How to Manage Board of Directors’ Conflict of Interest

Directors take on a fiduciary duty as a result of their position in a company and this obligation to act in the best interests of the organisation and its stakeholders means that their actions are scrutinised closely. Across Europe, jurisdictions have laws in place to guide directors towards good corporate governance, including board of directors’ conflict of interest requirements.

Examples include:

In Spain, Article 228 of the Corporate Enterprises Act 2015 states that board members must adopt “the necessary measures to avoid situations arising in which their interests, whether their own or of another party, may enter into conflict with the company’s interests and their duties to the company.”

Section 107 of Germany’s Stock Corporation Act requires that board of supervisors should ensure “the majority of the committee’s members must be persons regarding whom there are no concerns regarding a conflict of interest due to their relationship with a related party.”

An actual or perceived conflict of interest on behalf of a board member can be damaging to the reputation of the company in the eyes of shareholders, clients, regulators and other stakeholders. They can lead to regulatory sanctions and even criminal prosecutions, which is why organisations must ensure there are processes in place to identify, monitor and mitigate conflicts.

Holding directors accountable in this regard sets the tone from the top for the organisation and can help create a culture of compliance within the company. This article explores the types of conflicts you may find on a board and a procedure to manage those conflicts.

1. Types of conflict of interest on the board

Type	Explanation
Self-dealing	Where executive or independent directors stand to make a personal gain from the board’s decision-making. For example, where a director has a stake in a company that supplies goods and is part of a procurement process for a contract from the company on which they hold a directorship. Their personal financial interests could influence the way they vote on the board, meaning they vote for the option that might not necessarily be the best solution for the company seeking vendors.
Related party transactions	Where a director is split between their duty to the organisation and their connection to a friend, family member or other person closely associated with them. This could involve the awarding of a contract, recruitment of a related party, promotion for a close associate or any other example of a director’s decisions being influenced by their personal connections.
Perceived conflicts	These conflicts occur when there is a perception of bias or conflict, even if no actual conflict exists. For instance, a director's close relationship with key stakeholders could lead to suspicions of bias. It is important for directors to be aware of how their actions might be perceived by others to maintain trust and integrity relating to the company’s reputation.
Structural conflicts	These are conflicts that exist within the governance structure itself. For example, individuals holding dual roles such as chief executives who also serve as the board chair can create conflicts. As chair, they would have a vote on their own CEO compensation, which would make it difficult to act impartially.

2. How to identify board of directors’ conflict of interest

2.1 Create a policy and process

The first step towards managing your board directors’ conflicts of interest is to formalise your approach to dealing with them and setting in place requirements and procedures for board members regarding them.

A conflict of interest policy should set out to whom it applies and clearly define what you mean by ‘conflicts of interest’. It should also illustrate the potential impact of an unchecked conflict, set out requirements for your directors in terms of disclosure and outline the consequences for non-compliance.

You might want to oblige your directors to disclose their outside interests on an annual basis and compel them to update the register of interests if anything changes, such as taking up a new role. Inform them of the process to do so and the time frame in which they should make this disclosure.

Make sure the policy covers both pecuniary (financial) and non-pecuniary interests so that you cover all occurrences by which the company could be affected by a director with a conflict of interest.

2.2 Monitor for conflicts

You should have in place systems to monitor for conflicts of interest. This means keeping track of the financial disclosures of your board members. For example, if you have a pre-clearance system in place for employees’ personal trades, you will have a record of the companies in which they are invested. If, for example, one of the organisations in which they own a stake comes into contention for a tender from your business, your monitoring will show this to be a conflict of interest.

Use conflict of interest software like TradeLog to automate this process. The platform holds the outside business activities and interests of your board directors, comparing them with your client and vendor lists to spot potential conflicts of interest. This improved transparency provides an early warning that allows you to take action before the conflict causes problems.

Other monitoring methods include analysing the patterns of decision-making by the board. If there seems to be undue bias towards a particular topic or business, it is advisable to check in with the director about their affiliations.

Make sure you regularly audit and assess the accuracy of your conflict monitoring. Also, implement whistleblowing channels to allow for easy, confidential reporting of conflicts of interest that directors witness or suspect in their colleagues.

2.3 Manage conflicts

Conflicts of interest do arise in the business world and how companies manage them is of utmost importance for minimising their impact. On a board of directors, where there is a conflict of interest, the first step is to have the board decide whether it believes the conflict is materially impactful on the ability of the directors to carry out their duties.

