Company law reform may threaten NEDs

Draft new rules on directors’ duties could make it difficult for non-executive directors (NEDs) to work with more than one company at the same time. Under the proposed new rules, which are currently being debated by Parliament, a director would have to 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.’ Angela Sormani reports.

According to Simon Witney of SJ Berwin, the main concern for the private equity industry is that if the reform does go ahead, it may deter private equity managers from taking on a directorship. He says: “It is the wording in the reform which could cause problems for anyone with multiple directorships. It is hard to see how a director could ever be certain that in taking a second directorship he is not putting himself in a position of conflict with the first company’s interests.”

Neil Cameron, head of the NED Practice at interim management provider, AshtonPenney, adds: “There are several controversial issues in the proposed company law reform – most people are fully behind the proposals in principle but, as usual, the details have not yet been fully thought through. Amendments are likely.”

As the law currently stands, a director in this position is allowed to manage the conflict by removing himself from the company’s decision-making process when a conflict arises. The draft new law seems to go much further by imposing a duty to avoid the possibility of a conflict in the first place.

Adam Levin of law firm Dechert says: “If this goes through in its unamended form, private equity partners who hold directorships will have a series of new issues they’ll have to pay attention to. From a private equity house’s perspective, the well-advised ones shouldn’t be that worried. However, you just can’t put a director on a board and have them as a check-the-box person. On investee company boards, directors will need to be alive, awake and aware of this new angle to their duties.”

The draft rules may also restrict the pool of NEDs for public companies, and would particularly affect private equity investors who commonly hold multiple posts. Although there are carveouts from the rules, and an authorisation procedure, Witney says these are inadequate and will be calling on the Government to make it clear that NEDs can hold multiple posts so long as there is no conflict when the appointment is made.

Witney says: “At the moment if you’ve got a director of a private equity-backed company and you find yourself in a conflict, you can manage that conflict. If the new law goes through it would create a duty for the director: if you have a conflict, you can’t be a director and this is clearly an issue for private equity firms as there are often issues of conflict within their portfolio companies which they are used to managing.”

The draft law is currently being debated in the House of Lords and is expected to go to the House of Commons this month (April.) It is expected to be finalised by the summer and in force by next year.

The British Venture Capital Association (BVCA) has sent a letter to the Government explaining its concerns about this particular clause to ensure as little damage is done as possible to the industry’s ability to operate and compete efficiently in the workplace.

BVCA chief executive Peter Linthwaite says: “High calibre non-executives are critical for the industry. Our concern for the new reform is that in respect of conflicts of interest the duty for non-executives is vague, which may discourage professionals from taking on directorships. In the past, conflicts were handled by the person concerned declaring the conflict on a particular topic and if necessary withdrawing from discussion at the board. This seems to be an appropriate modus operandi.”

Neil Cameron of AshtonPenney is all for private equity firms looking further afield for their NED candidates: “The private equity industry is understandably very worried, but I have long argued that they should have been casting their net wider, beyond their usual suspects, for NEDs in their investments anyway. It is essential that the investors feel their interests are being well protected, but a more adventurous selection of NEDs can be extremely beneficial to company performance without compromising this protection.”

Markus Golser of Graphite Capital doesn’t see any implications for his firm, which takes a different approach to many private equity firms in that it does not allow its partners to take directorships. He says: “Most private equity firms still take active directorships on the board of their portfolio companies. We stopped doing that in the mid-1990s, instead appointing independent non-executive directors. We take the view that we are not well placed to take objective action if we are directors of companies. We could see the conflict of interest between our role as shareholders and our role as directors, particularly if the company starts underperforming.”

He adds: “If it changes, the new law would probably not have any implications for us as we have been acting on that principle for a long time now. We have always felt the potential for conflict already exists and that there are bound to be conflicts of interest if the director is both a shareholder and a company director.”