Multiple directorships – multiple problems…

Introduction

It is common these days for a person to be a director of two (or more) companies at the same time. This is particularly so within corporate groups, where an individual may sit on both parent and subsidiary boards.

Whilst being on the board of multiple companies is permissible, it often comes with higher risk. This is not just because of the additional duties involved, it is also because of the greater risk of “conflicts of duties” – that is, occasions where an individual is required to fulfil two or more directorship roles that conflict with each other, whether that conflict is actual, potential or perceived.

Conflicts of duty have the capacity to land a director, and the companies of which they are a director, in trouble. It is therefore important that both directors and companies are proactive and put processes in place to identify and manage conflicts of duty early, before they become an issue.

It is also important to remember that a conflict of interest is almost always a conflict of duty. But, a conflict of duty need not involve a conflict of interest. This is why “disinterested” directors in corporate groups can be unaware of their increased risk.

Background – directors’ duties

Each director of an Australian company is subject to “directors’ duties” – a series of legal duties imposed by general law, the Corporations Act 2001 (Cth) and other statutes such as Work, Health and Safety legislation. Directors’ duties are designed to safeguard shareholders’ interests, promote good governance of company affairs and ensure directors meet a minimum standard of care.

There are a large number of directors’ duties which directors must comply with. However, there are some which are particularly relevant in the context of multiple directorships, for example:

1. General law duties (non-legislation based duties):

1. 1. common law duties, including the duty to exercise reasonable care, diligence and skill; and
   2. equitable fiduciary duties, including the:

2. 1. 1. duty to act in good faith in the interests of the company as a whole;
      2. duty to act with care and diligence;
      3. duty to retain discretion;
      4. duty to avoid conflicts of interest;
      5. duty not to act for an improper purpose;
      6. duty not to disclose confidential information; and
      7. duty not to abuse corporate opportunities.

2. Statutory duties primarily imposed by the Corporations Act 2001 (Cth), including the duty of a director to:

1. 1. exercise their powers and discharge their duties with a reasonable degree of care and diligence (section 180);
   2. exercise their powers and discharge their duties in good faith in the best interests of the company and for a proper purpose (section 181);
   3. not use their position improperly to obtain an advantage for either themselves or a third party, or to cause detriment to the company (section 182); and
   4. not improperly use information obtained through their position as a director to gain an advantage for either themselves or a third party, or to cause detriment to the company (section 183).

The consequences of a director breaching their duties are serious. A transaction made in breach of a director’s general law and/or statutory duties may place a company at risk of shareholder oppression proceedings brought by disgruntled shareholders under section 232 of the Corporations Act. The transaction may place the relevant director at risk of investigation by ASIC, criminal/civil sanction and/or disqualification. Further, in some circumstances, a transaction made in breach of a director’s fiduciary duties may be voidable at the option of the company, often through shareholder derivative action or by a liquidator.

In a nutshell, a director breaching his, her or their duties can be a costly exercise for both the director and the company.

The problems arising from holding multiple directorships

Where an individual is a director of two (or more) companies at the same time, they will owe directors’ duties to those two (or more) companies equally. However, this can be difficult, if the duties a director owes to one company conflict with the duties owed to another.

For example, a director may struggle to properly discharge their duties to two separate companies, if they are a director of each of those companies and each company is pursuing / negotiating:

1. an IP licence between the two companies (as often happens when all the group’s IP sits in one IP entity), where an increased licence fee for one company means higher cost to the other; or
2. a management contract or services arrangement between two companies in a group (if the terms of the contract / arrangement are more favourable to company A, then the director may be in breach of their duties to company B).

A director may struggle to properly discharge their duties to two separate companies within a corporate group, where there is a transaction (such as an IP licence, a reorganisation or an asset transfer) which is not necessarily on arm’s length terms with individual entities but overall the “group” is better off.

How to manage multiple directorship scenarios – the legal answer

The generally accepted position is that where an individual holds multiple directorships, that director needs to bear in mind their directors’ duties to each company they are a director of and ensure that they do what is required to adequately protect each company to which they owe duties. In doing this, the director must consider the individual legal and economic interests of each company they are a director of.

In the context of corporate groups, this means that directors cannot make decisions purely based on the overall (more general) interests of the group. Rather, they can only take group considerations into account to a limited extent, as they must still consider the individual interests of each company they are a director of.

How to manage multiple directorship scenarios – the practical solutions

Demonstrating the requisite standard of conduct is easier said than done. Directors and companies must therefore put practical measures in place to try to mitigate conflict of duty risk.

Unhelpfully, the Courts have not always clearly articulated what is required of directors to avoid a conflict of duty issue. Instead, they emphasise that the question of whether a conflict of duty (and indeed, more broadly, a conflict of interest) exists largely depends on the particular circumstances. This makes it difficult for companies to develop a standard risk matrix to fit all procedures and protocols to mitigate risk.

