Conflict of Interest, Secrecy and Insider Information of Directors

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday December 28, 2012 at 8:05 am
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Editor’s Note: The following post comes to us from Klaus J. Hopt, a professor and director (emeritus) at the Max-Planck-Institute for Comparative and International Private Law, in Hamburg and was advisor inter alia for the European Commission, the German legislator and the Ministries of Finance and of Justice.

This article concentrates on conflict of interest, secrecy and insider information of corporate directors in a functional and comparative way. The main concepts are loans and credit to directors, self-dealing, competition with the company, corporate opportunities, wrongful profiting from position and remuneration. Prevention techniques, remedies and enforcement are also in the focus. The main jurisdictions dealt with are the European Union, Austria, France, Germany, Switzerland and the UK, but references to other countries are made where appropriate.

The duty of loyalty is highly developed in Anglo-American countries, but it has received more hesitant attention in continental European countries. While the main reason for these path dependencies is the Anglo-American trust analogy, other circumstances may have contributed. Traditionally, in the USA and the UK the duty of the directors is owed to the shareholders, while in many continental European countries the duties of the directors are owed to the enterprise or even directly to the different stakeholders. Under the German, Dutch and Austrian two-tier board system the board is split into a managing board and a supervisory board. The latter is more remote from the daily operations of the business and as a general rule only operates on a part-time basis. This reduces, though does not completely exclude, personal conflicts of interest. Group law as in Germany and other countries may also play a role. Personal duties of the directors of the parent company and the subsidiaries exist, but are less relevant than duties between the members companies of the group, not least because of the parent company’s deeper pockets.

More recently there are tendencies to more convergence. They stem from company law scholarship, but also from more institutionally driven developments such as the independent director movement, the corporate governance codes, to a certain degree also the harmonization efforts of the European Commission and the general influence of US American law on European company law and practices.

Special conflict of interest situations arise in takeovers in relation to the duties of the target company board members. The two prime examples on how the law can deal with this are the UK and the USA. In the UK, the no frustration rule has been in place for a long time, while in the USA the board of the target company is free to say no to the offer. The Takeover Directive of the European Union of 2004 (as well as many continental European jurisdictions) has followed the British rule, but has given in to the pressures from lobbies and Member States to allow the Member States to opt out of this and related rules of the Directive. Since this is a highly politicized issue, when revising the Takeover Directive in 2013 the European Commission is not expected to take up this matter.

The evaluation of the two contradictory policies is controversial. As a general rule the directors of the target company board who risk losing their job in a successful hostile takeover have a serious conflict between their own interest and the interest of the shareholders. It is true that the directors are in a position to force up the takeover bid price and that they have a fiduciary duty to act in the interest of the shareholders, but this duty is hard to follow and even harder to enforce. What is true is that this rule has a dampening effect on takeovers, but this has not prevented the UK takeover market from flourishing and is a price to be paid for solving this conflict in the interest of the shareholders. The complicated legal and economic arguments as regards the no frustration rule are analyzed more fully in a recent book.

Recently more attention is paid to prevention, remedies and enforcement. The main technique in the context of the duty of loyalty is disclosure. In order to check whether the disclosure obligation has been fulfilled, but also in the interest of the directors for defense and evidentiary purposes, ample documentation is advisable. Sometimes there is even a legal duty of documentation, the violation of which may result in a harmful presumption. Other techniques are requiring the consent of the board or the shareholders. A modern way is prevention by organizational duties, such as implementing Chinese walls, installing consent requirements, involving independent directors, auditors or experts or more generally establishing a compliance organization.

Substantive remedies are nullity, prohibition against voting, liability for damages, disgorgement of profit and stepping down or dismissal. Enforcement can be private or public. Here the European states have different policies.

The full article is available for download here.

  1. [...] this recent post, by Klaus J. Hopt, a professor and director (emeritus) at the Max-Planck-Institute for Comparative [...]

    Pingback by Catching up on directors’ conflicts | Conflict of Interest Blog — January 16, 2013 @ 6:40 pm

 

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