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The board of directors of a company is not limited to de-jure directors (directors by law), who are elected to the board. Some of the directors are de-facto(directors by fact) and shadow directors as well. They are not exactly elected but exercise functions and powers like a de-jure director. Section-250 of the 2006 Companies Act of the United Kingdom(UK)provides that formal consent is not required to be a director which means that a person can be a director just by his acts.
The Board of directors is appointed by the shareholders of the company who want the company to prosper as they have contributed their money into it. Shareholders, therefore, provide the directors with power and also with an equally important responsibility. A director has to run a company, complying with the need for prosperity, growth, and ethical standards of the company. Therefore, the directors are held accountable if the company becomes insolvent. Even the de-facto and shadow directors are made accountable as they make decisions for the company. De-facto directors are sought in a lack of de-jure directors for a company. They are also subjected to any liabilities that a de-jure director would incur in dealings of the company, based on trustees de son tort. A director is restricted from being appointed as a director or secretary and from taking part in the promotion of a company, directly or indirectly, for a certain period of time, if his company becomes insolvent. Such restrictions are not imposed if the director has acted honestly and reasonably and even then, the company became insolvent.
There has always existed debate on grounds to determine a person as de facto or shadow director. Since shadow directors are provided with some exemptions, while de-facto directors are not, in some provisions, even in the currently existing Companies Act in the UK, it is important to differentiate between de facto and shadow directors. The analysis section incorporates the Irish Companies Act, 1990, as it specifically mentions de-jure and shadow directors and restrictions upon them, when a company goes insolvent. The analysis part also incorporates criticisms of the case at hand and how concepts of de-facto and shadow directors have developed.
The case was decided in 1998 and was presented before Robert Walker LJ, Thorpe LJ, and Stuart Smith in Court of Appeal, Civil Division, UK. The case was brought by Secretary of State for Trade and Industry based on Company Directors Disqualification Act, 1986, seeking for disqualification of an alleged director of an insolvent company. The person who was complained about was not a de-jure director, but disqualification was sought based on the allegation he was a de facto director.
- Who is a de-facto director and how is it defined?
- Should the director be disqualified?
Decision by the Court
It was concluded that the respondent was a de-facto director as he had helped raise capital for the company and had also described himself as a director once. Therefore, an order of disqualification was passed. The court decided that involvement in all of the company’s affairs was not required to be a shadow/de facto director. The court also decided that the concept of de facto and shadow directors were not necessarily mutually exclusive. It was also held that a person is provided the benefit of the doubt when it becomes hard to establish his directorship, as decided in a previous case, but the court decided that the facts must not be strained by the courts to submit to this observation.
Difference between de facto and Shadow Directors
Some claim that the position of de-facto and shadow directors are mutually exclusive. Nevertheless, there exists a fundamental character to both de-facto and shadow director; both have a capacity to exert real influence on the company. While determining whether a person is a shadow director or a de facto director, the grounds are fairly the same. Thus, we observe that courts, while providing grounds to determine either shadow director or de facto director, provide grounds for determining the other type as well. Therefore, aground for differentiation is the definition in the statute itself.
There has been a “wrong turn” in the debate regarding who a shadow and a de-facto director is. In re Gasco Ltd., a person who effectively ran the company was restricted under Section-150, of the Irish Companies Act, 1990, but the court concluded that he was a shadow director rather than a de-facto director. As per Section-27 (1) of the 1990 Act, shadow director is a person who gives directions and instructions to the company and the company is accustomed to act according to the instructions. Therefore, the shadow director is not someone who actually manages the company but gives advice.
The distinction between de facto and shadow directors have been nuanced since the decision of the present case and Holland case.Shadow and de facto directors, “assume the status and function of a director” and have “real influence in the company’s affair”. These decisions can help in determining if a person falls under the umbrella of “non- de jure director”. Now, the problem of the distinction between de facto and shadow director arises, within the umbrella. To resolve this, we can simply see the definition provided by the act. Such distinction is important because, in many provisions of the act, shadow directors are not made liable while de facto directors are. In case of restriction on directors due to insolvency of a company, de-jure and shadow directors are on equal footing. Shadow directors have no exemption of any kind from such restrictions. This must be why in the case of Kaytech, the judges didn’t focus on differentiating the two.
