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Conflicts of interest – careful management is needed to safeguard major commercial transactions

01 May 2007

Conflicts of interest and the proper management thereof is a hot topic. The heat has been generated by the recent decision in the Diagnostic Medlab case1, where the High Court concluded that a board member had been conflicted and had misused confidential information. The errors at board level were seen as so grave as to warrant a $560-million contract being set aside. This note discusses conflicts of interest generally, and the Diagnostic Medlab case in particular.

Identifying and managing conflicts of interest

Other than to avoid the obvious problem of the matter ending up before a court, proper management of conflicts of interest is essential to maintain the credibility of the relevant organisation and confidence in its decision-making processes.

How easy is it to identify an actual or a potential conflict of interest? While most would be confident that they could pick an actual conflict of interest at twenty paces, the task is somewhat harder when identifying whether a potential conflict, or the possibility of an appearance of a conflict, arises. Case law is a reminder that many people in diverse sectors have made the wrong call, in respect of both actual and potential conflicts. The Diagnostic Medlab case is a further illustration of the potential for a disagreement about whether a conflict exists and, if so, whether a board has taken appropriate steps in light of that conflict.

That there may be confusion about whether an actual or potential conflict exists is understandable, despite the proliferation of material on conflict of interest. As an example of the breadth of information available, at least twenty current New Zealand statutes contain references to conflicts of interest, from subjects as diverse as those under the Companies Act 1993, the Cadastral Survey Act 2002 and the New Zealand Public Health and Disability Act 2000. Oddly enough those twenty something Acts set out circumstances in which a conflict must preclude participation, but shy away from defining a conflict of interest.2 Many articles have been written and codes of conduct promulgated.3

So what is a conflict? The short-form description is that a conflict exists when one’s interests and duties collide. Or, as Justice Asher put it in the Diagnostic Medlab case, "a conflict arises when a person carries out a particular function with two or more interests in conflict".4

At its core, successfully managing conflicts of interest relies upon an individual’s own appreciation of when their personal interests may give rise to an actual or potential conflict of interest. It is only when that self realisation takes place, that disclosure of the relevant interest can occur.

So what should directors and board members do to make sure they are not perceived to be acting improperly? As is wisely spelt out in the Institute of Directors in New Zealand (Inc) "Best Practice for New Zealand Directors", when in doubt, board members should discuss the matter with the Chair, and if necessary take legal advice.

The Diagnostic Medlab case

This case concerned a successful challenge to the lawfulness of the decision by three Auckland District Health Boards to award an eight-year contract worth more than half a billion dollars to a consortium associated with one of Auckland DHB’s board members, Dr Bierre. While there were a number of grounds of challenge, the issues of interest to directors will be those relating to conflict of interest and misuse of confidential information. The Court was asked to decide whether Dr Bierre had acted when conflicted and had misused confidential information, such that the consortium with which Dr Bierre was associated should not have been permitted to participate in the tender process.

Dr Bierre maintained that at all relevant times he had fully disclosed his conflict, claiming he had participated in board and other DHB processes only after making the full disclosure required of board members, and in circumstances where he had either stood aside or been permitted to participate. The Court disagreed. It considered that Dr Bierre’s disclosures, both when standing for election and in the Board’s interest register, were obscure. Justice Asher explained that a disclosure of interest:

  • "should disclose the nature of any conflict that might arise so that other DHB members can properly assess it".5

On the facts, Dr Bierre had made entries in the DHB interests register, including recording his interests as owner/director of various companies. That level of disclosure was held to be woefully inadequate, as it did not signal that he was interested in obtaining a contract. The Court said:

  • "Dr Bierre’s intention to open a laboratory and seek funding from December 2004, the fact his company LabTests [note: a different entity from that ultimately awarded the contract] was operating as a boutique laboratory between March and June 2005 and the fact he sought ADHB funding for it, should have been formally disclosed. Only that sort of disclosure statement would have adequately informed a person examining the interests register of the true nature of Dr Bierre’s interests".6

The Court also emphasised that the DHB boards had an important role to play upon discovery that a member may be or is conflicted. In the circumstances of the case, Justice Asher concluded that the boards should not have sat back. His Honour determined that the process was so tainted that the DHB Boards should have advised Dr Bierre that it would refuse to accept a bid from him. The alternative was that "the whole RFP process [be] suspended or cancelled".7 This point of clarification is helpful, as previously there was no legal certainty as to the correct course of action in the circumstances. Board members will no doubt be noting the commercial consequences that may flow when a board does not do the right thing, and carefully considering options when a director or employee has an actual or potential conflict of interest in a relevant transaction.

What should boards do now?

In light of Justice Asher’s conclusion on this point, it may be timely for boards to examine their interests registers to see whether members agree that they fully understand the nature of the interests their fellow board members have disclosed, and that their own disclosures are fully understood by others. If not, boards would be wise to put in train a process for obtaining more detail and updating the information contained in the registers.

As this article goes to print, Lab Tests has appealed the High Court judgment. A further update on what the Court of Appeal has to say on conflicts will follow, as events unfold.

Footnotes

  1. CIV 2006-404-4724, Auckland High Court, 20 March 2007, Asher J.
  2. The approach taken in legislation is to specifying the circumstances in which a person is "interested in a transaction": see for example s 62 of the Crown Entities Act 2004.
  3. A Google search of "codes of conduct" and "conflict of interest" produces 689,000 hits and gives immediate access to information on how public and private sector entities across the globe seek to manage conflicts. Remedies are varied. At the upper extreme, Arizona State legislation provides that contracts entered into by public agencies in breach of Arizona’s code, including the strict provisions relating to conflict of interest, are voidable.
  4. At paragraph 122 of the judgment.
  5. At paragraph 146 of the judgment.
  6. At paragraph 146 of the judgment.
  7. At paragraph 146 of the judgment.