Shadow director

INTRODUCTION

Shadow director means holder of controlling or majority stock (share) of a private firm who is

not (technically) a director and openly participate in firm’s governance, but whose directions or

instructions are routinely compiled with by the employees or other directors. In the eyes of law,

he or she is a de facto director and held equally liable for the obligations of the firm with other de

facto and de jure directors.

A "shadow director" is someone who has enough influence over a majority of the directors of the

company to be able to influence company decisions.

A "de facto director" is someone who performs the tasks of a director, but are not formally a

director of the company.

So someone who performed company tasks that a formal director should have done, is able to

influence decisions with other directors, is a de facto director. Someone who is able to get the

other directors to do what he wants them to is a shadow director.

A “shadow director”, according to law, is a person in accordance with whose directions or

instructions the directors of a UK limited company are accustomed to act. In short, a shadow

director is anyone who is directly calling the shots at a company or an area within the company.

However, a person is not to be regarded as a shadow director by reason only that the directors act

on advice given by him in a professional capacity.

The Steering Committee for Review of the Companies Act has reviewed the key provisions in

the Companies Act relating to directors and directors’ duties, with a view to identifying areas

which would benefit from reform and refinement. This chapter sets out the Steering Committee’s

recommendations arising from the review. In particular, it relates to the meaning of shadow

director, appointment of directors, qualifications of directors, disqualification of directors on

conviction of certain offences, vacation of office and removal of directors, payment of

compensation to directors for loss of office, loans to directors and connected companies, the

supervisory role of directors, power of directors to bind the company, power of directors to issue

shares of company, directors’ fiduciary duties, imposition of liability on other officers, disclosure

of company information by nominee directors and indemnity for directors.

CORPORATE LAW PAGE 1

Shadow director

OBJECTIVEOBJECTIVE

1. To study the origin of term shadow director.

2. To study about the concept of shadow director.

3. To study its applicability in India.

RESEARCH METHODOLOGYRESEARCH METHODOLOGY

This work is descriptive and analytical in nature. Secondary and Electronic resources have been

largely used to gather information and data about the topic.

Books and other references as guided by Faculty of Law have been primarily helpful in giving

this project a firm structure. Websites have also been referred.

Footnotes have been provided wherever needed, either to acknowledge the source or to point to a

particular provision of law. Uniform citation has been followed.

CORPORATE LAW PAGE 2

Shadow director

HISTORY OF SHADOW DIRECTOR

Reviewing UK Legislation the term “shadow director” is first defined in the UK s.63 of the

Companies Act 1980 as “a person in accordance with whose directions or instructions the

directors of the company are accustomed to act1.

English judicial precedents are therefore helpful in order to better understand what factors are

used to determine whether an individual or a corporate entity is a shadow director. A useful

starting point is Harman J’s description that the Shadow Director must be in effect “the puppet

master controlling the actions of the board” Re Unisoft Group case2 which in turn implies that

his influence stretches across the majority of the company’s directors. If only a minority of

directors of the board are accustomed to acting according to a person’s instructions this is not

enough to make that person a shadow director Kuwait Asia Bank EC v National Mutual Life

Nominees Ltd3.

Furthermore, a shadow director must have been giving the majority of directors instructions as a

regular practice over a period of time (Re Unisoft Group). A one-off instruction, even if accepted

by the majority of directors, is unlikely to give rise to the figure of the shadow director.

Ultraframe (UK) Ltd v Fielding4 the High Court clarified a number of matters concerning shadow directors and de facto directors.

A shadow director is defined in section 251 of the Companies Act 2006 as a person in

accordance with whose directions or instructions the directors of a company are accustomed to

act (although a person is not deemed to be a shadow director simply because the directors act on

advice given by him in a professional capacity).