As per the definition provided by Section-251 of the Companies Act, 2006, shadow directors are the persons, whose instructions the directors of the company are accustomed to. The exception is if instructions are being provided in professional capacity. The definition was same in the 1990 Act as well. Here again, a problem arises. The definition simply says “directors of the company”. It also doesn’t use phrases such as “some of the directors” or “majority of directors” but it has been accepted that the provision means “majority of directors”. Further, the words “accustomed to act” suggests more than one occasion, over a period of time.The real purpose of the section is to identify shadow directors other than professional advisors who have control over the affairs of the company.The words “directions or instructions” do not require influence to be exercised over the whole field of a company’s activities.Differentiation between de facto and shadow can be made as; shadow directors don’t take the name as directorsbut advise the board of directors (including de facto and de jure directors) in an influential manner while de facto directors are simply directors who didn’t have to go through the process of appointment but are somewhat a part of the board of directors.
Determining a de-facto director
In the case Re Hydrodam (Corby) Ltd., Millet J. said that, to establish and prove that a person is a de facto director, it was necessary to see if the person had taken functions which could have only been discharged by a director.So, what is the function of a director? To answer this, it was important to determine the duties of a director under the common law. A director owes duty to inform himself of the affairs of the company and supervise the affairs with other co-directors.Therefore, a person who undertakes such duties are de-facto directors. Lord Hope said that, merely being engaged in management of affairs and tasks of business in a company didn’t make one a director, as such acts could have been done by managers as well. Assuming the function and status of a de jure director while being involved in corporate governing structure can also establish that a person is a de facto director. Actions of de facto directors can bind the company as if they function as appointed directors.In addition, some say that there is another independent test as well. The individual in question may also be part of an “ultimate decision-making body” in management of the company or directs and supervises the management, to be a de facto director. Nevertheless, the concept of directorship is narrower than management.
Test in Re Richborough Furniture
O’Neill J followed the test used in Re Richborough Furniture Ltd.It provided three circumstances for a person to be de-facto director. One is if the person was the only person directing the affairs of the company. Second is, the persons had been directing affairs with other, while lacking appointment as a director. Third is that, his influence is equal to or more than the influence of the de jure directors of the company. A limitation provided to this test is that if the role can be performed by anyone other than a director, the person shall not be called a de-facto director. This test has been subject to criticisms in the UK.
Multi-Functional Test and Balance of Probabilities
Jacob J in Secretary of State for Trade and Industry v Tjolle, said that one decisive test to determine de facto directorship was difficult and the court should consider relevant factors like; holding out of the person as a director by the company, use of title of director by the person, duty in major decision of the company, etc. He said that these factors are to be considered, else, a person would be made liable for a position which he didn’t acquire and for powers he didn’t exercise,that came along with the position. This argument was accepted by Mrs. Justice Finlay Geoghegan and endorsed by Robert Walker L.J, as well.Robert Walker LJ, in the present case, said that some of these circumstances are to be fulfilled but not all. Further, he added that the crucial determining point is, assumption of the status and function of a director of the company, by the person and claimed that even Jacob J accepted this.Mrs. Justice Finlay Geogheganfurther concluded that the application of the section was to be proved on balance of probabilities, in case of de facto and shadow directors. This means, for a person to be de facto or shadow director, the probability that the person is a de facto or a shadow director must be higher than the probability of the person not being so.
To determine whether a person holds the position of a de facto director, all circumstances must be looked upon and multi-functional test must be done. To establish a person as a de-facto director, the most important factor is that he must have acted on an equal footing with the other directors, rather than acting on a sub-ordinate position. Judge Crook interpreted this equal footing test as having an equality in ability to involve themselves in board meetings.  Jacob J. in Secretary of State v. Tjolle, had applied a similar concept although not expressly mentioning it.
