rules
 Judge
made law concerning the fiduciary relationship
between the director and the company

Statute
 Companies
Act 2009
 State-Owned Enterprises Act including relevant SOE
Act, and State Owned Enterprises Regulations 2010
Sources of rules about conflicts

The company’s rules, codes of conduct or policies and
expectations (company culture about ethical behaviour)



For example, compare a sales company where directors
may be involved in hospitality events that involve gifts, and
compare this situation to an auditor or law enforcement
person who would be compromised by such behaviour. 1
Director’s employment contract
Codes of conduct or professional rules applying to the
particular industry
AICD, Conflicts of Interest (2010, p 7)
General law: the fiduciary relationship
9


The law concerning fiduciary relationships is relevant
to directors’ duties concerning conflicts under the
general law.
Solomon Island general law recognises that
directors are in a fiduciary relationship with the
company, see
 Emery
v Hashimoto [1995] SBHC 114
General law: the fiduciary relationship
10
What is a ‘fiduciary relationship’ and what are the
legal implications of being in such a relationship?

The general law recognises that in particular kinds
of relationships one person (the fiduciary) has a
great deal of opportunity to abuse a position of
trust and confidence that has been placed in them
by another person (the principal).
General law: the fiduciary relationship
11

To protect the person vulnerable to abuse, the law
developed strict rules applying to fiduciaries to
encourage the fiduciary to be loyal to the principal
and not to abuse their position of power.
General law: the fiduciary relationship
12



Thus the law requires a fiduciary to put the other
party’s interests first. In a competition between interests,
a fiduciary cannot prefer his or her own interests over
the other party.
A fiduciary must act with the utmost loyalty to the other
party.
These ideas are expressed in two fundamental duties
that the law applies to fiduciaries.
General law: the fiduciary duties
13

A fiduciary is under a duty:
 not
to put themselves in a position where their personal
interests or duties to some third party conflict with the
interests of their principal (the no conflict duty); and
 not
to make a profit out of the relationship they have
with their principal (the no profit duty)
except with the fully informed consent of the principal.
General law: the fiduciary duties
14
These duties for the most part overlap. That is, where
a director has the opportunity of making a profit
because of their relationship with the company, they
will generally be in a conflict of interest and duty
situation.
The fiduciary duties apply to:
executive, non executive and shadow directors
(shadow directors are described in s 72 Companies
Act 2009). They can also apply to senior employees.
Examples of conflict of interest
15

The classic example of a conflict is where a
company buys from or sells to one of its director’s
own personal businesses.
 Director’s
duty to the company is to get the lowest possible
price (buy) or highest price (sell) these are the opposite of
what the director wants for their own personal interest.
 Director
therefore has a conflict of interest.
Examples of conflict of interest
16

Other clear examples include where a director:
 is
involved in company decisions to contract with or
benefit the director’s friends or family;
 is
involved in decisions to write off a debt the director
owes to the company;
 is
involved in a decision about his or her remuneration.
Examples of conflicts of interest
17


All the previous examples involved a conflict
between the director’s own personal interest and
the company’s interest.
A conflict can arise when the director has nothing
personal to be gained but owes a duty to a third
party that may conflict with his or her duty to the
company.
Examples of conflicts of interest
18


For example, the director is a director of both Red
Company and Blue Company. Blue Company is
selling goods to Red Company.
Looking at this from the perspective of Red
Company, the director has a conflict between his or
her duty to Red Company to ensure the lowest price
is paid with his or her duty to Blue Company to
ensure the highest price is obtained.
Sometimes it is difficult to say whether
or not there is a possible conflict
19
There may be other situations where because of particular facts it is not clear whether a director
has a conflict of interest.
For example:
Company set up to act as the agent and manager for a syndicate of 20 people to purchase
particular land for development by the syndicate. One member of the syndicate was a director of
the company. There were discussions about buying new land for development with some of the
members of the syndicate but it was recognised a new syndicate would need to be formed to
purchase the further land. The director then fell out with everyone and resigned as director. The
company bid at the auction for the new land for syndicate no 2 and the ex director bid for the
land for himself. The ex director was the successful bidder. The company claimed the ex director
had breached his fiduciary duty by having a conflict of interest and taking up a corporate
opportunity that belonged to the company. The court held that there had been no breach of
fiduciary duty because the ex director had not known about the sale of the land from information
he’d gained as a director (it was public knowledge the land was available before purchasing it
was discussed by syndicate no 2) and the company was not in the business of investing in land. Its
only activity was to manage the first development as agent for syndicate no 1and to act as agent
for other purchases on instructions from others. The company did nothing on its own account and its
attendance at the second auction was merely as agent (for syndicate no 2), therefore the ex
director did not breach his fiduciary duty and there was no conflict.
General law: test for conflict
20


