Company governance - conflicts of interest for officers and members

Introduction

Being a director of a local authority controlled company requires officers appointed to those roles to operate in a completely different legal and philosophical framework to the one they are used to within their local authority. Companies bring entirely different, and sometimes potentially conflicting, governance requirements compared to the regime governing local government.

This can lead to real conflicts between the duty owed to the company and the interests of the council. It can also lead to conflicts of interest on a personal level which makes holding some roles in a local authority unviable whilst continuing as a director. These conflicts must be carefully managed to prevent problems arising for the individuals concerned and the bodies they represent.

It is recognised that, as companies have a separate legal personality from the council, the success and good governance of the company depends upon those involved understanding their roles and responsibilities both collectively and individually.

Officers appointed as directors of companies should ideally have prior experience in the role and be able to manage these different rules and requirements whilst still undertaking their primary duties and responsibilities. They must be able to balance their duties as employee of the authority with their duties when acting as a director of a council owned company.

Accordingly, governance arrangements should ensure that there is sufficient induction, training and other safeguards in place so that:

their legal duties;
the stewardship of assets;
the provisions of the governing documents;
the external environment; and
the total structure of the organisations and the venture
are appropriately understood by:
elected members (in their role as part of the Executive or Overview and Scrutiny);
officers associated with these duties; and
the directors of the companies.

Directors’ duties

Company director duties are codified in sections 171-177 of the Companies Act 2006:

Duty to act within powers: A director must act in accordance with the company’s constitution and must only exercise powers for their proper purpose.
Duty to promote the success of the company: A director must act in good faith and in a way that would be most likely to promote the success of the company for the benefit of its members as a whole.
Duty to exercise independent judgment: A director must exercise their own judgment, independent of the views of others on the board or elsewhere, e.g. the council. This duty does not prevent a director from taking advice but their own judgment must be used in deciding whether to follow the advice.
Duty to exercise reasonable care, skill and diligence.
Duty to avoid conflicts of interest: A director must avoid situations where there could be an interest that conflicts with the interests of the company, although the directors who are not conflicted may be able to authorise a director to continue to act despite there being a conflict.
Duty not to accept benefits from third parties: A director must not accept any benefit from a third party that is given due to their position as a director unless the benefit cannot reasonably be regarded as likely to cause a conflict of interest.
Duty to declare interest in a proposed transaction or arrangement: There is no duty to avoid interest in transactions or arrangements with the company. However, a director must disclose to the other directors the nature and extent of any interest in a proposed transaction or arrangement with the company, whether direct or indirect. Such a declaration must be made at a board meeting before the company enters into the transaction or arrangement and must be updated should the interest change. There is also a duty under section 182 of the Companies Act 2006 to declare any interest in an existing transaction or arrangement.

The consequences of a breach of these duties are that the company may seek an injunction, damages or compensation from its directors. Failure to disclose an interest in an existing transaction or arrangement with the company carries the risk of a criminal fine.

The duties may not be limited, waived or contracted out of, but companies may provide indemnity insurance to cover directors for costs in the event of a breach.

Directors’ responsibilities

When acting as director, an officer is obliged to act in the best interests of the company. As the Institute of Directors' Corporate Governance Guidance and Principles states:

"An important principle of company law is that directors have a duty to promote the success of the company as a whole. They are specifically prohibited from directing the activities of the company in favour of themselves or particular shareholders and/or stakeholders".

The most important point to bear in mind for local authority appointed directors is that although the council makes the initial nomination or appointment, after appointment the director holds office according to the constitution of the company.

Once an individual accepts an appointment as a director, they assume all the responsibilities of the role and their duty when acting as a director is to the company, not to their appointing council. They must therefore act in accordance with what they consider necessary to promote the success of the company.

It would, for example, be a breach of a director’s duty to the company to disclose confidential company information to their appointing council, even if it were relevant to something that the council was discussing. This applies both ways and it would be equally wrong to disclose confidential information belonging to a council to the company.

The duty towards the company only applies when the individual is acting in their capacity as a director. When acting in their role as a local authority officer, they must act in the best interests of the council, subject to the above point about confidentiality. It is therefore very important that directors have a clear understanding of ‘which hat they are wearing’ at any time.

A director should never be seen to use their position as a council officer to advocate for an outside organisation, because that would be putting the other organisation’s interests ahead of the council’s. This applies regardless of whether or not they were appointed by the council.

In circumstances where the interests of the company do not coincide with the interests of the council, both the directors of the company and the council could expose themselves to liability if they simply cause the company to do the council’s bidding.

All conflicts of interest must be entered on the company’s register of interests and disclosed to the board of directors. A failure to acknowledge and manage a conflict of interest could cause a significant reputational risk, may result in disqualification and have financial consequences for the director. Moreover, some conflicts can also have criminal implications.

Potential conflicts when acting as an officer

Conflicts of interest can be actual, potential or perceived:

Actual - there is a real conflict between duties and interests.
Potential - there could be conflict between duties and interests.
Perceived - a third party could form the view that there is a conflict between duties and interests.