If the directors agree that the conflict of interest would have an impact on its fiduciary duties, the board must take one of the following options:

Restricting the director's involvement in motions relating to the area in which there is a conflict. This might mean that they are permitted to discuss the topic – having declared their interest – but not to vote on it.

Removing the director from both the discussion and decision-making process, having them recuse themselves from connected motions at a board meeting.

Appointing independent directors to oversee the matter in the boardroom.

Recommending the director relinquishes the conflicting interest. If they refuse to do so, the next step would be to request their resignation from the board.

However you choose to manage the conflict of interest, record the reasons in the meeting minutes to show how the decision was made. This will help in the case of a potential investigation in the future, showing that the business understood and took steps to mitigate the effects of the conflict of interest.

2.4 Prevent future conflicts of interest

There are steps you can take to prevent conflicts of interest occurring on your board. Here are some examples:

Ensure that your conflict of interest policy and procedures are part of the onboarding process for new directors. Add the information they need to their board orientation pack to demonstrate the importance you place on eliminating conflicts of interest.

Provide comprehensive training to directors on what constitutes a conflict of interest, how to spot it and how to declare it. Remind them of their duty of loyalty to the business.

Conduct due diligence before approving major contracts and transactions to ensure that the processes and decision-making have been conducted in a fair and unbiased manner.

Cultivate a culture of transparency, openness and integrity where the directors lead the drive to prioritise the company’s interests over personal interests in accordance with good corporate governance.

It is a wise decision to create a reporting process and database for declaring gifts and corporate hospitality to help with monitoring of potential conflicts and avoiding corporate governance issues.

3. Early signs of potential conflicts

Unusual decision-making trends, which could suggest that a director or directors are showing favour to certain outcomes. Investigate further to discover whether these are indeed due to conflicts of interest or if there is a legitimate reason for the decisions.

Sudden policy changes from the board might be as a result of members bending the company’s strategy to a more advantageous route for their own interests. The meeting minutes should provide background to legitimate reasons for this shift, if they exist.

Inconsistent financial disclosures by board directors could suggest that they are hiding certain interests that might lead to a financial gain in conflict with the interests of the business.

Personal relationships with vendors could make it difficult for directors to make decisions in the best interests of the company, if they are detrimental to their friend or family member. In this case, they should withdraw themselves from business related to this vendor.

Frequent private meetings, particularly with vendors, suppliers or competitors might be a sign that there is a potentially problematic relationship. In this case, it is advisable to remind the director of their obligations to avoid or declare conflicts of interest.

4. FAQ

4.1 What constitutes a conflict of interest for a board member?

A conflict of interest for executive or independent directors arises when their personal or financial interests could improperly influence their judgement, decisions or actions in their official capacity. This includes situations such as having a significant financial stake in a company that competes with the organisation or having familial relationships that could impact on their impartiality.

4.2 Why is it important to address conflict of interest?

Board member conflicts of interest can result in suboptimal decision-making for the business as well as acting in a way that the business or its clients lose financially or otherwise. There can be regulatory, criminal measures and other legal actions taken and companies can suffer from reputational damage. An ethical board with a duty of loyalty to the business presents a better impression of the organisation to the outside world.

4.3 What is the role of the board chair in managing conflicts?

The chair should ensure that all directors on the board of supervisors understand their obligations regarding conflicts of interest. This includes reminding them to declare any conflicts and ensuring those board members with a conflict of interest do not take part in discussions and voting on topics for which they might not be able to guarantee impartiality.

4.4 How can shareholders influence conflict of interest policies?

Responsible shareholders can influence conflict of interest policies by voting on governance practices, proposing resolutions and demanding greater transparency and accountability from the board. They can also engage in active dialogue with the board to ensure that there are robust policies in place for corrective action and that they are effectively implemented.

4.5 What should a board member do if they find themselves in a conflict of interest?

At a board level, individual directors should promptly disclose the conflict to the chair or governance committee in the manner set out in the conflict of interest policy. They must also step back from any board meeting discussions or decisions related to the matter to ensure impartiality and protect the integrity of the board’s decisions.

5. Conclusion

To manage a board of directors’ conflict of interest, you should put in place a policy that sets out what a conflict of interest is, why it can be detrimental and what to do if board members find themselves with a conflict of interest. You should also set in place monitoring to be able to identify and manage conflicts of interest early and before they cause damage to the business.

Use TradeLog to highlight any conflicts of interest relating to your directors. It matches their outside interests to the list of vendors and clients, alerting you to any potential issues. You can then deal with the situation accordingly. Request a demo of TradeLog today.