In the case Declan Gray (liquidator) v. John McLoughlin, Mrs. Justice Finlay Geoghegan concluded that the person in question was a director based on the facts that other de jure directors of the company considered him as director, he was participating regularly in board meetings, he was a cheque signatory to the company, he had full information of the affairs of the company, controlled availability of financial information in the company and his control and supervision were beyond financial function. Therefore, the court sorted to check the relevant factors of the case before passing a decree, which was that the person in question did assume status and function as a director of the company. Nonetheless, they were not restricted from future appointment to other companies. Here again, to determine whether they acted honestly and reasonably, the court again sorted to checking the relevant factors of the case. Here, although the directors invested in under-capitalized company and incurred significant debts, it was a fact that they organized the financing and improved business profile which helped in getting loans. Therefore, their honesty was proved.
Holding out of a person as a de facto director
In the case of Gemma Ltd v. Davies, the court referred to various cases which dealt with de facto director. Etherton J said that “holding out” can be an important evidence which supports the claim that the person was a director to the company. Nevertheless, holding out is not sufficient to establish the claim. What he did is to be looked upon rather then what he called himself,or what other hold him out as.
Determining Shadow Director
It is not necessary for a “shadow” director to lurk in the shadows as the name itself suggests. Further, it was also not necessary for a shadow director to cover everything by their direction or instructions as decided in the case of Secretary of State for Trade and Industry v Deverell. This was one of the first cases to deal with shadow directors in the UK. This decision widened the net of liability as the test done to determine who a shadow director was, was fairly flexible. However, conduct forced from a person due to financial lending arrangement or transaction didn’t constitute shadow directorship.
To establish a person as shadow director, it is sufficient if the de jure directors make themselves subservient to the guidance of the alleged shadow director. It is not necessary that influence should be exercised over every field of activities.Interpreting “shadow” directors literally as someone who doesn’t work out in the open has been misleading. They can operate out in the open but according to the definition of the statue. Further, it has also been observed that courts have been misled into thinking that a certain degree of control is required for a person to be a shadow director while statutory definition doesn’t require any such degree of control.
Sir Nicollas Brown-Wilkinson opines that de-facto directors are covered under Section-212, Insolvency Act and also in Enterprise Act, 2002. The purpose is to make liable a person who exercises real direction control but for whatsoever reason has lacked appointment as a director to the company. Further, as already mentioned some directors are provided with exemption from some liabilities. Therefore, differentiation among them is necessary. In case of insolvency of a company, all the de jure, de facto and shadow directors provided with restriction and therefore, the case judges in Re Kaytech have provided that it is not necessary for them to be mutually exclusive and differentiate between the two. This created a lot of confusion. While other judgments of the present case were accepted, the judgement that de facto and shadow directors are not mutually exclusive, has been rejected, in the present. The claim that a person may be both shadow and de facto director at the same time, has also been rejected.
The conduct of a person should be seen rather than his intent in determining his position.Multi-functional test must be used so as to determine directorship and its type. Circumstances of the case must be analyzed by the court. In the present case, Robert Walker LJ determined that the person was a de facto director due to his activity of raising capital for the company. Therefore, the court adopted multi-functional test. While there are common grounds for a de jure and shadow director, like, real influence on the company and assumption of status and function of a director, we must also look into the difference. De facto directors actually manage the company as a director and might also use “director” as his title at times but shadow director merely advices the board of directors in an influential manner. Such interpretation has been accepted in the present as well. A de-jure director can act whole relying on de facto and shadow directors, therefore, courts have provided liabilities to such directors as well, as problems arising in a company can be due to their actions as well.
Also read Director’s fiduciary duty of good faith
Companies Act, Section 250 (2006).
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 Re Hydrodan (Corby) Ltd.  2 BCLC 180 (Eng.).
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 Revenue and Customs Commissioners v. Holland  UKSC 51 (Eng.).
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Declan Gray (liquidator) v. John McLoughlin  IEHC 289.
Re Kaytech International plc.; Secretary of State for Trade and Industry v. Kaczer BCC 390 (Eng.)
Declan Gray (liquidator) v. John McLoughlin  IEHC 289.
Re Richborough Furniture Ltd  1 BCLC 507 (Eng.); Secretary of State for Trade and Industry v. Hollier EWHC 1804 (Ch) ,  (Eng.).
 Secretary of State for Trade v. Elms ( unreported).
Secretary of State v. Tjolle 1 BCLC 333,  (Eng.).
Declan Gray (liquidator) v. John McLoughlin  IEHC 289 (Eng.).
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