Solicitor non-executive directors: Law Society publishes guidance

The Standards and Guidance Committee of the Law Society has published guidance for private practice solicitors on the issues to be considered before accepting an appointment as a non-executive director. The Law Society and the Department of Trade and Industry (DTI) do not consider that the two roles are necessarily incompatible but that they may be in certain circumstances and the guidelines aim to help prevent conflicting situations from developing.

The guidance has been issued following consultations with the Law Society Company Law Committee and the DTI.

Non-executive directors

In June the Committee on Corporate Governance published its Combined Code which sets out the principles of good governance and a code of best practice. The publication is a combination of the Hampel Committee's final report and the Cadbury and Greenbury Reports. The Combined Code emphasises the importance of non-executives in the balance of a company's board, acknowledging the importance of a degree of objectivity from the day to day management of the company. The code recommends that non-executive directors should comprise not less than one third of the board (Provision A.3.1, Combined Code).

Incompatibility

The duties that directors owe to their shareholders and that solicitors owe to their clients may in certain circumstances be incompatible:

• Duty as director. A director solicitor owes the company a duty as director to act in the best interests of the shareholders. As a non-executive director he must bring his objectivity to bear on the actions of the board. The Combined Code recommends that the majority of non-executive directors should be independent of management and free from any relationship which could materially interfere with the exercise of their independent management (Provision A.3.2, Combined Code).

  A director solicitor who is closely involved in advising a company will normally be instructed by the board of that company to carry out its instructions. This may put him in a position where he is unable to be independent of the board and therefore unable to fulfil the role of non-executive director.

• A director solicitor has a duty as a solicitor to act independently and impartially in the interests of the client. Close involvement with the client as a director may affect this independence.

Particular areas which may create incompatibility include:

• The negotiation of fee arrangements.
• A solicitor non-executive director who is providing legal advice to the controlling shareholder in the company.
• Where the solicitor non-executive director becomes increasingly involved in the management of the company so as to become, in effect, an executive director.
• Where the solicitor non-executive director receives sensitive information about the company. As a solicitor he has a duty of confidentiality to the client. However, as a director he has a duty to 'whistleblow' to the board or possibly even to the shareholders.
• The difference between acting as a lawyer on behalf of a client, where the primary aim is to complete a transaction and the objectivity required of a non-executive director.

Existing rules

The latest (1996) Guide to the Professional Conduct of Solicitors contains the existing Law Society guidelines on the subject. This requires a solicitor who is a director of a client company (or a shareholder) to consider whether he is in a position of conflict when advising the company. If a conflict or a significant risk arises or a solicitor's ability to act impartially is inhibited he must decline to act.

Avoiding conflict

The guidance identifies five situations where the chances of conflict arising can be minimised.

• Before appointment. Both the solicitor concerned and the client should address in writing all potential areas that may cause conflict for the solicitor. Ultimately, it will be a matter for the professional judgement of the solicitor to decide whether he is able to accept appointment as a non-executive director.
• Declarations of interest. Directors are required under the Companies Act 1985 to declare any direct or indirect interest in a contract or proposed contract (section 317, Companies Act 1985). A company's articles are likely to contain provisions covering the event of a conflict of interest arising and specify the consequences for attendance and voting at board meetings. Even if a declaration of interest is made, the articles may still allow directors to attend and vote when the relevant item of business is discussed at a board meeting. However, the guidance states that there may be circumstances when the solicitor non-executive director should absent himself from any discussion or decision on the subject of which the conflict arises. The guidance acknowledges that there are cases where this solution will not be adequate and it recommends that any conflict issues should be resolved in writing. Other possible solutions include resigning as a director and the firm resigning as advisers in relation to a specific transaction or completely.
• The provision of legal advice. Many companies, in particular smaller companies, invite solicitors to be non-executive directors in order for that person, in his capacity as director, to identify and solve potential legal problems. The guidance considers it to be unrealistic to expect differentiation of roles but the Law Society expects solicitors in that position to keep the potential difficulties in mind and ensure that, where appropriate, formal external written advice is obtained.

  The guidance recommends that where a solicitor who personally advises a company becomes a non-executive of that company, the firm should consider whether a different person should advise the company. Firms should keep under review the relationship with client companies of which partners are directors. If any potential conflict is identified the guidance advises that the firm informs the company and agrees in writing a process to identify any issues of conflict.

  When accepting an appointment as a non-executive director of a client company the solicitor should consider whether he should personally stop providing legal services to the client.

  The involvement of a solicitor as a non-executive director will, in most circumstances, involve some form of payment by the company. The nature of any payments should be clarified with the company including the implications in terms of VAT and income tax. Will the payments be on a fee basis for legal services or in the form of director's remuneration?

• Professional indemnity. Professional indemnity insurance cover may be (and under the Solicitors' Indemnity Fund) is limited to work as solicitors and does not extend to the performance of duties as directors of companies. Reliance should therefore be on the relevant company's own liability insurance for directors and officers. Solicitors should also take account of the limitations on indemnities for directors under section 310 of the Companies Act 1985 and company law generally.
• Conflicts with interests of other clients. Firms should regularly review whether a solicitor's appointment as a non-executive director may conflict with the interests of other clients.

Charitable companies

It is important to be aware that a solicitor director of a charity company is a charity trustee and must be alert for possible conflicts of interest. Before accepting an appointment as a director of a charitable company a solicitor ought to be familiar with the general legal framework in which charitable companies are administered and the particular provisions of the constitution of the company (and its parent).

Directors' authorities to charge for their services are almost invariably more limited in the constitutions of charitable companies than they are in the constitutions of commercial companies. It is more difficult to justify charging for time spent as a trustee than for time spent acting in a specific matter. It is not safe to assume that there will be authority to charge, even for specific professional services. It may be difficult to make amendments to the company's constitution as Charity Commission approval is likely to be required. AM