Keeping it Above Board: A Costly Lesson in Corporate Governance

March 19, 2024

Keeping it Above Board: A Costly Lesson in Corporate Governance

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By Rich Craven

A recent court case involving Elon Musk and his contentious pay package from Tesla is a useful reminder of the importance of proper corporate governance in a business.

At the end of January, a US court found that a negotiated pay package for Musk in 2018, a total of £44 billion, was “unfathomable” and ordered for the package to be cancelled and re-evaluated. The case was brought by a minority shareholder in the company and alleged that that Musk had been involved with his pay package negotiations, instead of being independent to its discussions.
Whilst the specifics of that case relate to the US, there is no denying that good corporate governance is important for businesses and organisations in England and Wales – both in terms of directors’ conflicts, and circumstances when a company seeks to enter into a transaction with one of its directors.

What are the relevant rules in England and Wales?
There are various rules which relate to directors’ interests and conflicts, and it is important that directors understand both (i) when a conflict arises, and (ii) what steps need to be taken to deal with a conflict. In addition, it is important that directors have an understanding of what types of transactions require approval of the shareholders.

What is a director’s conflict?
There are 2 types of director’s conflict: situational conflicts and transactional conflicts. A situational conflict relates to the circumstances of the directorship (for example, a director being a director of another company), whereas a transactional conflict arises in relation to a particular transaction (for example, the director being involved in the transaction personally).

What happens when a director’s conflict arises?
The actions the board must take in relation to a director’s conflict or a director’s interest in a transaction will depend on a number of factors, including:

1. the nature of the conflict which has arisen;
2. whether there are any relevant provisions in the company’s articles of association;
3. whether there are any additional provisions in any shareholders’ agreement.

The articles may enable the other, non-conflicted, directors to authorise a conflict, which will enable the conflicted director to participate in the meeting and form part of the quorum. However, the articles may require the shareholders to authorise the conflict.
Beware also, there are certain types of transactions which require shareholder approval under the Companies Act 2006 (CA) which the board of directors will not be able to override.

What transactions need shareholder approval?
A company’s articles may specify additional transactions which require shareholder approval. However, under the CA, the following types of transaction require authorisation from the shareholders:

1. entering into a long-term service contract with a director;
2. a “substantial property transaction” whether the company is buying or selling a substantial property (or other non-cash asset) from/to a director;
3.  loans and guarantees to directors; and
4. payments to a director for loss of office.

Directors should ensure that they are familiar with these rules to ensure that they comply with them when conflicts arise.

Key take aways for directors
There are protections in place under the CA when it comes to long-term director service contracts, to ensure that shareholders have the opportunity to scrutinise the proposed agreement and make the decision at shareholder level as to whether the agreement is approved.
Directors should ensure that they have a good understanding of their responsibilities when it comes to their own duties to declare any interests, and to ensure that the rules set down in the company’s governing documents and the CA are followed. This will ensure good governance and that decisions are taken properly.

If you would like any advice in relation to corporate governance, please contact a member of our corporate team, Rich Craven via email on rcraven@darwingray.com or via telephone on 029 2082 9130 for a free initial chat to see how we can help you.