RECONFIGURING THE NO CONFLICT RULE

Citation(2011) 23 SAcLJ 714
Date01 December 2011
Published date01 December 2011
AuthorBrenda HANNIGAN MA (TCD), LLM (Harvard); Professor of Corporate Law, University of Southampton, UK.

Judicial Strictures, a Statutory Restatement and the Opportunistic Director

This article explores the scope of the no conflict duty as it applies to company directors in the UK in the light of the bright-line statutory formulation of the duty adopted in the Companies Act 2006. That statutory clarity sits alongside existing judicial disagreements, however, on key aspects of the duty, such as whether directors have a duty to disclose information to their companies and the significance to be attached to the scope of a company's business. The question is whether the statutory formulation affords the courts the opportunity now to develop a more coherent statement of this most important duty.

I. Introduction

1 One of the main innovations in the UK Companies Act 2006 (“CA 2006”) was the inclusion for the first time in the companies legislation of a statement of the general duties of directors.1 Central to a director's duties, of course, is the long-established equitable rule precluding a fiduciary from entering, without consent, into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect (the no conflict rule),2 and the equally inflexible rule that, without consent, a person in a fiduciary position is not entitled to profit

from that position3 (the no profit rule). Whether one rule or two (a matter of debate), together the two strands4 express the duty of undivided loyalty owed by a fiduciary to his principal.5 The rationale for the two strands was explained in Chan v Zacharia6 as follows: the no conflict rule is designed to prevent the judgment of the fiduciary being swayed by self interest and the no profit rule is designed to strip the disloyal fiduciary of gains made by reason of his position or his misuse of company property or opportunity. In most instances, both rules will be relevant, as where a director exploits his fiduciary position or an opportunity presented or information learned in that capacity in breach of the no profit rule and the pursuit of that personal advantage places his personal interests in conflict with the company's interests. It has been suggested, on occasion, that only the no profit rule may apply, with Regal (Hastings) Ltd v Gulliver7 usually cited as an example.8 There the House of Lords accepted that the directors had acted bona fide in the interests of the company so, though they breached the no profit rule by profiting in the course of the execution of their duties as directors,9 there was no breach of the no conflict rule. Most recently, in Wilkinson v West Coast Capital,10 Warren J commented that it was “not an easy question” as to whether liability could arise independently of the no conflict rule where a profit is made in the course of and by reason of the fiduciary office.

2 As far as these fundamental no conflict and no profit rules are concerned, the key statutory provision is CA 2006 s 175 which provides as follows:

(1) A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company.[11]

(2) This applies in particular to the exploitation of any property, information or opportunity (and it is immaterial whether the

company could take advantage of the property, information or opportunity).

3 Other aspects of the no conflict rule are addressed in s 176 (duty not to accept benefits from third parties) and s 177 (duty to declare an interest in the proposed transaction or arrangement with the company) but the focus of this article is s 175.

II. Issues to be addressed

4 Here we will consider the nature of the obligations imposed by s 175 and, in particular, consider the relationship between a director's duty of disclosure and the no conflict rule; the extent to which the scope of a company's business is relevant to the application of the no conflict rule; and the implications of stating the no profit rule as a subset of the no conflict rule, as is done in s 175(2) above. All statutory references in this article are to the CA 2006 unless otherwise indicated.

III. The no conflict rule, old and new

5 As a starting point, we find that CA 2006 s 175(1) mirrors the famous expression of the no conflict rule by Lord Cranworth in Aberdeen Railway Co v Blaikie Bros12 in 1854 who stated that:

And it is a rule of universal application, that no one, having [fiduciary] duties to discharge shall be allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict with the interests of those whom he is bound to protect.

6 Given the very similar wording in s 175(1), clearly the intention is to continue to apply the no conflict rule as previously established.13 A director must avoid a situation of conflict or possible conflict because “human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect”.14 Once a conflict or possible conflict arises, the director's duty of undivided loyalty requires him, if he wishes to pursue the

opportunity personally, to communicate the information concerning the situation to the company, it being “information which it is relevant for the company to know”.15 Once the no conflict rule is engaged, it is irrelevant whether the company would, could, might, take the opportunity itself. It is for the company, as the beneficiary of the fiduciary duty, to decide how to proceed and, in particular, where the company does not wish to proceed, the company (ie, the shareholders and now the disinterested directors, see CA 2006 s 175(4)(b)) may decide to consent to the fiduciary exploiting the situation for his own benefit.16

7 One of the key modern decisions on the no conflict rule is Bhullar v BhullarUNK17 (“Bhullar”). Here two directors of a family company were held in breach of the no conflict rule when they acquired property adjacent to the company without telling the company that the property was available for purchase.18 They had come across the information that the property was for sale quite by chance and in circumstances which had nothing to do with their directorships. The company was a family business which was deadlocked and it had been agreed by the shareholders that the company would not acquire further properties; instead the intention was that the parties would go their separate ways but they had not actually taken any formal steps to bring that about.19 The court found that the directors' personal interest in acquiring the

land was in conflict with their duty to promote the company's interests which required them to communicate the existence of the opportunity to the company which could then have considered whether to acquire it. There was a real sensible possibility of conflict, the court said, and they were in breach of their duty when they acquired the property for themselves.

8 Two significant issues are highlighted by Bhullar. First, the breadth of the no conflict duty. A director can be in breach of the no conflict rule though he does not exploit his fiduciary position or information or opportunity acquired in that capacity. There is no need to show the exploitation of property “belonging” to the company – there is no proprietary element to it20– merely a need for a real sensible possibility of conflict and the fiduciary's exploitation of an opportunity in such circumstances.21 As the company is entitled to the undivided loyalty of its directors, the very act of a director putting himself in a position of conflict or possible conflict is a breach of duty, without more, as was explained in Quarter Master (UK) Ltd v Pyke:22

It is not because he has made a profit from trust property or a profit from his fiduciary position that the director is liable under the conflict rule. Rather, it is because, being in a fiduciary position, he has entered into a transaction, inconsistent with his fiduciary duty of loyalty to the company, which has yielded the profit and he has thereby misused his position. The opportunity to make the profit may not arise from the director's fiduciary position; he might just as well have had the opportunity if he had not been in that position but even so, his liability in respect of the profit arises because of the conflict of interest. In many cases, where the conflict rule applies, the director will also have taken advantage of the property of the company or of his fiduciary position but this will not always be so.

9 The second issue arising from Bhullar is this “duty” of the director to communicate the existence of the opportunity to the company. It is useful to address this complex issue first before returning to consider the breadth of the no conflict rule.

A. The duty of a director to disclose information

10 In Bhullar, Jonathan Parker LJ (with whom Brooke and Schiemann LJJ agreed) concluded that “the existence of the opportunity (to acquire the adjacent property) was information which it was

relevant for the company to know, and it follows that the appellants [directors] were under a duty to communicate it to the company”23 [emphasis added], applying Roskill J in Industrial Development Consultants Ltd v Cooley.24 This approach was developed, controversially, in Item Software (UK) Ltd v Fassihi25 (“Item Software”) by Arden LJ (with whom Holman and Mummery LJJ agreed) into a prescriptive obligation on a director to disclose his own misconduct to his company,26 not as a result of some free-standing duty of disclosure,27 but, as Arden LJ saw it, as part of the fundamental duty of loyalty to which a director is subject, that is the director's duty to act in what he in good faith considers to be the best interests of his company.28 The Court of Appeal held that the...

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