1 http://www.city.ac.uk/__data/assets/pdf_file/0008/133937/Shadow-Director.pdf

2 1994 BCLC 906 Court of Appeal3 1990 3 All ER 4044 2005 EWHC 1638 (ch)

CORPORATE LAW PAGE 3

Shadow director

The High Court spelt out what this means in practice:

On the question of who must be accustomed to act, this means that a governing majority of the

board must be accustomed to act in accordance with the directions or instructions of the alleged

shadow director. The purpose of the legislation is to catch a person who effectively controls the

running of the company by controlling the board. Therefore, a person is unlikely to be within the

definition of a shadow director if only one or two directors on a board of several directors follow

his instructions

On the question of how must the directors react to the instructions, the directors must “do

something in conformity with” such instructions. It is not sufficient for the alleged shadow

director simply to give instructions to the directors; his instructions “must be translated into

action by the board”

The directors must act on the alleged shadow director’s directions as a matter of regular practice;

it must be a regular course of conduct of the directors over a period of time.

A de facto director is a person who performs the functions of a director but who has not been

formally appointed as a director. The High Court reiterated that a de facto director is a person

who undertakes functions that should probably only be discharged by a director and who has an

equal ability to participate in decision making.

It is unlikely that a person will be a shadow director and a de facto director at the same time,

although it will be possible for a person to be a shadow director before becoming a de facto

director5.

5 https://walkermorris.co.uk/business-insights/shadow-directors-and-de-facto-directors

CORPORATE LAW PAGE 4

Shadow director

CONCEPT OF SHADOW DIRECTORS

Re Hydrodam (Corby) Ltd6 is a UK company law case, concerning the meaning of a shadow

director, De facto and De jure director, in this case the concept of De facto and De jure director

was first established.

Fact of the cases:

There were two corporate directors of a parent company of Hydrodam (Corby) Ltd, which was a

wholly owned subsidiary of Landsaver MCP Ltd, itself a wholly owned subsidiary of Midland

City Partnerships Ltd, which was, finally, a wholly owned subsidiary of Eagle Trust plc, a TV

conglomerate chaired by David James, Baron James of Blackheath. The liquidator alleged that

the two directors of Eagle Trust, Leslie Thomas and Dr Hardwick, were liable for wrongful

trading, and contended they were liable as shadow directors under the Companies Act 2006

section 251.

Judgment:

Millett J held the directors of the parent were not shadow directors of the subsidiary, just by

being members of the parent company’s board. It would need to be shown that they personally

instructed and directed the subsidiary’s board. The first step is to identify the de jure and de facto

directors, then to say that they had been directed, then that the real directors acted in accordance

with the directions, and then that they were accustomed to do so. For instance there must be a

pattern ‘in which the board did not exercise any discretion or judgment of its own but acted in

accordance with the directions of others’. De facto directors are those who ‘undertook functions

in relation to the company which could properly be discharged only by a director. It is not

sufficient to show that he was concerned in the management of the company’s affairs or

undertook tasks in relation to its business which can properly be performed by a manager below

board level.’

6 [1994] 2 BCLC 180

CORPORATE LAW PAGE 5

Shadow director

Liability for wrongful trading is imposed by s. 214 of the Insolvency Act 1986. The statutory

liability is imposed exclusively upon persons who are or were at the material time directors of

the company in liquidation. But s. 214(7) provides that in the section ‘director’ includes a

shadow director. A shadow director is defined in s. 251 of the Insolvency Act 1986 in these

terms:

‘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.

Directors may be of three kinds: de jure directors, that is to say, those who have been validly

appointed to the office; de facto directors, that is to say, directors who assume to act as directors

without having been appointed validly or at all; and shadow directors who are persons falling

within the definition which the purpose of these appeals only, that the liability imposed by s. 214

extends to de facto directors as well as to de jure and shadow directors. It appears to me that that

concession is plainly correct. Liability for wrongful trading is imposed by the Act on those

persons who are responsible for it, that is to say, who were in a position to prevent damage to

creditors by taking proper steps to protect their interests. Liability cannot sensibly depend upon

the validity of the defendant's appointment. Those who assume to act as directors and who

thereby exercise the powers and discharge the functions of a director, whether validly appointed

or not, must accept the responsibilities which are attached to the office. Nevertheless, the

statutory liability is imposed exclusively upon directors of one or other of the three kinds that I

have mentioned. Accordingly, the liquidator must plead and prove against each defendant

separately that he or it was a director of the company.