The general law only prohibits conflicts where there
is a ‘real sensible possibility of a conflict of interest’.
The test is an objective test. That is:
Would a reasonable person think there was a real
sensible possibility of a conflict in all the facts and
circumstances of the case?
General law: test for conflict
21



The question is not whether you were actually
influenced or whether or not you think you can make the
decision without taking your own interests into account.
It does not matter that a director actually acts with
perfect honesty.
If a reasonable person would think there is or was a
real sensible possibility of a conflict then the director is
or was in a conflict situation and the fiduciary rules
apply.
Tip


Test for Conflict
To help answer whether you have a real sensible
possibility of there being a conflict, ask the
following question:
Would a reasonable person knowing the relevant
facts and circumstances think that your interest in the
matter was of such nature that it could influence
your behaviour (such as a vote)?
Australian Institute of Company Directors, Conflicts of Interest (2010, p 7)
General law: duty very strict
23


Finally, it doesn’t matter that the transaction in
which the director has an interest is one that is
profitable for the company.
A director will still breach his or her duty if there is
a conflict.
General law: test for conflict
24
Exercise
Director of Purple Company is owed $500 by Green Company.
It is proposed that Purple Company buys goods worth $1000
from Green Company.
Do you think this represents a real sensible possibility of a
conflict of interest for the director of Purple Company?
What facts, if any, would make a difference to your answer?
Exercise
25
Can you think of any other examples in your business
where conflicts could arise?
General law: remedies for breach of
fiduciary conflict duty
26


Generally, the duty is owed to the company, so it
will be the company that has a remedy.
The remedies at general law relate to the
transaction and to an action against the director.
General Law: remedies for breach of
fiduciary conflict duty
27

General law: the company can set aside a contract
the company has entered into in which the director
has a conflict of interest or duty where the third
party knows or ought to have known of the conflict.
General law: remedies for breach of
fiduciary conflict duty
28


The director must account to the company for any profit
the director has made out of the contract (even if the
contract can’t be set aside e.g. because the other party
to the transaction did not know of the director’s conflict).
If the company suffers loss as a result of the contract,
the company may be able to sue the director for
equitable compensation (damages) if the company
would not have contracted if it had known of the
conflict.
Exercise: remedies
29
Director of a finance company has delegated
authority from the board to lend up to $100,000
without taking it to a full board meeting. The director
lends $100,000 to his cousin for a 20 year term. The
interest rate is 2% below the market rate.
General law defence: fully informed
consent
30


At general law, it is possible for the principal to
consent to a fiduciary’s breach of fiduciary duty if
the principal gives fully informed consent to the
breach.
For example, director may obtain the consent of the
company for his business to sell goods to the
company by obtaining prior approval of the
contract at a meeting of all the company’s
shareholders.
General law defence: fully informed
consent
31


For fully informed consent of the company to
be effective:
The nature and extent of the director’s interest must be
disclosed to the shareholders, e.g.
 what
profit, if any, the director is making out of the
transaction;
 what kind of interest or conflict the director has in
the transaction;
General law defence: fully informed
consent
32
 Must
disclose any pertinent facts the director
knows about the transaction.
 Should
disclose the fact that what is proposed is
a breach of the director’s duty unless consent is
obtained.
General law defence: fully informed
consent
33
Ultimately precisely what has to be disclosed to the
shareholders will depend on the facts and circumstances
of each case and on the level of sophistication of the
persons to whom you are disclosing.
General law: when will approval by the shareholders
with fully informed consent not be effective?
34


While the company in general meeting can approve
a transaction that would be in breach of a director’s
duties because it was a conflict situation, a bare
majority cannot a approve a conflict that amounts
to a misapplication of company property. E.g. a
sale at an undervalue.
If the company is insolvent, even approval of all
shareholders will not be effective to approve a
misapplication of company property.
General law: when will approval by the shareholders
with fully informed consent not be effective?
35


In short, the majority in general meeting of a solvent
company (that will remain solvent after the transaction)
cannot approve a breach of director’s fiduciary duty
not to be in conflict if the breach amounts to dishonesty,
or disloyalty to the company or not acting in the best
interests of the company (e.g. the sale at an
undervalue).
If the company is insolvent or will be insolvent after the
transaction, even approval of all shareholders will not
absolve the director because at that point duties are
owed to creditors of the company.
The Companies Act 2009
36
Director must not exercise any powers as a director if
the director is directly or indirectly materially
interested in the exercise of the power, except in
certain circumstances (see later).
S 67
The Companies Act
37
‘exercising a power as a director’ this includes:
 voting
 powers relating to managing, and directing and
supervising the management of the business and the
affairs of the company:
 e.g.
signing documents
 making decisions and directing staff
The Companies Act
38

