The prohibition of competition by directors: a mechanism to prevent unfair competition

Corporate governance carries with it a great deal of responsibility. A major concern is the potential conflict of interest of directors. In certain cases, a director could take advantage of his position to establish his own company, which is a direct competitor of the company he manages, thus diverting business opportunities or valuable resources to his benefit. To avoid such situations, the Capital Companies Act establishes the prohibition of competition, a mechanism that protects the corporate interest and guarantees the loyalty of directors. In this way, the creation of parallel companies is prevented from damaging the company’s assets and stability.

In this article we will discuss the legal basis of this prohibition, its scope, the possibilities for exemption and the consequences of non-compliance.

Basis and scope of the prohibition of competition for administrators

Article 229.1 f) of the Capital Companies Act prohibits directors from carrying out, for their own account or for the account of others, activities that are identical, similar or complementary to the company’s corporate purpose. This rule arises as an extension of the duty of loyalty, which obliges managers to always put the interests of the company before personal gain.

In simple terms, the aim is to prevent the director from taking advantage of his position to compete with the company itself, benefiting from opportunities or resources that should be used exclusively for the development of the business.

The scope of this prohibition is wide. It not only prevents direct competition, but also extends to indirect or complementary activities. This means that if a director participates in another entity – either as a partner or in a managerial position – that engages in a similar activity to that of the company, a conflict of interest may arise.

Likewise, the prohibition is deemed to be breached when the beneficiary of the competition is a person related to the trustee.

Judicial interpretation has helped to define and broaden the scope of this rule. Repeated rulings have recognised that it is not necessary to prove specific acts of disloyalty, such as the attraction of customers or the diversion of business opportunities. It is sufficient to prove that the director, without due authorisation, engages in activities that compete with the company’s corporate purpose.

Possibility of exemption from the non-competition obligation

Although the Capital Companies Act prioritises the interests of the company over the private benefit of the director, this prohibition is not absolute. In certain cases, a degree of flexibility may be necessary in order not to hinder business opportunities that, if well managed, could also benefit the company.

Therefore, Article 230 of the Capital Companies Act provides for the possibility of granting a dispensation from the prohibition of competition. This mechanism allows the director to be authorised, under certain circumstances, to carry out activities which, in principle, would be incompatible with the company’s corporate purpose.

For the waiver to be valid, certain requirements must be met:

1. Ensure that there is no harm to society: A waiver is only possible if it can be demonstrated that the authorised activity will not cause harm to the assets or functioning of the company. If there is a potential risk, this must be offset by benefits to society.
2. Express and separate agreement: The authorisation must be adopted clearly and specifically at the General Meeting, without room for ambiguous interpretations. In addition, the dispensation must be granted on a situation-by-situation basis, and a general authorisation to compete must not be included in the articles of association.
3. Qualified majorities and duty to abstain: To approve the dispensation, a favourable vote of two thirds of the votes cast is required, according to Article 199 b) of the Capital Companies Act. If the director who benefits is also a shareholder, he/she must abstain from voting in order to avoid influencing the decision.

Consequences of non-compliance with the prohibition of competition for administrators

A breach of the non-competition prohibition by a director has significant legal and practical implications for the company. These measures seek to protect the corporate interest and to deter any conduct that may give rise to conflicts of interest.

The main consequences include:

• Removal or dismissal of the director: If it is found that a director has engaged in unauthorised competition, any shareholder or the company itself may request his or her removal (Article 223 of the Capital Companies Act).
• Liability action: The director who breaches the prohibition violates his duty of loyalty, which may give rise to a corporate liability action (Article 236 of the Capital Companies Act). This action seeks to repair the damage caused to the company and can be brought by the shareholders or the company, provided that real damage is proven.
• Exclusion of the director as a shareholder: In certain cases, when the offending director is also a shareholder of the company, the General Meeting may decide to exclude him or her (Article 350 of the Capital Companies Act). This measure is applied when the director’s conduct seriously harms the company’s interests.

Practical considerations

From a practical perspective, it is crucial that both directors and partners have a thorough understanding of these provisions. The possibility of granting a waiver recognises the reality of business where, in certain circumstances, it may be beneficial to authorise competitive activities.

However, this authorisation must be subject to strict controls and a rigorous analysis of its possible negative impacts on society.

In order to identify potential non-compliance, it is important to pay attention to certain red flags that may indicate a conflict of interest:

• Creation of new companies: If a director founds or participates in companies with activities similar to those of the company he/she manages, this may constitute unfair competition.
• Misuse of corporate resources: If the company’s assets are used to benefit another company without economic justification, a conflict of interest may arise.
• Changes in attitude or disinterest in management: Lack of involvement of the manager or unusual behaviour may indicate that he or she is engaging in competing activities.

In the face of these signals, shareholders must act quickly. They can call a General Meeting to discuss the situation or, in serious cases, resort to the immediate dismissal of the administrator and to legal action to claim damages.

Conclusions

The prohibition of competition by directors is an essential tool to ensure the integrity and stability of limited liability companies. By requiring directors to act in the best interests of the company, the law protects shareholders from unfair competition and prevents managers from using their position to set up parallel companies that divert business opportunities and strategic resources.

The broad scope of this prohibition – covering direct, indirect and ancillary activities – underlines the importance of preventing conflicts of interest that could affect the development and sustainability of the company.

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