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Key12 Conflicts,contracts and independent directors

A board member represents the shareholders in a corporation. Directors’ decisions must be made in the best interests of the company, not their own or that of management.

Directors with a vested interest in pleasing management tend to focus on personal gains or business retention. A lawyer whose firm earns, say, one-sixth of its revenue performing services for a corporation will not be an independent director on that corporation’s board. Because her firm’s contract with the company and resulting revenues are contingent upon satisfying the company’s officers who arrange for the legal services, the lawyer/board member would have a conflict between what’s best for the shareholders and what senior management desires.

The same types of conflicts arise when an officer from a corporation’s major supplier agrees to sit on the board. The fiduciary duty of the director is in conflict with his vested financial interest. A banker on the board may be more willing to approve financial statements for the company that really should be qualified. After all, he may be more worried about having the loan repaid than informing shareholders that the company is in trouble.

Conflicts like these incestuous business interconnections are complex, and they don’t necessarily rule out serving on a board. But directors need to be careful to watch out for all types of conflicts, many of which at least merit disclosure or perhaps an abstention from a vote.

For example, a director may serve on the board of a bank and also on the board of a utility. If the board of the utility votes on a credit line arrangement with the bank, the director who serves on both boards is in conflict. She should abstain from voting on the credit line, disclose her interest in the bank, and have the secretary for the corporation put a note in the minutes reflecting the disclosure and abstention from voting. The same is true for a director who happens to be a major shareholder in the bank offering the line of credit.

Conflicts for board members as they seek to exercise their fiduciary responsibilities fall into the following general categories:

• The director has a financial interest in contracts with the corporation (supplier, law firm). The desire to retain business is in conflict with the best interests of the corporation.
• The director sits on the board or is a large shareholder of another company and that company will benefit from approval of a contract with a firm on whose board he also sits.
• The director has family beneficiaries of corporate contracts; for instance, the corporation is doing business with a company owned by his wife.
• The corporation is making substantial charitable contributions to an organization run by the director’s spouse.

The best advice for directors in avoiding conflicts is ADQ: abstain, disclose and always question your ability to be independent in those circumstances where your firm and the firm you are asked to serve on have conflicting interests. Remember, the conflict exists whether or not you are influenced by the different interests.