‘Exercising a power as a director’ does not include
conflict situations where no power is exercised e.g.
 Director
works for another company
 Director gives advice to a competing company
These kinds of conflicts will be covered by the general
law obligation not to have a conflict or other sections of
the Act dealing with directors duties e.g. duty to act in
good faith and in the manner the director believes to be
in the interests of the company (s 64) or the company’s
rules/policies
Companies Act provisions relevant to
conflicts of interest

‘materially interested in the exercise of that power’

No definition of ‘material’ in the Act

It is probable ‘material’ means ‘relevant’ rather than
‘significant’. In other words ‘is the conflict potentially
relevant to a director’s motivation’ in exercising the
power? So ‘material’ is similar to ‘is there a real
sensible possibility of conflict’ under the general law
formulation.1
Peter Watts, Directors' Powers and Duties (2009, p 231)
When there will not be a breach of s
67
40


If the Act expressly authorises the director to exercise the
power despite that interest; or
If the director has reasonable grounds for believing the co
will satisfy the solvency test after the power is exercised
and EITHER

The company rules authorise the exercise of the power after the
director discloses the nature and extent of their interest in writing
to the board and at least one member of the board is not
interested in the transaction; or if there is no non-interested
director, disclosure in writing is made to all shareholders other
than the director
or
When there will not be a breach of s
67
41
OR (remember solvency test also to be satisfied)
 the
exercise of the power is approved by all
shareholders at a meeting convened under s 50 of the
Act following disclosure of the nature and extent of the
director’s interest to all shareholders who are not
otherwise aware of those matters.
Exercise
42
Red Company has significant assets and is financially
healthy.
Red Company Rule 10 provides:
A director can exercise any power in relation to a transaction
in which she is materially interested provided she has disclosed
in writing the nature and extent of her interest in the
transaction to the board if there is at least one director who is
not interested in the transaction, or if there is no such director,
disclosure is made to all shareholders other than the director.
Exercise
43
Red company has 5 directors and is proposing to enter
into a logging joint venture with Pink Company whose
majority owner is Red Co’s managing director’s cousin. The
remaining 4 directors of Red Company hold between
them 49% of the shares in Pink Company. All of Pink
Company’s directors are independent.
(a) To manage these conflicts, what procedure should the
directors of Red Company take to comply with s 67?
(b) Suppose there was no Rule 10, what should the
directors of Red Company do?
Consequences of conflict of interest
44



A director who exercises a power and fails to disclose
his or her interest as required under s 67 contravenes
the Act and breaches his or her duty to comply with the
Act under s 65. Also breaches model rules (see later).
The director also breaches their general law fiduciary
duty because they have a conflict of interest.
The director will be liable to account for any profits
made by him or her from the transaction and will be
liable to pay equitable compensation (damages) if the
company would not have entered the transaction if it
had known of the conflict.
Can the company set aside the transaction
if a director has a conflict of interest?
45

This is governed by ss 107 and 108.

Section 107:

Any transaction entered into by the company in which a director
is indirectly or directly materially interested in can be set aside
by the company if it so chooses.
UNLESS
Can the company set aside the
transaction if a director has a conflict?
46


The Act or the company rules expressly
authorise entry into the transaction; OR
The transaction was approved by all
shareholders under s 50 following disclosure of
the director’s interest to all shareholders who
were not otherwise aware of the transaction;
OR
Can the company set aside the transaction
if the company has a conflict?
47

The other party to the transaction is not a director
or a person associated with the director (e.g. a
parent, child, or spouse of the director or the
director is a director, employee or trustee of that
other person or the director has a material financial
interest in that other person); and
 that
other person did not know of the interest of the
director; or
 The
company received fair value under the transaction
Setting aside the contract where
director breached other duties
48

Section 108 provides that the company can set aside a
transaction where a director breaches his or her duties
of good faith and acting in the best interests of the
company (s 64), or where the the director contravenes
the Act (s 65) or contravenes the company’s rules (s 66)
if:
The other party to the transaction is the director or a person
associated with the director; or
 The other party to the transaction knows or ought to know of
the director’s breach and the co does not receive fair value.

