What is a Shadow Director?
I often hear the term 'shadow director’; being bandied around by non-lawyers, but when I ask them what it means to them – their definitions vary. So, what is one?
My short answer is: Someone who the directors of a company are accustomed to taking instructions from and acting upon, without exercising their own discretion. In its rawest form, this is often a controlling shareholder (not a director) dictating what the directors do, and them doing it without question. However, there are variations on this and the existence of a shadow director will be a question of fact in the circumstances.
There are 3 types of director:
- De jure: Someone validly appointed as a director (for the purposes of this article, this includes alternate and nominee directors). The directors register should show this.
- De facto: Someone who acts as, and takes on the role of director, even though not appointed as one. The test is whether they are part of the company's governing structure to the extent they assume the functions of director. This is a question of fact in the circumstances.
- Shadow: Someone in accordance with whose instructions the directors of a company are accustomed to acting. The test for this can often be a little more grey.
To establish that someone is a shadow director you need to prove:
(i) Who the de-jure and de-facto directors are
(ii) (ii) that the alleged shadow director instructed those directors how to act (or was part of a group that did so)
(iii) (iii) that those directors acted in accordance with such instructions, and were accustomed to doing so (not a one off)
There must be a pattern of behaviour rand it is generally enough to show that when given instructions by the alleged shadow, the majority of the directors waive their discretion and act as per those instructions.
A common misconception is that a shadow director must 'lurk in the shadows'. That's not right (although they often do). They may openly (to the outside world) give instructions to the directors but take no part in management.
Someone is not a shadow director just because the directors follow their advice (e.g. professional advisors or experts). They must have real influence over the company, although it does not have to be influence over all of the company's activities.
In my experience the following people need to be careful they don't cross the line into shadow directorship:
- Management / turnaround consultants (incl. company doctors). They need to be clear about where their role begins / ends and make sure they don't inadvertently become a shadow director; and remind the directors that they must exercise their own judgement (and allow them to do so).
- Controlling shareholders (incl. holding companies). They will not automatically be a shadow director unless the ley criteria outlined above is met). Sometimes controlling shareholders forget that the company has its own legal identity and responsibilities (e.g. its money is not the shareholder's money).
- Directors of shareholders, their own personal actions must separately make them shadow directors. An example: Assuming the criteria are met, then where the directors of a parent company individually issue instructions to the directors of a subsidiary, they would be a shadow director of the subsidiary; but if they only act in their capacity as a director of the parent (e.g. passing parent board resolutions) then the parent would be the shadow director.
- Investors who:
Appoint nominee directors. A nominee director owes the same duties as an ordinary director, and should exercise their own independent judgment
Implements investor controls that are too controlling. There is a line between what is necessary and reasonable (to protect their interests) and becoming a shadow
- Lenders and creditors. They are allowed to protect their interests, and that alone does not make them a shadow director. Likewise imposing conditions on providing financial support does not make them a shadow director, even if the directors consider they had little practical choice but to accept them (there is always the choice not to accept the money). They must go that step further.
- Founders who sell their company and, as part of the sale agreement, insert a broad list of restrictions / controls on what the buyer can do without their consent. While this is often primarily aimed at protecting reputation by association, I have seen circumstances where they have gone too far and arguable become a shadow director (because they can't let go).
The consequences of being a shadow director are that they adopt the duties, risk and liabilities of being an actual director. Their duty is to act in the company’s interests (or that of its creditors where insolvent) rather than their own when giving instructions to the actual directors.
Shadow directors are also subject to the disqualification regime (disqualification of unfit directors); and personally liable for wrongful trading, misconduct, misfeasance, breach of fiduciary duty and the various other potential personal liabilities that attach to a director who breaches their duties.
For further information on Shadow Directors please contact Frank Bouette or you can give us a call on 0345 070 6000.