This is the fifth installment in the Year in Governance Series from the In-House Subcommittee of the ABA Business Law Section’s Corporate Governance Committee. Each month, the series will share key tips on a different corporate governance topic. To get involved in the Corporate Governance Committee, please visit the committee’s webpage.
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Conflicts of interest undermine a director’s duty of loyalty, erode trust and effective decision-making, and create litigation and enforcement risk. Directors should identify, disclose, and manage any conflicts of interest to maintain the integrity and effectiveness of a board. It is essential to meticulously document conflicts of interest and efforts to overcome these conflicts in order to protect both the company and its directors.
- Draft a conflicts of interest policy. Directors need to know the types of conflicts that could arise, such as direct and indirect financial conflicts, dual representation, corporate opportunity, confidentiality, and personal interest. Draft and circulate a comprehensive policy that describes what constitutes a conflict, establishes a disclosure protocol, and lays out procedures for managing conflicts. The policy should also explain what is considered a material conflict.
- Ask about conflicts, to facilitate disclosure. The director onboarding process will initially identify conflicts, but that is just the beginning. Directors should complete disclosure forms (typically D&O questionnaires) at least annually, and consider requiring directors to update their disclosures whenever their circumstances change.
- Talk about conflicts, to cultivate culture. If you talk regularly about the importance of early and fulsome disclosures, then you will help create a culture where directors identify potential conflicts before they become a problem. You can place a brief disclosure statement at the top of every meeting agenda, or just remind directors before each meeting of how important it is to disclose any material conflicts.
- Recuse conflicted directors. When there is a conflict—when a director’s interest could reasonably be expected to influence judgment—recuse that director, immediately. Exclude the director from deliberations (the meeting), decisions (the voting), and information (the minutes, although you can provide a redacted version). The minutes should reflect these efforts in order to record your compliance.
- Manage board communications to restrict access when necessary. After asking the director with a conflict of interest to leave the room, use the available technology to restrict the information shared with that director by monitoring what is placed on the director’s portal or revising access controls. If it is necessary to maintain confidentiality, consider using separate counsel and advisors. Make sure to consider the timing of disclosures to the full board after committee deliberations.
- When board independence is in doubt, consider forming a special committee. A special committee (made up of independent, disinterested directors) might be appropriate when, for example: multiple (or even a majority of) directors have conflicts; the transaction under consideration will be reviewed under the entire fairness doctrine; the board anticipates litigation related to the decision; or the proposed transaction involves a controlling shareholder. The special committee needs the authority to do its job properly, so it should be formed early, truly independent, and authorized to make decisions (including saying “no”). Keep in mind that the special committee may need separate counsel and advisors.
- Consider whether a special committee is worth the trouble. A special committee likely brings inherent challenges that require careful consideration. It is costly. It creates delay. And it may generate the perception that there is more concern than exists or is warranted. Unfortunately, that perception alone could lead to litigation rather than help avoid it. Consider whether recusal of the interested directors would adequately address the conflict.
- Address conflicts in related-party transactions. Related-party transactions bring higher scrutiny, as the standard of review examines both the process (i.e., “fair dealing”) and the economic terms (i.e., “fair price”). Using additional safeguards, such as approval from a special committee and a majority-of-the-minority vote, may help shift the burden of proof. You should also disclose all material facts, consider engaging third-party valuations or fairness opinions, and document the business rationale, among other things. Required disclosure of these transactions in Securities and Exchange Commission filings leaves them open to enhanced scrutiny.
- Guard corporate opportunities closely. A strong conflict of interest arises when a director diverts a corporate opportunity. To avoid this, draft and adopt a policy that defines the company’s “line of business,” establish a formal process to determine if an opportunity belongs to the corporation, and document when the company declines to pursue an opportunity.
- Leverage independent advisors. Use disinterested advisors to help a special committee, or the full board, to craft a rigorous process and establish fair-price credibility. Such advisors can be bankers, valuation experts, or outside counsel. Get them involved early in the process. It may be helpful to vet candidates beforehand so that you have a bench to draw from when the expected (or unexpected) time comes.
The views expressed in this article are solely those of the authors and not their respective employers, firms, or clients.
