Directors' duties: can a director be liable even if not formally appointed?

5th June 2018

Two recent cases in the High Court have explored the differences between de jure, de facto and shadow directors and looked at when individuals, whether formally appointed as directors or not, can be held responsible for breach of their directors’ duties.

Classification of directors

Any director of a limited company should understand the duties that are imposed upon him by common law and the Companies Act 2006. Accepting the position of director should not be undertaken lightly or in ignorance of those duties and responsibilities. There are three types of director recognised under company law; a de jure director, a shadow director and a de facto director. An individual who is formally appointed to the position of director and whose appointment is registered at Companies House is said to be a ‘de jure‘ director.

Shadow directors

As referred to above, company law imposes a wide range of duties and responsibilities on company directors. These are coupled with penalties and sanctions for breach, and the possibility of disqualification from acting as a director under the Company Directors Disqualification Act 1986. The effectiveness of this regime would be greatly diminished if an individual could avoid liability by ensuring that he was never formally appointed as a director, while still being able to direct and instruct the appointed directors. Thus the statutory concept of a shadow director was created by section 741(2) of the Companies Act 1985 (and largely restated in section 251 of the Companies Act 2006) to help address this concern. The Companies Act 2006 provides that the term ‘shadow director’, in relation to a company, means a person in accordance with whose directions or instructions the directors of the company are accustomed to act.

The name ‘shadow director’ suggests a background figure who deliberately conceals his real influence over the company’s directors. However, in Secretary of State for Trade and Industry v Deverell [2001] it was emphasised that it is not necessary for a shadow director to lurk in the shadows, though frequently he may. For example, in the case of a person resident abroad who owns all the shares in a company but chooses to operate it through a local board of directors, if he is exerting influence over the directors he could be classed as a shadow director. In Revenue and Customs Commissioners v Holland [2010], Lord Walker referred to a chief executive of a group of companies who openly gives directions to the board of a subsidiary on which he does not sit as potentially being a shadow director.

The concept has moved on from the time when a shadow director was commonly assumed to be a person with a dubious commercial reputation who needed to hide his association with the company from the public, and who often could not be formally appointed even if he wished to be because he had been disqualified from acting as a director.

It is important to note that, depending on the facts and circumstances, shadow directors can be subject to the same fiduciary duties as de jure directors. This will include, for example, liability for wrongful trading under section 214 of the Insolvency Act 1986. The term ‘director’ is widely defined by the Insolvency Act 1986 to include any person occupying the position of director, by whatever name called, and so references in section 214 to a director includes a shadow director and a de facto director.

De facto directors

In addition to de jure directors and shadow directors a third type of director exists, the de facto director which literally means a director ‘in fact’ (rather than ‘in law’). Up until the 1980s a de facto director was the term applied to someone who had purportedly been appointed as a director but whose appointment was defective in some way, or alternatively someone who had been validly appointed as a director, but later ceased to be one and yet continued to act as a director. These days, however, the definition of a de facto director has become more expansive. Since the Supreme Court decision in Revenue and Customs Commissioners v Holland [2010] it has been clear that there is no definitive single test for a de facto director and a person may be a de facto director even if there has been no invalid appointment. In that situation, the question is whether he has assumed responsibility to act as a director.

The court will in general have to determine the corporate governance structure of the company so as to decide in relation to the company’s business whether the person’s acts were directorial in nature. The court is required to look at what the person actually did and not any job title given to him. The question of whether or not a person is a de facto director is to be determined objectively and irrespective of his motivation or belief and relevant factors include:

• whether the company considered him to be a director and held him out as such
• whether third parties considered that he was a director.

Recent cases

The first recent case to look at the question of de facto directors is David Ingram (Liquidator of MSD Cash & Carry plc) v Mohinder Singh & Others [2018] where a liquidator applied for various orders following the liquidation of a family cash & carry business. The company had traded as a wholesale alcohol cash and carry business until 2010 when it sold most of its stock to an associated company which then began trading mainly in excess duty suspended products. The first respondent was the major shareholder and director until he resigned in June 2011. The third respondent had been a director, and the fourth respondent had been the company secretary. The second respondent, who was the first respondent’s son, had worked as a buyer for the company. One of the questions that the court had to answer was whether the second and fourth respondents were de facto directors of the company in liquidation.