A de facto director is a person who assumes to act as a director. He is held out as a director by

the company, and claims and purports to be a director, although never actually or validly

appointed as such. To establish that a person was a de facto director of a company it is necessary

to plead and prove that he undertook functions in relation to the company which could properly

be discharged only by a director. It is not sufficient to show that he was concerned in the

management of the company's affairs or undertook tasks in relation to its business which can

properly be performed by a manager below board level.

A de facto director, is one who claims to act and purports to act as a director, although not

validly appointed as such. A shadow director, by contrast, does not claim or purport to act as a

CORPORATE LAW PAGE 6

Shadow director

director. On the contrary, he claims not to be a director. He lurks in the shadows, sheltering

behind others who, he claims, are the only directors of the company to the exclusion of himself.

He is not held out as a director by the company. To establish that a defendant is a shadow

director of a company it is necessary to allege and prove: (1) who are the directors of the

company, whether de facto or de jure; (2) that the defendant directed those directors how to act

in relation to the company or that he was one of the persons who did so; (3) that those directors

acted in accordance with such directions; and (4) that they were accustomed so to act. What is

needed is, first, a board of directors claiming and purporting to act as such; and, secondly, a

pattern of behaviour in which the board did not exercise any discretion or judgment of its own,

but acted in accordance with the directions of others.

Perhaps the most comprehensive judicial assessment of the term shadow director was carried out

by the Court of Appeal in Secretary of State for Trade & Industry v Deverell & another7 where

it was concluded that:

a. the term should not be narrowly construed;

b. the giving of non-professional advice could result in a shadow directorship;

c. the concepts of “direction “ and “instruction” also included advice, as the common feature

these terms all share is guidance;

d. it would be sufficient to show directors had subordinated themselves or surrendered their

discretion in the face of guidance from the shadow director (although this element may not

always be present);

e. such guidance did not need to stretch across the whole of the Company’s activities;

f. the communication did not necessarily have to be understood or expected to constitute a

direction;

g. it was not necessary to show a degree of compulsion in excess of that implicit in the fact the

company was accustomed to act in accordance with them (although the most clear example of a

shadow directorship is where there is a penalty for not complying with the shadow director’s

instructions); and

h. it is not necessary for the shadow director to “lurk in the shadows”, but this may often be the

case.

7 2001 CLC 905 court of appeal

CORPORATE LAW PAGE 7

Shadow director

CONCLUSION

A “shadow director”, according to law, is a person in accordance with whose directions or

instructions of a company are accustomed to act. In short, a shadow director is anyone who is

directly calling the shots at a company or an area within the company. However, a person is not

to be regarded as a shadow director by reason only that the directors act on advice given by him

in a professional capacity.

A shadow director is treated in many ways as a real director of the company concerned and so

will be bound by the same duties and obligations. However, in most cases the shadow director is

unaware of his/her need to comply with the laws relating to directors and accordingly takes no

protective action. Furthermore, the shadow director may not be covered by the company’s

directors’ and officers’ liability insurance (if any). The issue whether a corporate shareholder

could be regarded as a shadow director in a situation where its nominee director did not exercise

independent judgment and only acted in accordance with the instructions of his corporate

shareholder should be left to the court if such a case arises.

More importantly, both the shadow director and de facto director must be acutely aware of the

duties that are imposed upon them by law so as not to fall short of these requirements.

Finally, it should be kept in mind that the existence of a shadow or de facto director could have a

direct impact on the place in which the company is deemed to be managed and controlled, which

circumstance can lead to important tax consequences.

CORPORATE LAW PAGE 8

Shadow director

BIBLIOGRAPHR

https://answers.yahoo.com/question/index?qid=20131029024226AAXIG7j

http://www.caclubindia.com/articles/shadow-directors-myth-or-reality-

16347.asp#.Uz00lPl3j6c

http://www.city.ac.uk/__data/assets/pdf_file/0008/133937/Shadow-Director.pdf

http://www.legal500.com/assets/images/stories/firmdevs/hassans_shadow-and-de-facto-

directors.pdf

http://www.businessdictionary.com/definition/shadow-director.html

CORPORATE LAW PAGE 9