The primary potential for conflict for officers who are appointed as directors when carrying out their work with the council is if they are involved in decision making processes in respect of the relevant company. For example, if a council service is considering awarding a contract to a council-owned company, and the Head of Service is a director of that company, a conflict may arise.

Council officers also have fiduciary duties to the council. Situations can inevitably arise where the same person will be a decision maker or advisor both for the council and one of its entities.

An officer can never waive their duty to act in the public interest in exercising their responsibility for functions of the council. This will occasionally, therefore, create an inescapable conflict of interest between someone’s role as an officer of the council and as a director of a company, of which those involved need to be aware.

The officers who would often be the most suitable appointments (based on their technical and professional knowledge of key areas of the activity of the company) are most likely to experience conflict or contact with the companies’ activity. The council should seek to manage the potential for such conflicts arising by avoiding, wherever possible, appointing officers who might frequently be conflicted as directors of the companies.

In order to be transparent about any potential conflicts, officers must comply with their employment contract and the Employee Code of Conduct and are required to disclose any interest or association with any council activity which could cause a potential conflict of interest. They particularly will have duties in relation to the confidentiality of council information, such as business or commercial information. Officers who are appointed as directors of council companies should therefore record this appointment as part of their employee declarations. Failure to do so could result in disciplinary action.

If there is a risk of a conflict of interest, the officer or member should not act for both the council and the company unless they agree that they are both seeking the same common objective.

All potential conflicts of interest should be referred to the council's Monitoring Officer for a decision about whether a conflict exists. In the event of a conflict of interest, the Monitoring Officer should operate an ‘ethical wall’ policy, whereby an information barrier is erected to prevent communication that could lead to the disclosure of information which is confidential to one organisation or the other.

Examples of areas where conflicts can arise include:

Individuals acting as representative for both the company and the council. For example, given that it is likely that certain decisions of the shareholder will require ratification by the Section 151 Officer, it is not considered good practice for a Section 151 Officer to hold a position with a council-owned company.
Holding a council role which involves potential oversight and scrutiny of the company, while also holding a position with the company. For example, a company board member who also holds a position on the council's Audit Committee would clearly be conflicted.
Holding a position as a company board member while having private financial or non-financial interests which may conflict or may be perceived to conflict with the role. For example, a company board member, or member of the family, having an interest in a supplier or competitor to the company board members receiving benefit (such as gifts and hospitality) from third parties (such as potential suppliers to the company).
The exploitation by a board member of any asset, information or opportunity related to the company.

Safeguards for officers appointed as directors

Where an officer is placed on a company board, they should be provided with an indemnity for their actions in that role under the Local Authorities (Indemnities for Members and Officers) Order 2004. It should be noted, however, that any such indemnity only covers actions taken honestly and in good faith.

Officers appointed as directors may find themselves in a position where they are, or are negatively seen to be, acting against the interest of the council and also challenging the council as their employers or senior managers to whom they might normally answer. As a result of such activities, their performance in the company or actions they feel are required of them by the company, those officers may find themselves in a position where it is no longer felt tenable for them to be appointed by the council as a director of a company. The council as an employer should recognise the unusual position in which such officers may find themselves. The council should therefore undertake that no officer will suffer any ill affect to their employment or career with the council for fulfilling these activities to the best of their ability or in undertaking these actions asked of them.

The remuneration of officers appointed directors to a company controlled or influenced by the council, other than permitted expenses, should be met by the council and not the company. This is because, whilst that director’s overriding duty is to the company, that person’s role as director on the company board is only because of, and in fulfilment of, their employment as an officer of the council, for which they are remunerated by the council under their contract of employment. The position on the company is an inherent part of their job, for which payment is not to be made twice, directly or by different persons, for the same work.

Officers should report back to the council on their involvement in outside entities to which they have been nominated by the council. This should involve making themselves available for scrutiny committees and other council governance forums which oversee the company (although they should not be obliged to disclose commercially confidential information about the company).

Appointments to the board should relate to the relevant post or office of the council, not to a specific individual. It follows that, if a council appointed director ceases to be an employee or office holder of the council, then they should automatically no longer be able to hold board membership.

Appointments should be based on a review of the skills, qualifications, diversity, and other attributes required for the role.

Before accepting any board member appointments, officers should ensure that they have:

Appropriate levels of relevant expertise, experience and training;
Sufficient time capacity to undertake the role effectively;
Sufficient authority to make decisions on the council's behalf.

The duty to avoid conflicts of interest will continue to apply after a person ceases to be a director as regards the exploitation of any property, information or opportunity of which he became aware when he was a director.

Specific issues for members appointed as directors

Councillors must ensure that they comply with the Member Code of Conduct. They particularly will have duties in relation to the confidentiality of council information, such as business or commercial information. Acting as a director of a company, their duties to the company may at times conflict with their duties as a councillor and vice versa. If they have any concerns about this then they should seek advice from the Monitoring Officer.