Example 1: no disclosure
49
Director of Red Company has a majority shareholding
in another company that sells land to Red Company
for market value. The directors of Red Company and
its shareholders are not told of this conflict. There is no
company rule that authorises the company to enter
into the transaction.
EG 1 Answer: no disclosure example
50

The company can set aside the transaction despite
receiving market value because:

the seller is a person associated with the director (the
director has a material financial interest in the seller –
the majority shareholding); and
 there
has been no approval by all shareholders under
section 50; and
 The
company’s rules or the Act do not expressly
authorise the transaction.
EG 1 Answer: no disclosure example
51

In addition to a right to set aside the contract, the company
could:

require the director to account for any profit that he or she made
personally out of the transaction (e.g. suppose the seller company
declared dividends to its shareholders solely as a result of the
sale of its property to Red Company); or

obtain damages from the director if Red Co could show it would
not have entered the transaction if it had known of the conflict
(e.g. suppose even though market price was paid at the time the
contract was signed the property market crashed 2 weeks later
and the property is now worth 50% of what Red Company paid
for it).
Example 2: disclosure and insolvency
52
Green company is in financial difficulty. All the directors
know this. Its company rules provide that a director can
exercise a power of a director despite the director being
interested in the exercise of that power provided the
director discloses his or her interest as required under the
Companies Act.
The board decides to sell some of the company’s income
producing assets to the managing director’s company. The
MD gives notice of her interest to the board that has at
least one independent director. The board (including the
MD) unanimously approves the sale. As a result of the sale
Green Company becomes insolvent.
EG 2 answer: disclosure and insolvency
53


Assuming there are no reasonable grounds for believing
the company would be solvent after exercising her vote,
the MD is in breach of ss 67 (conflicts) and 65 of the
Act (duty not to contravene the Act) and probably best
interests duty (s 64) and probably duty of care (s 69).
Can the company avoid the transaction?
The transaction can be avoided by Green Company because
under s 108 the MD breached her directors’ duties under s 64
and 65 and the other party to the transaction is a company
that is associated with the director.
EG 2 answer: disclosure and insolvency
54

What liability will the MD have to the co?
 Account
for any profit she has made out of the deal
with Green Company; or
 Pay compensation for any loss Green Company has
suffered as a result of the transaction.

The other directors will at least have breached their
duty of care, diligence, and skill (s 69).
How do the model company rules deal
with conflicts?
55


None of the model company rules in schedules 2 – 4
allow a conflicted director to exercise a power after
giving notice to the directors or the shareholders (where
relevant) where the company will be solvent after the
exercise of the power
All of the model company rules require a director who
is materially interested in any transaction or a
proposed transaction to notify the board or
shareholders (where relevant) of the nature and extent
of the interest within 10 working days. (Remember any
breach by a director of company rules is a breach of a
director’s duty under s 66)
How do the model company rules deal
with conflicts?
56



Public companies have more detailed requirements
about disclosure contained in the Schedule 4 model
rules.
They are contained in Schedule 4 clauses 59 and
63.
In particular a public company must maintain an
interests register
Public Company Interests Register
57


Any director or shareholder is entitled to inspect the
interests register and the annual report of the company
must contain all entries in the register for the relevant
accounting period.
The interests register must contain various things but in
particular it must contain details of any:

Indemnity or insurance provided for the director

Remuneration or other benefits of the directors

Disclosure of any material interests
Public Company Interests Register
58


A director can make a general disclosure in the interests
register that the director is a director or employee or
shareholder of another company or is otherwise
associated with another company or person. (Schedule
4 clause 63(5))
Such a general disclosure will mean the director has
complied with his or her obligations under the
Company’s rules to notify the company of their interest
in material transactions (Schedule 4 clause 63(6))
To Sum Up
59



As you can see the legal rules relating to conflicts of interest are
complex.
The precise legal answer to any problem on conflicts will depend on
what is in the company rules and how those rules are drafted.
Remember that merely declaring your interest may not be enough in
some situations (even if the rules say you can act after disclosure).
Because disclosing your interest will not help if you are not acting in
good faith or the conflict results in harm to the company because the
contract arising from the contract is unfair to the company.
Disclosure doesn’t cure dishonesty or bad faith

You must also look to any contract of employment, company, industry
or professional codes of conduct or policies.
To Sum Up
60

If you have a conflict or possible conflict
As soon as possible notify the board in writing or the
shareholders where there is no disinterested director on the
board.
 Ensure details are put into the interests register (if the
company is required to have one or has one as a matter of
policy)
 Do not act in relation to the matter unless you can satisfy
yourself that you can act following appropriate disclosures.
 You may have to consider resigning or removing the conflict
if the conflict cannot be managed within the requirements of
the law and company rules.

