Managing conflict of interest is proving tricky for many of SA’s directors

It only takes one look at recent headlines to realise how important it is for directors to manage their conflicts of interests. As fiduciaries, directors must not put themselves in a situation where their personal interests conflict with their duties to the company. It is important that directors are not swayed by their own personal interests, as a failure to properly comply with prescribed disclosure requirements could have dire consequences.

Directors are required to disclose to the board any “personal financial interest” — being a direct, material or significant interest of a financial, monetary or economic nature. Further to this, directors must also disclose the personal financial interests of people related to them, such as their spouse, and people within two degrees of consanguinity or affinity, such as their parents, children and siblings. Remember, a related person includes a company where the director directly or indirectly controls, or a second company of which the director or a related person is also a director.

Another important point is that a director will be regarded as having knowledge of the personal financial interest of a related person if he reasonably ought to have investigated the matter or to have known of that interest. Directors must take reasonable steps to obtain information about the interests of people related to them.

As far as disclosure goes, a personal financial interest may be disclosed to the board at any time by delivering a standing written notice setting out the nature and extent of that interest. This notice remains in effect until it is amended or withdrawn by the director.

A personal financial interest in respect of a specific matter to be considered at a board meeting must be disclosed before the board sits, while any relevant, material information known by the director must also be disclosed. He may also disclose any observations or pertinent insights relating to the matter. Thereafter, he must recuse himself from the meeting, not participate in the consideration of the matter, and not sign documents relating to the matter (unless the board asks this of him). If he acquires a personal financial interest after the matter has already received board approval, he must promptly disclose the nature and extent of his interest, and the material circumstances relating to how he acquired that interest.

A director must revise his general disclosure if there are any noteworthy changes to it. It is also essential that he manages his conflict on an ongoing basis. If the board is considering a transaction in which a director has an interest, despite having disclosed his interest in a standing notice, he must still recuse himself from the meeting.

A personal financial interest, however, does not mean there is any transgression — the transgression arises when the director fails to properly manage that interest. The rationale of the disclosure requirements is that if the board is informed of a director’s interest in a matter, it would be free to decide whether, and on what terms, to proceed with a transaction. Managing a conflict may be as simple as recusing himself from a decision. But if the conflict results in an untenable situation, the director may have to withdraw from the situation altogether, such as resigning from the board of one of the companies.

The King IV Report (principle 7) recommends that directors declare their personal financial interests at least annually, or whenever there are significant changes. It also recommends that at the commencement of each board meeting, all directors should declare any conflict of interest regarding matters on the agenda. This is good practice and should be done even if directors have submitted a standing notice of their interests.

It cannot be stressed enough that the failure to disclose a personal financial interest could render the transaction invalid, unless the decision is ratified by the shareholders or declared valid by a court. But it would be costly for a company to take these steps and may delay the transaction. Explaining to shareholders the reason its directors initially failed to disclose their interests may reflect poorly on the reputation of its directors.

Furthermore, a director will be in breach of his fiduciary duty to avoid a conflict of interest if he fails to disclose his interest (unless the transaction is ratified by the shareholders). He may in certain circumstances even face criminal action for fraud or theft. A key point is that material information must not be withheld from the board to the detriment of the company and its shareholders.

When all is said and done, a company can only make decisions through a properly informed board, and withholding proper information makes it impossible for a board to do its job in the best interests of the company and its shareholders.

• Dr Cassim, an admitted attorney and notary public, has contributed to numerous books on company law and is a senior lecturer in the department of mercantile law at the University of SA.