Welcome to the December 2008 edition of The Director's Dilemma newsletter. I hope you find it interesting, informative and inspiring.

I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers three experts' responses to a real issue. Which response would you choose?

Suellen is a director on a not-for-profit board. One of her colleagues is a long standing board member and widely respected across the organisation for his contribution. Suellen is worried, however, because he often proposes contractors or suppliers to undertake work for the company.

She asked about this in a meeting, suggesting that the contracts which ensue should be noted as related party transactions and that he should declare a conflict of interest when his friends are awarded work by the company. Her colleague reacted with great anger and shouted that there was no conflict as he received no money for making the introductions and it was management and not him that awarded the contracts. Suellen is aware, however, that management usually act upon his suggestions and that on every occasion she has investigated there has been no tender process to solicit comparable offers. Often the work awarded was not planned until the suggested contact was introduced.

Suellen believes that her colleague is not taking commissions but she feels uneasy and would like to implement some more robust procedures. She is aware, however, that the issue has the potential to split the board and that her colleague will become aggressive if she raises the issue again.

What should Suellen do?

Dean's Answer

In determining if the director has breached his duty to avoid conflicts of interest it needs to be established that the director has a material personal interest in the transaction. Whilst the interest needs to be material, it does not need to be direct, so a 'you scratch my back and I'll scratch yours' type of agreement, even if only implicit, is a conflict of interest. There is no evidence presented that a material personal interest, and hence a conflict of interest, exists.

However, directors also have a duty not to misuse their position to gain advantage for themselves or someone else. To establish a breach of this duty it would have to be shown that the contracts in question were either not for a proper purpose (that is, provision of unnecessary goods or services) or provided an advantage to someone (that is, provision of goods or services at greater than market rates). Again, there is no evidence provided that this is the case. It could even be suggested that the director was doing what he was engaged to do by using his experience and contacts to suggest useful services and obtain favourable rates.

Under the Australian Corporations Law the contracts in question would not be regarded as related party transactions unless the contract was arranged on the understanding that the director would receive a financial benefit, which does not appear to be the case. It could also be argued that the contracts were arranged by management at arms length from the director, however it should be noted that management's authority to enter into these contracts has been delegated by the board and it could be inferred that the board has some influence on the actions of management.

Suellen is right to have concerns about the governance procedures in the organisation, however her concerns about the particular director are probably unfounded. She should suggest to the board that, just like she has, others outside of the organisation may have concerns about conflicts of interest regarding the contracts in question and that this could bring the organisation and the board into disrepute. She should propose that contracts that are to be awarded without soliciting comparable offers must be referred to the board for approval. By having the board vote on each contract it would have the effect of directly highlighting the awarding of these contracts with the director's duties to avoid conflicts of interest and misuse of position.

Dean Cording is a consultant at SMS Management & Technology and specialises in the government and defence sectors.

Julie's Answer

At first glance this looks like a process issue:

  1. A board should have an agreed definition of 'conflict of interest' with policies for annual and ad hoc declarations. My personal preference is for declarations of both pecuniary interests and ties of affection.
  2. A board should also oversee the strategy and budget. Any significant item which is not included in those should come to the board. Small items can be included in a delegation of authority for management.

Implementing good policy would resolve Suellen's concerns.

On close inspection this is a people problem. On strong boards people will work together to implement sound policies and build relationships of trust. On weak boards, as in this case, symptoms will include inappropriate defensive behaviours, such as avoiding written records, and offensive behaviours, such as bullying tactics. It is difficult to value equally the contributions from a process-focused 'compliance freak', such as Suellen, and an opportunist 'deal maker', such as her colleague. Good boards do this well and they reap the rewards in the form of robust debate and sound decision-making.

This board is already split because it doesn't know how to unite its members into a cohesive team. Suellen is right to fear making the split worse but, unless they focus on this issue, the board is unlikely to resolve it.

There is no indication these contracts and services threaten the viability of the company. Rather than try to tighten up the processes immediately Suellen should focus first on building the team. She could discuss with the chairman the idea of having teamwork be the major focus of the next performance review. If possible she should be involved in briefing and selecting the consultants to ensure the issues are addressed by a suitably qualified specialist.

A strong team will implement good processes and react appropriately to challenges.

Sheilah's Answer

First of all a conflict of interest does exist regardless of whether he is accepting any form of remuneration. Not all conflicts of interest include a monetary gain. In addition to that there is a potential for an ethics violation as well. Suellen should certainly bring this up to all board members and ask that if this other party's suggestions are considered then at the very least a minimum of three bids from other firms should be requested and most importantly the other person who has the conflict of interest should not vote at all.

Regardless of whether he will blow up or not makes no difference. These are adults, not children and someone must address this issue. A Board member must not ever allow the conflict to arise and if it does he/she must recuse themselves from weighing in with a vote. Technically, he should refrain from even being a part of the process at all. He basically needs to choose between being an impartial board member or a buddy to these firms.

Suellen, and all board members must also realize that there is more than just a conflict of interest occurring. If in fact there was no work planned or needed prior to his suggestion of these contractors or firms, this could actually be seen as corruption. It may not be intentional, but his knowledge that management always acts on his suggestions and resulting in his friends getting the contract for the work others could view this as either a serious ethics violation or as corruption. He need not be accepting bribes or payments of any kind. His standing in their (his friends) eyes is elevated and therefore a gain on his part. Further, if he did ever receive anything from these friends even unrelated to the contracts he may have a very difficult time proving it was totally unrelated.

These issues should never be glossed over because one person is afraid of the reaction of one or more members or fears they will be seen poorly by others. Each board member owes a duty to the business and it is never in any business' best interest to create work for friends.

Sheilah Etheridge is the owner of SME Management, a specialist accounting and management advisory firm based in Anchorage Alaska.

Disclaimer
The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances have been changed to ensure anonymity.

What's New

Video tips I occasionally present courses for IIR Executive Development. Together we have recorded a brief video about presenting to boards.

Book review Directors do a lot of reading. I keep a note of my thoughts on each book I read. Here is my review of Boardrooms that Work by Margot Cairnes.

Be an expert I will post the next dilemma on LinkedIn. If you would like to feature in February just log on to my Q&A and type in your advice. I will pick the best answer to be published in the December newsletter.

This newsletter Due to the Christmas break the next issue will be out on 1 February 2009. If you have any ideas for improving the newsletter please let me know. It is currently read all around the world and I hope to reach 20,000 subscribers soon. This is the season of goodwill so why not invite one of your friends or colleagues to sign up for a subscription?

Suggestions for dilemmas Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Farewell until next year. Enjoy governing your corporations; we are privileged to do what we do!

Best wishes

Julie

www.mclellan.com.au | PO Box 97 Killara NSW 2071
email julie@mclellan.com.au | phone +61 2 9499 8700 | mobile +61 411 262 470 | fax +61 2 9499 8711


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