Can directors' conflicts of interest be ignored if a company is performing well?
Federal Court of Australia considered extent to which directors’ conflicts of interest can impact upon their effective and lawful decision-making for their companies
Conflicts of interest of company directors are generally regarded as inconsistent with good corporate governance. They leave the company and the directors exposed to claims of breach of duty and oppression of shareholders.
In the recent court decision in RBC Investor Services Australia Nominees Pty Limited v Brickworks Limited  FCA 756 the Federal Court of Australia considered, among other things, the extent to which directors’ conflicts of interest can impact upon their effective and lawful decision-making for their companies and can cause company actions to be oppressive to shareholders.
Interestingly, although being satisfied that the directors in question had actual or potential conflicts of interests, in its written judgement, the Court referred to the following gratuitous remark from Crikey regarding the companies in question:
“Shareholders are sniggering all the way to the bank – they enjoy regular dividends”
The Court essentially came to the view that shareholders in the two companies involved had little to complain about in respect of their conflicted directors, given the well performing boards and profitability of their companies.
In the context of rising community and legal expectations regarding corporate governance, this article discusses this case and what it means for directors who have actual or potential conflicts of interest.
Conflicts of interest
There is no express legal prohibition upon directors having fully transparent conflicts of interest per se. Having a fully disclosed conflict of interest does not, of itself, result in a breach of law.
However, there are specific notice requirements and voting restrictions where a director of a public company has a material personal interest, such as when a director would personally benefit from a transaction with the company (see sections 191 – 195 of the Corporations Act 2001).
There may also be specific restrictions and requirements contained in a company’s constitution.
But where the conflict is between two competing duties owed by a director and does not involve a material personal interest of the director, or is not otherwise regulated by the company’s constitution, the legal issues around directors’ conflicts of interest come to be examined under the law relating to directors’ duties.
In general terms, directors have statutory duties (among others) to:
- exercise their powers and discharge their duties with care and diligence (s. 180 of the Corporations Act 2001)
- exercise their powers and discharge their duties in the best interest of the corporation and for proper purposes (s. 181 of the Corporations Act 2001)
- not improperly use their position to gain advantage for themselves or someone else, or cause detriment to the company (s. 182 of the Corporations Act 2001)
- not improperly use information gained as a director to gain advantage for themselves or someone else, or cause detriment to the company (s. 183 of the Corporations Act 2001).
It can constitute an offence if directors breach those obligations recklessly or intentionally dishonestly (s. 184 of the Corporations Act 2001).
In addition to those statutory duties, directors have an overlapping fiduciary duty to act in the best interests of their company and to avoid undisclosed conflicts of interest. This means that in making decisions for the company, directors are required, among other things, to put the company’s interests ahead of their own personal interests or the interest of third parties. Directors cannot allow their own personal circumstances or competing obligations to influence their decision-making.
Directors often hold multiple board positions with different companies, even companies in direct competition with each other. Directors also often have shareholdings in their companies (as a very general rule of thumb, shareholdings of less than 5% are unlikely to constitute a material personal interest) .
This gives rise to inherent conflicts of interest for directors. Their duty to act in the best interests of one company may conflict with their duty to act in the best interest of another company of which they are a director. They may also have conflicting personal interests as small shareholders of those companies even if they do not stand to obtain a material personal benefit from the matter they are voting on.
The question is – how can a director comply with his or her director’s duties and act in the best interests of different companies where the companies’ interests are not completely aligned and a decision by one board may have detrimental effects upon the other company of which the director is also a director and/or a small shareholder?
This has been a vexed practical and legal issue since companies were first established in the 19th century. In modern times, successive cases and legislative intervention seem to be inexorably elevating the standards to which directors will be held.
Therefore, directors who have conflicts of interest and who make decisions that disadvantage a particular class of shareholders, are at risk of a claim by their company (often through a shareholder derivative action or by a liquidator) for breach of their directors’ duties, and place the company at risk of shareholder oppression proceedings brought by disgruntled shareholders under s. 232 of the Corporations Act 2001.
However, the Brickworks case confirms that directors can have actual or potential conflicts of interest but also participate effectively and lawfully on the boards of which they are members in some circumstances.
Since the 1960s, the ASX listed companies Washington H Soul Pattinson and Company Limited (Soul Pattison) and Brickworks Limited (Brickworks) have held substantial cross holdings now at levels approaching 45 percent. The boards and shareholder registers of each company are dominated by members of the Millner family and their close associates.
This has not only provided those companies with a measure of protection from potential takeovers, but has meant that by having board members on both boards, the Millner family has been able to maintain effective control of the two companies.
The cross shareholdings are certainly very unusual in modern times. The cross-shareholding arrangements between Brickworks and Soul Pattinson would not now be able to be introduced, due to prohibitions in the Corporations Act 2001. However, the cross-shareholding structure between Soul Pattinson and Brickworks pre-dated the introduction of the statutory prohibition, which meant those companies were permitted to continue with the structure without having to unwind it.
