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The Concept of Conflict of Interest Revisited

06-15-2016 09:44 AM CET | Business, Economy, Finances, Banking & Insurance

Press release from: Eastbirds

A comprehensive reform of the Luxembourg Company Act (and associated legislation) will soon be completed. The legislative process started in early 2007 (Bill N° 5730) with a structural modernization as its main objective.
Of note is the government’s express commitment to remaining faithful to the guiding principles of the original 1915 Company Act, to wit: (1) contractual freedom and (2) third party protection.
This difficult balancing act also applies to the concept of conflict of interest. Board members would be well advised to have a close look at the proposed new wording of Article 57.

Article 57 Amended

Assuming Bill N° 5730 is voted in the format containing the most recent amendments of the Committee on Legal Affairs, the amended Article 57 of the Company Act will read as follows:
“Any director having, directly or indirectly, a financial interest in a transaction to be decided by the board of directors conflicting with that of the company, shall be obliged to advise the board thereof and to cause a record of such statement to be included in the minutes of the meeting. He may not take part in the deliberations.
At the next following general meeting, before any other resolution is put to vote, a special report shall be made on any transactions in which any of the directors may have had an interest conflicting with that of the company.
By derogation of the first paragraph, where the company comprises a single director, transactions made between the company and its director having an interest conflicting with that of the company are only mentioned in the decisions register.
When, due to a conflict of interest, the statutory required number of directors to deliberate and vote on the relevant item is not met, the board of directors may, unless the articles of association provide otherwise, decide to refer the decision on this item to the general meeting of shareholders.
The preceding paragraphs shall not apply where the decision of the board of directors or the single director relates to day-to-day operations entered into under normal conditions.”
So What’s the Fuss?
It is important to note that the original text of the proposed reform was much more intrusive than what the Committee on Legal Affairs has finally tabled at the end of March 2016. The proposed invalidity action against decisions taken in violation Article 57 has, for instance, not survived. And rightfully so: this type of provision would only be a source of litigation and insecurity while the purpose of the legislative initiative was indeed to keep things simple and to remain faithful to the guiding principles of the original 1915 Company Act.
On the other hand, the argument “that the absence of case law indicates that the current legal provision raises no problems of application in practice”, is misleading. There are many situations where members of the board would have welcomed some more guidance. Furthermore, the legal practice has evolved (single director companies, management committees, etc.) and certain clarifications or a fine-tuning of the applicable legal provisions are therefore no luxury.

Things to Watch Out For

Several situations will require particular attention of board members.
• As a reminder, there is no conflict of interest where the decision (or the transaction) of the board of directors or the single director relates to day-to-day operations entered into under normal conditions. Jurisprudence and legal authors will further specify the concepts of “day-to-day operations” and “normal conditions”. As guiding principles, directors could take into consideration (i) the ordinary business of the company, (ii) the general arms’ length principles and (iii) the relative importance of the matter.
• A first important change to be introduced under the amended rules is that the director’s interest must be of a “financial” nature. While certain authors have already interpreted the existing law in that sense, it is now officially clarified. Purely “moral” interests must not be taken into consideration. This is clearly a restriction of the concept of conflict of interest. Moral interests (from the perspective of the director) can, however, conflict with the corporate interest and have financial or other adverse consequences for the company. Historically the concept of conflict of interest had a broad and general meaning. The proposed amendment now introduces a limitation by excluding non-financial interests.
• As a second change, the concept of conflict of interest is formally extended to both “direct” and “indirect” conflicts. This is also nothing more than a clarification of the existing situation and a confirmation of legal doctrine. Some have criticized the vagueness of the term “indirect”. It will be up to the judges and legal authors to further elaborate and interpret this concept. In the meantime, directors should be warned.
• Directly linked to the two previous bullet points, is the question of potential conflict of interest for a person that is member of both board of directors of two contracting companies. For many years these multiple directorships have caused important discussions. Is there a functional conflict only or is there a potential conflict of a financial nature as well? The factual situation can be extremely complex and it is therefore difficult to address this matter by legislative way. A principle-based solution could, however, be worked out in practice on the basis of the existing provisions taking into consideration the following concepts: indirect interest, financial nature, day-to-day operations and normal conditions.
• It seems that Article 57 does not tend to catch intra-group transactions. This is probably a consequence of the fact that the initiative for the present legislative change has been taken a decade ago when transparency and profit shifting where not that high on the political agenda.
• Non-directors such as members of the executive committee (comité de direction), executive officers, and specially delegated persons (fondé de pouvoir) are still not formally concerned by conflicts of interest. This is surprising, given that the present Bill does extend the liability provisions of Article 59 (directors’ liability) to the CEO and members of the executive committee. Also here the winds of transparency should have opened the concept of conflict of interest to such executives.
• Conflicted directors “may not take part in the deliberations”. But what about voting? The revamping of the law would have been the perfect occasion to clarify the situation and to add the words “and the vote”. Indeed, while certain legal authors confirm that this is (a fortiori) the case under the existing legislation, it would have been useful to formalize this prohibition. Moreover, in its 4th paragraph the same article explicitly mentions, “to deliberate and vote”.

Conclusions

It is clear that the existing provisions governing conflicts of interest are not that bad after all. The proposed changes are therefore limited. On the other hand, it remains useful to review these provisions and adapt or update them in accordance to a changing legal and business environment. Notwithstanding some minor criticisms, we must admit that in matters of conflict of interest, the proposed new provision indeed remains faithful to the guiding principles of the original 1915 Company Act, contractual freedom and third party protection.

We strive for excellence in everything we do and guarantee true independence to our clients. Corporate transactions and corporate structuring for over 25-years combined with hands-on management experiences, are the basis of our today’s service offering.

​Eastbirds S.A.
1 boulevard de la Foire
L-1528 Luxembourg

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