What Should a Conflict of Interest Policy Include?

A conflict of interest policy does one thing: it sets the procedure the company follows when a director, officer, manager, or key employee has a personal stake in a decision the company is making. Without the procedure, every related-party transaction is a potential breach of the duty of loyalty, and the burden can fall on the insider to prove the deal was fair. With it, the company can approve a transaction with a conflicted person, document that the disinterested decision-makers approved it after full disclosure, and rely on the safe harbors in state corporation and LLC statutes. Capitol Law Partners’ corporate governance and policy drafting practice prepares these for companies of every size, and the elements below are the ones that do the work.

Who the policy covers

Define covered persons broadly enough to catch the real conflicts. Directors and officers are the minimum. Add managers and members of an LLC, committee members, and any employee with authority to commit the company to contracts above a threshold. Then extend the definition to family members and affiliated entities: a director’s spouse, parent, child, or sibling, and any company in which a covered person or a family member holds a meaningful ownership or management role.

A policy that covers only the director personally is easy to sidestep by routing the transaction through a spouse’s company. Most policies therefore define an interest to include direct and indirect financial interests, and non-financial interests that could reasonably affect judgment, such as a board seat at a competing or contracting organization.

What has to be disclosed and when

The core duty is disclosure. A covered person who has or may have an interest in a proposed transaction must disclose the existence and nature of the interest, and all material facts about it, before the company acts. The policy should say to whom the disclosure goes (the board chair, the general counsel, or a designated officer), in what form (written is better), and at what point (as soon as the person becomes aware of the potential conflict, and in any case before the decision).

Require an annual written statement as well. Each covered person confirms that they have read the policy, discloses any current interests, and updates the statement when circumstances change. The annual statement catches conflicts that never surface in a specific transaction, such as an officer who has taken a consulting role with a vendor.

How the decision is made

Once a conflict is disclosed, the interested person leaves the room for the discussion and the vote. The policy should state that explicitly: recusal from deliberation, not just from the vote. The remaining, disinterested directors or managers then decide whether the transaction is in the company’s interest and on terms at least as favorable as the company could get from an unrelated party.

The procedure tracks the statutory safe harbors. Virginia, DC, and New York corporation statutes, like most, protect a transaction with an interested director from being voided for the conflict alone if the material facts were disclosed and the transaction was approved by a majority of the disinterested directors, or approved by the shareholders, or is shown to be fair to the company. The policy should be drafted so that following it produces the first of those outcomes, which is the easiest to prove. Our post on when a company needs a board resolution describes how to record such approvals.

For an LLC, the operating agreement governs. Many operating agreements modify or waive fiduciary duties to the extent state law allows; where that has been done, the conflict of interest policy should be consistent with the agreement, and the agreement should be reviewed with the policy, as our post on updating your bylaws or operating agreement explains.

How the record is kept

The minutes or written consent should state that the conflict was disclosed, summarize the nature of the interest, record that the interested person recused, identify the alternatives considered and any comparison to market terms, and record the vote of the disinterested directors. This record is what protects the transaction later. A challenge to a related-party deal years after the fact is decided largely on whether the documents show the process was followed.

The policy should also require the company to keep the annual statements and disclosure forms in the corporate records, alongside the minutes and resolutions. CLP’s risk management and legal compliance team usually ties the policy to a short compliance calendar: annual statements collected at the same time as the annual consents, with a named person responsible.

Enforcement and consequences

State what happens when a covered person fails to disclose. The policy can authorize the board to rescind the transaction, remove the person from the committee or role involved, or take other corrective action consistent with the bylaws and any employment agreements. It should also give the board a procedure for investigating a suspected undisclosed conflict: notice to the person, an opportunity to explain, and a determination by the disinterested directors.

Nonprofits and investor-backed companies

Two groups treat the policy as mandatory rather than optional. Tax-exempt organizations are asked on IRS Form 1023 whether they have adopted a conflict of interest policy, and Form 990 asks each year whether the organization has a written policy, requires annual disclosures, and monitors compliance. The IRS publishes a sample policy that many nonprofits adopt with modifications.

Investor-backed companies usually face a contractual requirement: the investor rights agreement or shareholders’ agreement requires board approval, often including the investor director’s approval, for transactions with officers, directors, or their affiliates. A conflict of interest policy that matches those contractual terms keeps the company compliant with its investors without a separate process for each deal.

If your company needs a conflict of interest policy or has a related-party transaction to approve, a consultation with Capitol Law Partners can draft the policy and the approval record. Schedule a consultation.

This article is for informational purposes only and does not constitute legal advice. No attorney-client relationship is formed by this communication.

Attorney Cagatay Ersoy. Practical strategy for founders, investors, and growing companies.

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