For some years now, institutional investor Perpetual Investment Management Limited (Perpetual) has been on the register of both Soul Pattinson and Brickworks. For most of that time, Perpetual has also been lobbying the companies to unwind the cross shareholdings and open up their boards, which Perpetual regarded as depressing the value of both companies.
The companies did not adopt any of the proposals put forward by Perpetual, so Perpetual sought the intervention of the Federal Court to force the unwinding of the cross shareholding.
Perpetual made its claim under s. 232 of the Corporations Act 2001 as a shareholder oppression action. Perpetual claimed the cross shareholding disenfranchised minority shareholders (such as Perpetual), entrenched the control of the Millner family, which ultimately had a negative effect on the value of both companies and depressed the price of shares in each company. Perpetual claimed this was oppressive or unfairly prejudicial to it.
What the court said about conflicts of interest of directors of Soul Pattinson and Brickworks
Among many aspects of the cross shareholdings that Perpetual complained about, a particular complaint was a number of directors on both boards were put in actual or potential conflicts of interest because they were directors of both boards and/or had shareholdings in the companies.
It was said that this prevented them from acting in the best interests of both companies. Perpetual said this was one of the reasons the conduct of the companies’ affairs was oppressive and unfairly prejudicial.
The Federal Court was happy to accept that many of the directors of the companies had real or potential conflicts of interest. The Federal Court was also of the view such conflicts are generally undesirable as a matter of good corporate governance.
However, among reasons why the Federal Court was not troubled by conflicts of interest caused by the cross shareholding, was the apparent fact the boards of both companies had performed well and the companies were profitable. Relevantly, the Court made the following comments regarding shareholder oppression and directors’ conflicts of interest:
- The touchstone of oppression is that conduct be so unfair that reasonable directors who consider the matter would not have thought the conduct or decision fair. This is designed to reinforce the fact that the role of the Court is not to step into the shoes of the directors and unilaterally decide what it thinks to be in the best interests of the company as a whole. The Courts recognise it is the responsibility of the directors to weigh the competing considerations with which they will be routinely confronted and determine what is in the best interests of the company as whole. They recognise also that, as the task of the directors is to evaluate, it is necessarily one about which reasonable minds may differ. In performing its own evaluation, accordingly, the Courts do not merely substitute what appears to them to be the preferable commercial decision.
- The Millner family is represented on both boards and thus the cross shareholding facilitates their retention on both boards as it does the retention of all directors. There is also increased potential for perceived and actual conflicts of interest of various kinds as a result.
- Moreover, the management and boards of both companies are aware of the potential conflicts of interest involved in the cross shareholding and the corporate governance dynamics to which it gives rise. Both boards must be taken to be aware of the effect of the cross shareholding on corporate governance, including the risks of conflicts of interest.
- In terms of corporate governance implications, if the boards are perceived to be performing well, this could be characterised as a positive attribute of the cross shareholding by facilitating stability and thus decision-making with a view to longer term benefits.
- The consensus appears to be both boards have performed well and both companies are well-managed, lending weight to the perception that the fully transparent cross shareholding, to date, has facilitated stability and a capacity for long term decision-making.
- If the cross shareholding had resulted in any adverse consequences, such as retention of a poorly performing board or a poor decision affected by a conflict of interest or an improvident transaction, then the directors may have something to explain.
- The directors of each company have diligently considered the structure of the companies with their obligations to act in the best interests of the company firmly in mind.
- There is good reason to infer the directors of each company are committed to continuing to consider the structuring issues with their obligations to act in the best interests of the company firmly in mind.
- Weighing all of the circumstances, reasonable directors would not consider maintenance of the cross shareholding to date to be unfair or oppressive. It does not disenfranchise minority shareholders.
What can we learn from this case and existing principles?
- Directors may have transparent and fully disclosed conflicts of interest it is not unlawful or problematic per se except that there are specific disclosure and voting restrictions that apply when a director of a public company has a material personal interest in a transaction with the company.
- Some circumstances that give rise to the potential for conflicts of interest for directors can be beneficial by facilitating stability and providing a capacity for long term decision-making and good company performance.
- Directors are often still able to make decisions in the best interests of their companies even if they are conflicted.
- If a company is well managed, the board is performing well and the shareholders are benefiting from good profitability, then it is less likely that a director will be (legally) called on to explain or justify their actions.
- If a company is performing poorly or the board is not able to function effectively, then the conduct of directors with conflicts of interest will inevitably be heavily scrutinised and there is a greater chance of a court finding a breach of director’s duty, or that the company has engaged in oppressive conduct.
- Directors are held to high standards. Where they have actual or potential conflicts of interests, they will need to be vigilant to ensure that they act in the best interests of their company. They may be able to do so even if they are conflicted.
- If there is any doubt about whether a director can act in the best interests of a company due to conflicting obligations or interests, then they should not participate in the decision in question. That means not being involved in the deliberations or the actual voting.
- In some circumstances, it may be necessary for conflicted directors to go further than withdrawing from the decision-making process in question. They may have a positive obligation to disclose confidential information to the other directors in some circumstances.
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