Companies and conflicts of interest

Freeths, Nottingham

Companies have long been a feature of the local authority scene. Back in the 1980s, they were often regarded as a ‘cunning wheeze’ and worth a whirl to try and get round irksome statutory restrictions.

But while this was not inevitably effective (since the acts of a local authority-controlled company could often at common law be imputed to its proprietor local authority), the government nevertheless stepped in to try and bring these beasts under some statutory regulation.

So was born part V of the Local Government and Housing Act 1989 and its subsequent offspring the Local Authorities (Companies) Order 1995 (S.I. 1995 No 849). These (among other things) regulate companies controlled by, or under the influence of, local authorities. But although for many years subject to prospective repeal (following the Local Government and Public Involvement in Health Act 2007) they still apparently remain alive, well – and on legislative ‘death row’.

For the purposes of the 1995 order, a ‘regulated company’ is a company controlled by, or under the influence of, a local authority and where, during any financial year, the authority exerts a ‘dominant influence’ over the company (in the company law sense). Alternatively (or in addition), if it were a company the authority would be required to prepare group accounts in respect of the company in question.

A controlled company (per section 68 of the 1989 act) is either a subsidiary of the authority (per section 1159 of the Companies Act 2006), or where the authority controls the majority of the votes at the company’s general meeting, or where the authority has power to appoint or remove a majority of the company directors. And, in a corporate hall of mirrors, a company is also controlled if it is under the control of another controlled company.

An influenced company (under section 69 of the 1989 act) is where a business relationship exists between authority and company. This is where the authority provides more than 50% of funds or value to the company and either at least: 20% of voting rights are held by those associated with the authority, 20% of the company’s directors are so associated, or 20% of total voting rights at directors’ meetings are held by people so associated. Associated persons are specified in section 69(6).

Part II of the 1995 order sets out the requirements for regulated companies. These include mentioning the regulated status on notepaper and other relevant documents, restrictions on director remuneration, and provision of information to the authority’s members and auditor.

Invisible hazards

All this is of course a well-integrated part of the local authority landscape. However, conflicts of interest can sometimes present hazards invisible to the unwary. They can arise in particular when council officers or members are appointed by their authorities, or are otherwise asked to become directors of council-related companies.

On the face of it, the nature of conflicts of interest should be straightforward. They exist where a person has conflicting duties to two or more other persons. Faced with such a situation, someone experiencing a substantive conflict must remove it by not taking part in the activity giving rise to that conflict. If s/he fails or is unable to do so, then that person is in breach of that duty – which may have professional, legal or even criminal consequences.

Solicitors will be well familiar with this professional duty, enshrined as it is in their Code of Conduct. This provides that a solicitor can never act where there is a conflict, or a significant risk of conflict, between the solicitor and their client. So, among other things, solicitors are expected to have effective systems and controls in place to enable them to identify and assess potential conflicts of interest and take appropriate action accordingly.

In the local authority situation, the Local Authorities (Executive Arrangements) (Meetings and Access to Information) (England) Regulations 2012 (S.I. 2012 No. 2089) require that any declared conflict of interest in an executive decision be recorded as specified together with a note of dispensation granted by the head of paid service.

As to companies, councils will often appoint their nominees as directors of companies in which their authorities are involved to ‘look after’ the authority’s interests and report back accordingly. There is clear potential for conflict here. While local authorities themselves have a fiduciary duty to their contributories, arguably their officers and members have an analogous duty to act in the best interests of their authority and the public interest generally. This is also enshrined in the seven principles of public life, namely: selflessness, integrity, objectivity, accountability, openness, honesty and leadership. The principles are amplified in the pages of the Committee on Standards in Public Life on the Gov.uk website.

However, company directors also have their own range of fiduciary and other duties. These are specifically detailed in part 10A of the Companies Act 2006 (sections 171-177). As noted by the January 2016 Cabinet Office publication Guidance for Directors of Companies Fully or Partly Owned by the Public Sector, in summary terms these are directors’ duties to:

• act within powers in accordance with the company’s constitution and to use those powers only for the purposes for which they were conferred;
• promote the success of the company for the benefit of its members as a whole;
• exercise independent judgement;
• exercise reasonable care, skill and diligence;
• avoid conflicts, or possible conflicts, between interests as a director and the interests of the company;
• not accept benefits from third parties, if they may be regarded as likely to give rise to a conflict of interest; and
• declare any direct or indirect interest in a proposed transaction or arrangement.

Section 175 deals specifically with directors’ conflicts of interest. In particular, this provides (at section 175(1)) that 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’. And by section 175(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)’. Furthermore, (by section 170 of the 2006 act) when a person ceases to be a director that person remains subject to the conflict of interest duty ‘as regards the exploitation of any property, information or opportunity of which he became aware at a time when he was a director’.

If a director breaches any of these duties, section 178(1) provides that the consequences are ‘the same as would apply if the corresponding common law rule or equitable principle applied’. These duties are regarded as fiduciary. For section 178(2) states that (apart from the duty to exercise reasonable skill, care and diligence) these duties are ‘enforceable in the same way as any other fiduciary duty owed to a company by its directors’.

Local authority nominee directors therefore have a duty (at appointment and otherwise) to properly identify, manage and address any potential conflicts of interest. As Cabinet Office guidance indicates: ‘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.’ It warns that ‘some conflicts can also have criminal implications’.

Therefore, local authority company directors will need at all times to remain alert to such conflicts, and when any potentially arise ensure that they take appropriate legal and other advice.

© Nicholas Dobson, October 2015. Nicholas Dobson is a Consultant with Freeths LLP
specialising in local and public law. He is also Communications Officer for Lawyers in Local Government.

This article was first published in the Law Society Gazette on 2nd May 2016.

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