We have outlined below a short list of practical measures which should, depending on the particular circumstances, reduce the risk of conflict of duty issues arising. Which actions an individual / company should take will vary from case to case, depending on matters such as the degree to which the individual has been involved in the relevant transaction and the gravity of the possible outcomes. We encourage companies and directors to consider each of the measures below and, if desired, discuss them with us – prevention is key in avoiding liability in conflict of duty scenarios.

1. Conflicts policy

If a director identifies any conflict of duty risk, whether actual, potential or perceived, then it would be prudent for that director to suggest that the board adopt a conflicts policy to help avoid problems arising in the future.

A conflicts policy should, amongst other things, clearly define what constitutes a conflict (in doing so, consideration should be had to what a reasonable person would conclude) and what to do when one arises.

For a conflicts policy to be successful, it is important to integrate the policy into a company’s culture and encourage ongoing compliance and currency. Some ways to do this include:

1. 1. internally publicising the conflicts policy and making it readily available to all officers / employees;
   2. internally publicising instances where directors have stood aside from decision-making because of a conflict to demonstrate that conflicts will arise and that dealing with them in a professional manner is the norm; and
   3. encourage a boardroom culture where:

1. 1. 1. conflicts are discussed as a matter of course (for example, at the start of each board meeting, the directors are asked to disclose and update any conflicts relevant to the meeting agenda); and
      2. each director is required to continually disclose conflicts (for example, each director is asked to make an annual declaration detailing all the businesses, groups and other boards that they are affiliated with).

Although the scope of this article is limited to conflicts of duty, a conflicts policy should also address conflicts of interest more broadly.

2. Conflicts committee

Alongside a conflicts policy, a company can task a person or body – a “conflicts committee” – to review contracts and transactions before entry, to ensure that neither party to the contract or transaction bears the other any special duty or obligation, and they are, to the extent practicable, bona fide, negotiated in good faith and each party’s own interests have been considered.

A committee helps to flag and address conflicts which may have otherwise slid by unnoticed. Ideally, a “conflicts committee” should include one or more independent persons, such as a lawyer with corporate governance experience.

3. Conflicts register

To help prevent potential conflicts from becoming actual conflicts, a company can establish a “Conflicts Register” that details all of the personal and business interests of the directors and their associates, as well as any past conflicts which have been disclosed. Such a register makes the identification of conflicts easier in the future and should be updated regularly as director interests change.

4. Disclosure and exclusion

It is generally accepted in the context of conflicts of duty that disclosure is required by the rules of equity. As such, it is common practice to treat conflicts of duty in the same manner as “material personal interests”^[1] – that is, with full disclosure (to a public company standard) and the relevant director excluding themselves from both board deliberations and voting.

5. Resign

If a conflict is sufficiently serious / unavoidable, then in some circumstances, the conflicted director’s risk may be best mitigated by resigning from at least one board.

6. Ensure the company’s constitution allows “group” interests to be considered

Where a company is a wholly owned subsidiary, a provision in the company’s constitution may validate a contract that would otherwise be voidable under general law. This is because section 187 of the Corporations Act 2001 (Cth) states that a director of a company that is a wholly-owned subsidiary of a body corporate is taken to act in good faith in the best interests of the subsidiary if:

1. 1. the constitution of the subsidiary expressly authorises the director to act in the best interests of the holding company; and
   2. the director acts in good faith in the best interests of the holding company; and
   3. the subsidiary is not insolvent at the time the director acts and does not become insolvent because of the director’s act.

Where there is a corporate group where individuals hold multiple directorships, it is prudent to ensure that each company’s constitution includes a provision to reflect section 187, in order to provide a degree of protection.

We point out however that amending the constitution is not a get out of jail free card. Regardless of what the constitution states, each director must still exercise their powers (and discharge their duties) for a proper purpose, not improperly use their position to gain an advantage for themselves or someone else, and discharge their fiduciary duties at general law.

7. Procure informed consent

A fiduciary may enter into an arrangement that would otherwise breach their fiduciary duties, or otherwise retain a benefit obtained as a result of their fiduciary relationship, in circumstances where the principal has provided informed consent.

This means that it is a defence in respect of breaches of fiduciary directors’ duties (but not statutory duties), if full and frank disclosure is made to shareholders of all material facts regarding a conflict of duty (in particular, the director’s position and prospective breach of duty), and shareholder consent is then procured.

Note that similar defences exist in respect of ratification by shareholders.

8. Procure an expert’s report

If there is doubt about the appropriateness of a particular transaction, where a conflict of duty might or does exist, then it would be prudent to consider consulting with an independent expert who is experienced in corporate law (for example, a lawyer who specialises in corporate law) and commissioning an independent expert’s report. 

Conclusion

Conflicts of duty arise frequently and, if not managed properly, can place both directors and companies in awkward, and costly, positions. If there is any actual, potential or perceived risk of a conflict of duty, then it is prudent to put protections in place now, to prevent the conflict from leading to liability in the future. Which protections are appropriate for the situation will differ from case-to-case, therefore discussing with an advisor is key.