Being a director of a company, even one owned by the council, will be a personal interest and also likely a prejudicial interest under the Councillor Code of Conduct. If you are appointed as a company director, you must ensure that it is registered as an interest with the Monitoring Officer in accordance with the Code of Conduct.

This means that if a councillor is present at a meeting where an item of business arises which relates to or affects a company to which they have been appointed as a director, that councillor must declare the existence and the nature of the interest before the matter is discussed or as soon as it becomes apparent to them. Circumstances when the Code is engaged will include, as examples:

A planning application by the company is being considered;
Consideration is being given to awarding a contract to the company;
Consideration is being given to possible action to enforce the terms of a contract with the company; and
Funding for the company is being considered.

Where a councillor has a personal interest then they will also have a prejudicial interest in council business when the interest is one which a member of the public with knowledge of the relevant facts would reasonably regards as so significant that it is likely to prejudice that councillor's judgment of the public interest.

If the councillor has a prejudicial interest in a matter under discussion then they must declare it. They must then leave the meeting room, unless members of the public are allowed to make representations, answer questions or give evidence about the matter. If that is the case, the councillor can make their representations but must leave the room immediately after doing so.

Even if a councillor believes that they have no prejudicial interest, their duties as a director may well be regarded on an objective appraisal as giving rise to a legitimate perception of lack of impartiality, especially having regard to the desirability of maintaining public confidence. Participation in the decision making at a committee meeting by a councillor who is biased or has predetermined the decision potentially invalidates the decision.

Given the individual and collective responsibilities of Cabinet members, the likelihood of conflicts of interest arising is much greater than for other members and therefore it is not advised that they take appointments as directors of council-owned companies.

An aspect of the executive role undertaken by the Cabinet relates to the establishment and continuation of council companies, the commissioning of services from them and ensuring delivery and performance standards are met. In such circumstances, it would be very difficult to ensure that both the statutory requirements for directors and the Member Code of Conduct are not infringed.

Similarly, members who sit on Scrutiny or Audit Committees are not advised to take positions as directors of council companies, as it is very likely that this would impinge on their committee responsibilities given the roles such committees undertake.

Members interested in taking director positions with council companies should therefore consider how they could address any apparent tensions. Their options will include declining a directorship because of the importance they attribute to their committee roles, or seeking variations to their committee seats from their political group so that they can take up the directorship whilst mitigating the conflicts that arise.

Members will need to think about how their involvement with a council company will impact on their work as a ward members, particularly in areas that interest them, or where they need to represent the communities who elected them. This latter point will most likely be impacted where their constituents have issues that need to be addressed in relation to services received from a council company. In such circumstances, the member is not prevented by their directorship from raising the issue with the relevant officers of the council and the council company, provided this is done in the correct way and not such as to seek improper advantage being gained or otherwise contravening compliance requirements.

In addition to the general duties of directors under the Companies Act 2006, there are some other requirements that should be complied with where a member is a director of a council company:

Members should not receive remuneration as directors. However, expenses may be payable by the company but should not exceed the level of members expenses agreed by the council, and should be declared;
Members must provide information about their activities as required by the Council (unless it is confidential); and
Members should immediately cease to be directors if disqualified as a member of the Council (disqualification is no longer possible under the ethical standards regime but it remains a possibility in other circumstances).

The dual roles mean that members may have access to Council information that is not appropriate to disclose at the company board meetings and vice versa, in respect of commercially sensitive information that is available as a director. This heightens the need for members to be aware of the potential for conflicts of interest.

The Member Code of Conduct is clear as to the treatment of confidential information and any requirements of a company as to confidentiality must be observed. Furthermore, members are aware of the restrictions on the disclosure of exempt information. The Council and each of the companies are different legal entities and so members must not make the mistake of assuming that information they acquire in one setting can be disclosed in the other setting.

Conflicts of interest may be waived by a company but, as a matter of public law, never in the decision making of the council: the member/company director will always have a conflict of interest when it comes to their role as a councillor, which must be resolved and resolved in the favour of the company. A member as director, therefore, must not be a party to making a decision of the council affecting the company, but may proffer evidence or advice to the council on the company’s behalf when invited to do so.

When acting as a director, a member must exercise their judgment in the best interests of the company and cannot just take instructions from the council (although they may take account of the council’s wishes and other relevant considerations). Importantly, where the council’s wishes conflict with the best interests of the company, members must still act in the company’s best interests when acting as a director.

If the member is at a board meeting, they may communicate the views of the council as shareholder but must make it clear that this is being done. The member must make their own judgment and where the interests of the company and the council diverge, the member’s overriding duty is to the company, whilst acting as a director.

Abstaining from the debate and/or vote alone may not be sufficient to avoid conflict. The member may need to go one step further and withdraw from discussions at a board meeting.

The council may provide a specific indemnity for councillors who are appointed as directors.

Geoff Wild is a Legal and Governance Consultant.

In his first article, Governance of Council Companies, Geoff looked at how councils can strike the right balance between oversight and interference in the governance of council trading companies and joint ventures.