AICD, Conflicts of Interest (2010, p 13)
To sum up
61

What is clear is that the board should have policies
to deal with conflicts to ensure the Act is complied
with and which also promotes ethical behaviour.
Checklist for conflicts
1
62


First understand and decide how conflicts are to be
handled in light of the legal requirements under the
Act and the company rules but also in light of what
is ethical and what is acceptable to your other
directors. This will be the company policy.
Once the policy is worked out document it. The
policy should at least:
Based on AICD, Conflicts of Interest (2010, pp 28-32)
Checklist for conflicts
1
63
 Set
out a list of key conflicts (e.g. what relationships or
transactions will raise a conflict)
 Set
out the legal requirements, at a minimum what is
required under s 67 and the company rules.
 Set
out what the company requires and expects of its
directors in relation to conflicts in addition to complying
with the legal requirements
Checklist for conflicts
64
Document what board papers a director can receive, if
any, in relation to a matter in which the director has a
conflict.
 Set out what happens to a director if procedures are
not followed.
 Set out a mechanism to record conflicts e.g. register of
interests (required for a public company under schedule
4 model rules).
 Require declaration of conflicts on the board agenda
as a standing item for the beginning of each board
meeting.

Checklist for conflicts
65


Training: ensure all directors are trained on what
the company regards as conflicts upon induction and
throughout their term as directors.
Set up a mechanism to review policies and
procedures relating to conflicts
State Owned Enterprises
Introduction
66





If the SOE is registered under the Companies Act the Companies Act
applies in addition to the State Owned Enterprises Act 2007.
State Owned Enterprises Regulations 2010 set out the duties of SOE
directors.
Must act in good faith and in what the director believes to be the
best interests of the SOE
Must exercise powers for a proper purpose
Must not act or agree to act in a manner that contravenes the Act,
the Companies Act, the rules of the SOE or any other establishing
legislation
State Owned Enterprises
Introduction
67




Duty not to engage in reckless trading
Must not agree to incurring an obligation unless
believes on reasonable grounds the obligation can
be met
Must not disclose information that obtains in
capacity as director or employee of SOE except in
certain circumstances
Must exercise the care, diligence, and skill
SOEs and conflicts: SOE Regs 2010
68
Directors will be subject to fiduciary duties
regarding conflicts of interest.
SOE Act Regulations 2010 (regs 25-27)
 Immediately upon becoming aware that the director
is interested in a transaction or a proposed
transaction, directors must enter in the interests
register and disclose to the board

 The
nature and monetary value of the director’s interest
 If monetary value can’t be quantified then the nature
and extent of that interest
SOEs and conflicts: the Regulations
69

Director does not have to enter the interest in the
register or notify the board if:
 The
transaction or proposed transaction is between the
director and the SOE; and
 The
transaction or proposed transaction is to be
entered into in the ordinary course of the SOE’s
business and on usual terms and conditions.
SOE and conflicts: the Regulations
70

Director can enter a general notice in the interests
register to the effect the director is:
a
shareholder
 director
 officer or
 trustee
of a named company or other person and is to be
regarded as interested in any transaction the SOE has
with that named company or other person.
SOE and conflicts: the Regulations
71



Such a general notice is sufficient disclosure of interest
under the regulations for that transaction.
The board must notify the Accountable Ministers in
writing within 10 days of the disclosure of an interest to
it together with a copy of the entry on the interests
register.
The Responsible Minister must table in the National
Parliament a copy of the notice within 5 days of
receiving the notice. If Parliament is not sitting the notice
must be lodged with the Clerk.
SOE interested director must not
participate
72
SOE Act Regulations, reg 27
 A director who is interested in a transaction or
proposed transaction may not:
vote on a matter relating to the transaction; or
 attend a meeting of directors at which a matter relating to
the transaction arises and be included in a quorum; or
 sign a document in relation to the transaction on behalf of
the SOE; or
 do any thing in his or her capacity as a director in relation
to the transaction.

SOE and conflicts: the regulations
73
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Failure of a director to comply with the obligation to
notify the board and enter the details in the interests
register will not of itself affect the validity of a
transaction entered into by the company or the director
(reg 25(4)).
If the company is also registered under the Companies
Act the provisions regarding conflicts will apply to the
extent they are not inconsistent with the SOE Act.
(Dealt with in more detail in SOE module)
Appointment of directors and conflicts
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Regulation 11: a preferred candidate must provide the
Accountable Ministers with a written notice, among other
things, disclosing the nature and extent of all interests
that he or she has at that time or is likely have in
matters relating to a SOE
A person who has any conflict of interest that is of such
significance that it would impede the person’s ability to
carry out his or her duties as a director of the SOE is
disqualified from being appointed or holding office as
a director of a SOE (reg 12(1)(i).
Exercise
75
Case study