Magazine • 46

COMPANY LAW

[2017] 137 CLA (Mag.) 46

Need for a special committee – Avoiding

conflicts of interest in M&As
Pragya Dhamija* • Chirag Jain**

A conflict of interest comes into play when a director’s or key

managerial personnel’s personal interest interferes in any
way with the interest of the company. In this article authors
highlight the need for a special committee in order to avoid
conflict of interest in merger and acquisition.   EFW

Introduction
1. Directors under the Indian company law have the duty not to place themselves
in a position wherein their fiduciary duties towards the company conflict with
their personal interest. But in recent years, unwarranted ‘transactions with
interested parties have been approved by the Board of public listed companies,
without looking in the unrevealed interest of a director and/ or key managerial
personnel with any third person or interested party in the transactions have
given rise to improper management of ‘conflict of interest’ and bad corporate
governance issue in Indian listed companies. A conflict of interest comes into
picture when a director’s or a key managerial personnel’s personal interest
interferes in any way with the interest of the company.
1.1 Upon witnessing various alleged issues and diverse display of conduct by
the independent directors and discomfort shown by founding members in two
of the major conglomerates in India, Securities and Exchange Board of India
(‘SEBI’) issued a ‘Guidance Note on Board Evaluation’ on 5th January, 2017
(‘Guidance Note’, which in a way clubs together the provisions of the Companies
Act, 2013 (‘the Act’) along with Securities and Exchange Board of India (Listing
Obligation and Disclosure Requirement) Regulations, 2015 (‘Listing Regulations’)
relating to evaluation of the performance of the Board as a whole, independent
directors and various committees of the Board and provides a gist of all
obligatory responsibilities upon such directors and committees to make certain
disclosures of operations affecting the right of shareholders.

*Associate Partner and **Associate, DSK Legal, Mumbai. Their view expressed in this article
are the personal views of the authors and should not be attributed to DSK Legal.

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1.2 One of the criteria of Board evaluation as provided for in the Guidance
Note is monitoring and managing potential conflicts of interests of
management, members of the Board of directors and shareholders, including
misuse of corporate assets and abuse in related party transactions. But it
nowhere states as to how the same is to be carried forward in order to
effectively monitor and manage the potential conflict of interest within the
management.

Interested party
2. Section 188 of the Act read with rules framed there under and regulation
23 of the Listing Regulations provide guidelines for identification of related
parties and the proper conduct and documentation of all the related party
transactions, but the same do not cover within its ambit the transactions
entered into with the ‘interested parties’ who are not recognized/ defined as
‘related parties’ under clause (76) of section 2 of the Act read with rule 3 of
the Companies (Specification of Definition) Rules, 2014.
2.1 An ‘interested party’ (not being a related party)in connection with a
proposed transaction could be any of the following :
• Any party/person forming part of the target company, who may have any
long-term or close business or personal relations with the director or manager
of the concerned company which may be perceived to constraint hard
bargaining.
• Any party/person forming part of the target company, who may have
any historical relationship with the director or manager of the concerned
company which would constitute domination or control of or undue
influence over such director which would likely make the director or
manager of the concerned company fell beholden to such party/ person in
the context of his or her representation of the target in connection with the
transaction.

Mandatory duties of directors to disclose their interest

3. Of all the duties enumerated under section 166 of the Act, one of the most
fundamental duties of a director is to avoid a situation where he has or may
have, an indirect interest that conflicts with the company’s interest.
Additionally, section 184 of the Act does mandate directors to make
disclosures of any indirect interest they may have in the proposed contract
or arrangement before the meeting of the Board in which any contract or
arrangement is to be discussed. But such voluntary disclosure of interest
before the Board is not sufficient to mitigate the risk of extraneous
considerations and influence that one director could exercise upon other
Board members.A thorough enquiry into each proposed contract or

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 Magazine • 48 S ECTION IV – COMPANY LAW

arrangement should be made in order to focus on the most obvious conflicts

as well as most subtle relationships that a director may have.
3.1 Under regulation 4(2)(f)(iii)(8) of the Listing Regulations, a responsibility
has been stipulated for the Board of directors of public listed companies
which states as follows :
“The Board of directors shall consider assigning a sufficient number of non-
executive members of the Board of directors capable of exercising independent
judgment to tasks where there is a potential for conflict of interest.”
Although we understand that it is the subjective nature of this potential
clash of interest that makes conflict of interest situations a difficult scenario
to deal with in practice, but a sound process is important for ensuring that
the necessary disclosures for identifying conflicts of interest which are
statutorily not required to be disclosed are madeavailable for public scrutiny.
We believe that the Listing Regulations shall bring in a mandatory approach/
obligation in order to adopt a mechanism to identify a potential conflict
situation and to certainly deal with it.

United States approach on conflict of interest

4. The United States (US) approach of delegation of the Board’s authority to
a special committee composed of directors who are disinterested and
independent and can oversee the best interest of shareholders could be an
option which can be adopted in our legislation. Over the years, it has been
clearly recognized by the Delaware Court of Chancery that a special
committee consisting of only disinterested directors is a judicially recognized
(and encouraged) way to address director’s conflicts of interest and to mitigate
the litigation risk as the burden of proof shifts back to the party which
opposes the transaction to demonstrate that the proposed transaction was
not entirely fair.

Conclusion
5. Such special committee formed should have the proper and unbridled
authority to negotiate the transaction and the special committee should also
have full authority to select its own advisors, and what compensation should
be paid to those directors serving on the committee. In order to ensure
decisions are made in the best interest of the shareholders of the company,
directors having interest in the proposed transaction should abstain
themselves from the relevant decision making process of the special committee
and should not be allowed to be present during the consideration of or voting
on the relevant matter, unless all of the other directors have passed a
resolution to enable that director to do so.With this we are not just expecting
fairness and complete disclosure in listed companies but also an increased
role and input of independent directors on Board.
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