Directors and officers (D&Os) of corporations must avoid situations where their personal interests conflict with the corporation’s best interests. This avoidance of conflicts of interest is part of their fiduciary duty to the corporation.
Any failure of a director or officer to disclose and avoid a conflict of interest can have significant legal and non-legal implications for the business, the director or officer and the Board so it’s critical that conflicts of interest be declared and properly managed at all times. Unfortunately, the identification of a conflict of interest and its proper management does not always come easily. D&Os don’t always receive the proper training on the identification of conflicts and Chairs, who are often depended on to react to a conflict declaration, aren’t always well-positioned to do so.
This is the first in a series of articles that will provide guidance on the proper management of D&O conflicts of interest.
When to declare a conflict of interest?
The law around D&O conflicts of interest can be complex. While I generally try to avoid introducing legalese in my articles, the following excerpt from the seminal Supreme Court of Canada decision, Canadian Aero Service v. O’Malley et al [1974] 1 S.C.R. 592 helps to illustrate the complexity:
“(t)he general standards of loyalty, good faith and avoidance of a conflict of duty and self-interest to which the conduct of a director or senior officer must conform, must be tested in each case by many factors which it would be reckless to attempt to enumerate exhaustively. Among them are the factors of position or office held, the nature of the corporate opportunity, its ripeness, its specificness and the director’s or managerial officer’s relation to it, the amount of knowledge possessed, the circumstances in which it was obtained and whether it was special or, indeed, even private, the factor of time in the continuation of fiduciary duty where the alleged breach occurs after termination of the relationship with the company, and the circumstances under which the relationship was terminated, that is whether by retirement or resignation or discharge“
As you can see, determining whether someone has a duty and whether there is an actionable conflict may not be straightforward. Generally speaking, D&Os are expected to declare any actual, potential or apparent conflict of interest. Having to declare an apparent or potential conflict of interest may sound overly broad but this is now a generally accepted threshold that triggers an obligation to declare a conflict.
Legal implications of failing to declare or to properly manage a conflict
Legal actions commonly at the root of matters involving conflicts are when decision-makers approve entering into contracts in which they, a relative, or a company they own, have an interest. Complainants taking issue with a decision-maker’s personal interest in the contract will ask the court to declare the contract void and the decision-maker may also be ordered to repay any gains received in connection with the contract.
D&Os appointed to serve on Crown corporations or other public bodies could also be subject to sanctions under federal, provincial and municipal conflict of interest legislation, which may include the payment of fines.
Non-legal implications
The non-legal implications of failing to properly declare and manage a conflict of interest are just as important. Examples of non-legal implications include damage to the corporate brand and loss of reputation. A failure to properly manage a conflict can also lead to loss of employee and stakeholder confidence in the Board and senior management which can seriously impair the Board and management’s ability to manage the corporation.
How do you “properly manage” conflicts of interest?
In light of the significant consequences around conflicts of interest, organizations should implement effective conflict management programs and ensure conflicts are properly handled.
This can be accomplished with the following:
- Establish a Conflict of Interest Code
- Provide training to D&O’s to help them identify and manage conflicts of interest
- Have D&O’s sign an Annual Conflict of Interest Statement
- Encourage early and “in-meeting” conflict of interest disclosures
In my next post, I’ll provide a basic checklist for writing a Conflict of Interest Code with various factors that need to be considered. The last post in this three-part series will cover the training, conflict of interest statement, and disclosures that will help corporations manage the conflicts of interest of directors and officers.
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This is the first post in a three-part series on Director & Officer Conflicts of Interest:
Part 1: Managing Director & Officer Conflicts of Interest
Part 2: Establishing a D&O Conflict of Interest Code
Part 3: Building a Culture of Ethics and Integrity with D&O’s
This post was originally published on the RIZEN Business Lawyers Alliance blog.
