Management of conflicts of interest in Lithuanian public limited liability companies
With the globalization of the business environment and the growth of public limited liability companies, and the business world still being dependent on business and other interpersonal relationships, official and other relationships and interests of successful corporate bodies (directors, board, supervisory board members and chairmen, etc.) become more and more broad and various. Along with the development of interpersonal relationships and interests, there is inevitably a risk of confusion of interests, i.e. there is a risk of a conflict of interest. A conflict of interest of a member of corporate bodies is a situation that meets the following characteristics:
- a director, a member of the board, supervisory board or other body (for convenience, let us refer to all of them as managers) has, in addition to an express interest in the company’s business (business interest), an interest in meeting his own needs or the needs of persons related to him (personal interest),
- the two interests mentioned are in conflict with each other (one of them can be satisfied only if the other is directly or indirectly affected).
An uncontrolled conflict of interest is detrimental to the company not only in its explicit form, but it is also related to operational, compliance, reputational and even strategic risks that are difficult to identify in advance. Therefore, proper management of conflicts of interest is very important for a successful business.
I. FUNDAMENTALS OF THE MECHANISM OF THE MANAGEMENT OF CONFLICTS OF INTEREST
It is important to understand that not every conflict of interest can be considered unlawful.
First, the shareholders of companies do not have obligations to the company in the course of which a conflict of interest may arise, and therefore they cannot face conflict-of-interest (they are not objects of the management of conflict of interest). Of course, this is a general rule that can be adjusted to the extent permitted by law in the company’s articles of association and/or shareholders’ agreements.
Second, it must also be understood that a conflict of interest should only be considered a conflict of business and personal interests which is not justified from the perspective of good business practice. For example, the manager’s reluctance to work overtime may be formally considered a conflict of interest (because it is in conflict with the company’s goal of maximizing profits), but such behaviour is clearly justified by protecting other values (manager’s health, family welfare, etc.). Accepting small gifts from business partners could also be considered a conflict of interest, but it is a de minimis conflict and there is no great need to prohibit it.
Third, an analogous decision (action or omission) may or may not be considered a conflict of interest, depending on who makes that decision (whether it is a director, a board member, etc., because the functions of these individuals are different).
Here lies the complexity. The concept of a conflict of interest, due to its nature, may take on a different meaning depending on the situation. Therefore, companies seeking to establish a clear management mechanism of conflicts of interest should not rely on a common understanding of the concept of conflict of interest, but should define in their internal documents the characteristics of conflicts of interest most common or likely to occur in the specific business sector in which the company operates. It is advisable to define these characteristics a little more broadly, also including the cases where conflicts of interest are less pronounced because there is a greater possibility to err in unclear situations.
However, it must be borne in mind that the management of conflicts of interest, as exemplified in international good practice (see, for example, the G20/OECD Principles of Corporate Governance), is based on the principle of the primacy of content over form. For this reason, although the identification of signs of conflicts of interest in internal documents is important for prevention purposes, the actual management of conflicts of interest should be delegated to specific bodies/individuals. These bodies/individuals can be grouped into two categories:
- Bodies/individuals used for the purpose of identifying potential conflicts of interest. Usually, such a function is entrusted to independent members of the board or other collegial bodies (see, for example, the Corporate Governance Code for the companies listed on NASDAQ OMX Vilnius). The purpose of the independent members is to analyse the decisions of the bodies to which they belong and to identify the threats related to those decisions before they are taken. Of course, the prevention of conflicts of interest may also be entrusted to individual, specially constituted bodies (for example, compliance officers, committees), but in any case the independence of the members of these bodies (or at least part of them) should be maintained.
- Bodies/ individuals approving the decisions of lower-level managers in situations of conflict of interest. No company avoids conflicts of interest. Sometimes acting in a conflict-of-interest situation is even necessary. In this case, a manager acting or intending to act in a conflict-of-interest situation may (should) be released from liability against the company even for unsuccessful actions if his actions in a conflict-of-interest situation are approved by a higher-level body (managers).
Both of these elements (drawing up a list of conflicts of interest and the structure of the bodies managing conflicts of interest) are essential elements of the management mechanism of conflicts of interest.
II. DISCLOSURE OF CONFLICTS OF INTEREST AND DECISION-MAKING
Appropriate disclosure of potential conflicts of interest is an integral part of the conflict-of-interest management process. This can be divided into two relatively separate stages:
- A clear and detailed declaration of personal interests, which may conflict with business interests, prior to the appointment of a person to the position of a manager, as well as regular updating of this information (ex ante declaration). The purpose of it is to make sure that a particular manager is fit for the job with regard to his personal interests.
- Declaration of a conflict of interest that has arisen or will inevitably arise to a higher body and, if the manager is a member of a collegial body, also declaration thereof to this collegial body (ex post declaration). The purpose of it is to make it possible to determine whether a particular decision, given the risks of conflict of interest, can be taken/implemented or cannot be taken / should be revoked.
It is advisable (and in some cases mandatory) for a manager to withdraw from a particular decision if that decision involves a conflict of interest for the manager. Of course, this recommendation applies if a specific decision is made by a collegial body and the manager facing a conflict of interest is one of the members of this body. If the decision has to be taken by a sole body (director), the management of the conflict of interest is limited to the transmission of this decision (together with the information on the conflict of interest) to a higher body for approval.
III. LIABILITY FOR THE DECISIONS TAKEN (ACTIONS PERFORMED) IN A CONFLICT-OF-INTEREST SITUATION
If, however, the manager makes a decision in a conflict-of-interest situation, it is important to understand that this decision will not necessarily be considered unlawful and may be a basis for claiming the manager’s liability. In accordance with the consistently formed case-law of the Supreme Court of Lithuania, a decision made in a conflict-of-interest situation is lawful and does not incur liability on the manager if:
- such decision is approved by a higher body if the manager has previously provided that body with sufficient information on the conflict of interest (nota bene: shareholder approval removes the manager’s liability only if the company is solvent and the shareholder approval does not infringe the public interest and rights of minority shareholders), or
- such decision is not harmful (does not cause damage).
Of course, reasonable modifications and/or exceptions to this rule may be provided in the company’s records. For example, the board’s rules of procedure could provide for a fine for acting by a board member in a conflict-of-interest situation, regardless of whether the company suffers damage as a result.
It is also important to note that even if a manager obtains the approval of a higher-level body to act in a conflict-of-interest situation, this does not completely eliminate his liability. If the manager subsequently performs actions that have not been approved by a higher-level body, he may be held liable for those actions. For example, if the company’s board approves the director’s decision to enter into a contract for the sale of fixed assets to the director’s spouse, the fact that the contract is entered into will not render the director liable (because the consent has been obtained). However, if the director who concludes the contract independently postpones the contractual settlement period in favour of the spouse’s company, this could already be a basis for liability.