Directors' Conflict of Interest in a Related-Party Lease
Ruposhi Textiles Ltd (RTL), a public company with 9 directors, leases a warehouse from a partnership in which its Managing Director, Mr. Alam, holds a 40% profit share. The lease was signed three years ago at BDT 450,000 per month; an independent valuer now puts the market rent at BDT 300,000. The audit committee flagged the arrangement. At the upcoming board meeting, the agenda includes ratifying the lease and approving a new five-year extension. Mr. Alam attends, participates in discussion, and votes in favour; the resolution passes 5-4. Two directors who voted against demand that the transaction be unwound and that Mr. Alam be held personally liable for the excess rent. The company secretary must advise the board on the legal position before the annual general meeting, where shareholders have tabled a question on the matter.
1. Analyse whether Mr. Alam's participation and vote invalidate the board resolution, and identify the correct procedural course for the board.
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A director who is interested in a contract or arrangement, directly or indirectly, must disclose the nature of his interest at a board meeting and must not vote on the resolution. Where he votes, the resolution is not automatically void at common law, but it is liable to be set aside and the interested director must account for any benefit. The correct analysis here turns on three points.
First, disclosure. Mr. Alam's 40% profit share in the lessor partnership is an indirect interest. He should have disclosed it at the meeting and the disclosure should have been recorded in the minutes.
Second, voting. The statutory bar on voting applies to his interest. His vote should be disregarded. The resolution passed 5-4; if his vote is removed the result is 4-4, which means the resolution fails. The board must therefore re-take the decision without him.
Third, ratification. Even a disinterested board should not simply ratify an above-market lease. The board should obtain a valuation, consider whether the excess rent is recoverable from Mr. Alam, and, if the lease is to continue, approve it at market rent. The company secretary should minute the conflict, exclude Mr. Alam from the discussion and vote, and advise the board to seek shareholder approval under the applicable related-party rules if the amount crosses the threshold.
2. Advise on the remedies available to the company and to dissenting directors in respect of the excess rent already paid.
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The company, not the dissenting directors, is the proper claimant. The excess rent is a loss to RTL caused by a transaction in which a director had an undisclosed or improperly approved interest. The available routes are:
Recovery of the excess. The company may claim the difference between the rent paid and market rent (BDT 150,000 per month for the period of the lease) as a benefit obtained by the interested director or the partnership. The claim is against Mr. Alam and, if it can be shown the partnership knew of the breach, against the partnership.
Account of profits. If Mr. Alam's profit share can be traced to the excess rent, the company may seek an account.
Rescission. Rescission of the lease is possible only if the company can restore the parties to their original positions. Because the company has occupied the warehouse for three years, rescission is likely to be refused, and damages or an account is the practical remedy.
Derivative action. The dissenting directors cannot sue in their own names. They may bring a derivative claim on behalf of the company, but they must first satisfy the court that they are acting in good faith and that the claim is in the company's interests. The board should be asked to pursue the claim first.
The company secretary should recommend that the board set up a committee of disinterested directors to quantify the loss and instruct counsel.
3. Draft the key elements the company secretary should include in the board minutes and in the notice to shareholders.
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The minutes should record, at a minimum:
- The date, time, place and quorum of the meeting.
- The agenda item and the nature of Mr. Alam's interest, stated in his own words and recorded verbatim.
- A note that Mr. Alam was asked to withdraw from the discussion and did not vote, or, if he did, that his vote is recorded and will be disregarded.
- The valuation evidence considered and the market rent figure of BDT 300,000.
- The resolution actually passed, the votes for and against, and the names of the dissenters.
- The decision to refer the matter to the audit committee and to seek legal advice on recovery.
- Any conflict-of-interest register entry.
The notice to shareholders should:
- State that a related-party transaction will be put to members.
- Describe the lease, the parties, the relationship and the amounts involved.
- Disclose the independent valuation and the excess over market rent.
- Explain the board's recommendation and the reasons for it.
- Confirm that Mr. Alam will abstain from voting at the general meeting.
The company secretary should ensure the notice is sent within the statutory period and that the explanatory statement is sufficient to allow members to make an informed decision.