New Law Relating To Conflicts Of Loyalty Pursuant To The Companies Act 2006

The Companies Act 2006 ("the 2006 Act"), the final provisions of which came into force on 1 October 2009, has changed the way in which directors of charitable companies and directors of charity trading subsidiaries must deal with a particular type of conflict of interest – generally referred to as a conflict of loyalty.

A conflict of loyalty will occur, for example, where a person is (a) both a director of a charity and a director of the charity's trading subsidiary or (b) a director of two charities which have a contractual relationship – ie there is a landlord/lessee relationship or one charity makes grants to the other.

Duty to avoid conflicts of interest (sections 175 and 181 of the 2006 Act)

Section 175, as modified pursuant to section 181 in relation to charitable companies, provides that a director of a charitable company must avoid a situation in which he/she has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of his/her charity.

The reference in the 2006 Act to "indirect interest" is interpreted as including an interest of those connected to a director (eg members of a director's family and companies controlled by a director). Consequently, any relevant interests of those connected to a director will also need to be addressed.

The duty to avoid conflicts of interest is not, however, infringed in certain situations as set out in section 175. One of these is that in the case of a conflict of loyalty the conflict is, subject to certain conditions, authorised by the directors.

For the sake of completeness, we should add that the legal position regarding conflicts of interest arising from transactions/arrangements between a director (or a connected person) and his/her charity or the charity's trading subsidiary where a personal benefit will be derived (eg payment of rent for use by the charity of a director's property or payment to a director for services or goods provided to the charity/trading subsidiary) remains the same. Here, all such benefits must be authorised by the charity's governing document or by the Charity Commission (or by virtue of the provisions of section 73A of the Charities Act 1993 regarding payment for services provided to the charity).

The practical consequences of the new law

Before the implementation of section 175 of the 2006 Act, when a conflict of loyalty arose it was acceptable practice for directors to vote on a matter on which they had such a conflict but to remember "which hat they were wearing" when making decisions on behalf of the relevant organisation.

However, pursuant to the 2006 Act, where directors have a conflict of loyalty they must now either (a) abstain from voting on the relevant matter, provided that there are sufficient directors who are not...