The court held (following Revenue and Customs Commissioners v Holland [2010]) that the test for a de facto director was whether a person solely directed the affairs of a company, or acted on an equal footing with other directors, whether they had been held out by the company as a director, or whether they were part of the corporate governing structure. In the instant case, there had been no formal governing structure. The second respondent had assumed a role in the company sufficient to impose a fiduciary duty to the company and to make him responsible for misuse of its assets. He had acted on his own authority and he was one of the nerve centres from which activities of the company radiated.

The liquidator succeeded in his claims that setting-off an amount owing to a director on his loan account against the value of assets transferred to the associated company had been a preference, that a credit note issued to the associated company was void, that two purported cash payments from the associated company remained outstanding, and that two de facto directors of the company were liable to account.

The second case to shine light on de facto directors and shadow directors and the distinction between the two is Instant Access Properties Limited (in Liquidation) v Mr Bradley John Rosser & Others [2018] EWHC 756. In this case the liquidators of Instant Access Properties Ltd (Company) brought an action for breach of fiduciary duty against certain individuals who, the liquidators claimed, were de facto and/or shadow directors of the Company. The breach was in relation to an alleged fraud on the creditors as a result of a commission-sharing arrangement with other companies in which those individuals had interests. The court was asked to determine whether Mr Moore and/or Mr Rosser were de facto directors or were shadow directors. If they were de facto directors, the court agreed that they owed the same duties to the company as would a de jure director. If they were shadow directors, there is a separate question as to whether they owed fiduciary duties to the Company and, if so, which duties.

It is clear that the question of whether a person is a de facto director or a shadow director depends upon the specific facts of each case. There does not appear to be a clear legal test to help the court decide whether a person is or is not a de facto or a shadow director. For the purpose of deciding that question, the judge said that it is necessary to focus on what the person actually did in relation to the company. Whilst in earlier cases, there were said to be clear distinctions between a de facto director and a shadow director, those distinctions have since been blurred and it is now possible to be simultaneously a de facto director and a shadow director.

Mr Justice Morgan examined the relevant case law and on the facts of the case found that the individuals were indeed shadow directors, at least in relation to some parts of the Company’s activities, but not de facto directors.

The judge held that, as shadow directors they owed a fiduciary duty to the Company however if they were to be found to have breached that fiduciary duty, they would not be liable to account for any loss arising from that breach since a de jure director in the same position could rely on section 1157 of the Companies Act 2006 to be relieved from such liability.

WM Comment

The above cases add some clarity to the distinction between de facto directors and shadow directors. In the case of an ordinary commercial lending, the likelihood of a lender being a shadow director of a borrower company may not be significant where that company is solvent and the relationship with the lender is on a relatively formal basis. However, where the company is in financial difficulties, or is deemed to be at risk of becoming so, the relationship between the parties will become closer. A particular area of risk for the lender is where it appoints someone to carry out a business review of the company and to work with the directors to try to restructure the company. If the directors are struggling, they may in turn look to the appointee for assistance and guidance (especially where the appointee is experienced at rescuing ailing businesses). However, the judge in Instant Access Properties referred to earlier case law in which it was said “A lender is entitled to keep a close eye on what is done with his money, and to impose conditions on his support for the company. This does not mean he is running the company or is emasculating the powers of the directors, even if (given their situation) the directors feel that they have little practical choice but to accede to his requests. Similarly with customers who may, because of their buying power, be able effectively to dictate conditions to their suppliers (or the other way around). In other words a position of influence (even a position of strong influence) is not necessarily a fiduciary position. To find otherwise would place a wholly unfair and unnatural burden on men of business.”

 To minimise the risk of being a shadow director or a de facto director, a lender (and any individual engaged at the behest of a lender who does not intend to act as a director) would be well advised to take precautionary steps to avoid liability (for example for wrongful trading), including:

• stating clearly in writing at the outset, and subsequently confirming to the board of directors, that any views expressed are solely with a view to protecting the lender’s interests, and that it remains for the board to manage the company and make decisions
• if communicating the view that the lender will continue to support the company upon certain conditions being met, repeating the basis on which these conditions are given, ensuring that the conditions are not presented as instructions  (ie it is up to the board to decide whether or not to accept these) and, where possible, suggesting that the board discusses the conditions and other requirements with the company’s professional advisers and then responds formally to the lender
• avoiding becoming a signatory of the company in any capacity or representing the company to any external authorities.