Shadow Director under the Companies Act, 2013

This article begins by defining the concept of directors, types of directors and then in great detail analyses the concept of Shadow Director. Meaning, legal status and role of shadow director is defined very clearly by way of various case laws. Ultimately the article is concluded by doing a comparative study between the law of United Kingdom and the law of India on Shadow directors.
Estimated Reading Time: 14 minutes

Introduction

A corporation is invisible, artificial and an intangible person which exists only as a fiction of law, in the contemplation of law. It does not have enough capacity i.e. brain and body to make decisions and put them to action. Therefore, it is compelled to act through other[1]. A company must have directors for this job. A director is appointed to direct the manner of daily business activities along with meeting the financial and statutory obligations of the company are met with. While carrying out these duties, they must act lawfully, honestly and make decisions which favour the company and its members. The term ‘Director’ is defined in the Companies Act, 2013 (hereinafter referred to as ‘the Act’) in Section 2(34) to mean any person appointed by the Board of any Company. There can be a single Director; but, on the contrary, it is advised that to ensure smooth functioning there must be more than one director for every company except a one-person company where one director suffices. Shadow Director

A ‘Board of Director’ is the term used jointly for the ‘Directors’. Section 2(10) of the Act is of utmost significance in this regard which defines the term Board of Directors. The term, in regards to a company, is a body formed collectively by all the Directors of a Company.

Position

The ‘Board of Directors’ (hereinafter referred as “Board”) is a professional group of persons serving a company in the capacity of a Director duty bound to direct the affairs of the company. The Directors are seen as the face of an association and termed as ‘Officers’ of a company. Their position is of an agent, a trustee or a Managing Director in a Company.[2] He is the controller of the affairs of the organisation and alongside can also be employed in any other capacities for the company[3]. It was recognized in the case of Fergusson v. Wilson[4] that the Directors are agents of the company, in the eyes of law. The court also observed that “The Company is not a person, its actions can be regulated through living persons, who are generally the directors of the company and the persons associated with the company to regulate and manage the affairs are agents of the company. Therefore, there is a principal-agent relationship between the company and its Director.”

Therefore, the relationship between the company and a director is governed by the principles of agency. There are various kinds of Directors that a company has. Each type of Director is provided with a specific work to be done as his portfolio in a company. Therefore, the qualification for each kind of director varies from one another.

The prosperity of any organisation relies upon the capabilities and truthfulness of its employees, mainly the ones at the top level i.e. the directors. It, therefore, is imperative that the management of a company is bestowed to correct persons[5]. Therefore, the Act makes strict provisions for the appointment and regulation of service of the directors in a company. According to the mandate of Section 149 of the Act, there is a requirement posed on all kinds of companies as to the minimum number of Directors that they must employ. A Public Company must have three, a Private Company must have two and a One Person Company must have one director at all times. The Act also puts a cap on the maximum number of directors. The number is set at 15, for all companies. According to the sub-section (2) of Section 149, a company cannot act as a Director for another company which provides for a mandate that only an individual can be appointed as a Director for a company. This vice was removed by the Companies Act of 2013. Earlier, in the absence of this provision, the scenario of companies acting as directors of other companies was rampant. It is important in ways more than one because if a company is allowed to be a director for another company, the liability cannot be demarcated, allowing companies and individuals to escape the catch of law. An individual must get a Director Identification Number before being appointed as a Director in any company, as provided for under Section 154[6]. A listed company shall have at least a third of its total directors being Independent Directors, as per the qualifications mentioned in the Act for an independent director. The government. may prescribe such class of companies which must have one woman Director in its Board. Additionally, every company shall appoint one Full-Time Director for all times. A Full-Time Director is a person who lives in India for more than 182 days in a year. A company may be mandated to appoint one director to represent the interests of minority share-holders[7].

Types of Directors

There can various kinds of Directors in a company. It is not a necessity for a company to have all the following types of Directors. If a company is mandated to have a type of Director specifically, either that is provided in the Act or the same shall be notified by the government categorically for a company or a group of companies. The following are the types-

Residential Director- As per Section 149(3) of the Act, every company must have one residential director at all times. All kinds and classes of companies must have one residential director at all times.

Independent Director- Further, according to Section 149(6), an independent director is aperson who has been appointed as a director but is not a managing director or a whole time director. The following public companies are mandated to appoint two independent directors[8]

  • A company which has a paid up share capital amounting to Rs 10 Crore or more.
  • A company with a turnover of Rs 100 Crore or more.
  • A company with aggregate loans, debentures and deposits amounting to Rs 50 Crore or more.

Director for small shareholders- Every listed company must have one Director for small shareholders appointed through an election. A director for small shareholders is chosen with the consent of not less than 1000 members or a tenth of theshareholders, whichever is lesser.

Alternate Director-According to Section 161(2), the Articles of Association (hereinafter referred as “Articles”) of any company may allow for the appointment of an Alternate Director on behalf of a director who is not in India for three months or more than that, at a time.  He shall be in that position until the original director is in a position to resume his job.

Additional Director- Section 161(1) allows the Articles of a Company to empower the Board to choose an additional Director. Such a person will be the director till the next Annual General Meeting of the company is conducted, where a decision in regards to his Directorship shall be made.

Women Director- Proviso two to Section 149(1) (a) provides that certain companies may be mandated to have one woman in its Board, at least, mandatorily. This requirement is currently applicable on a listed and a public company with-

  • A paid-up capital share of Rs 100 crore or more.
  • A turnover of Rs 300 crore or more.

Nominee Director- A nominee director is the one who is appointed on behalf of certain specific shareholders, an unrelated third party, a Public Financial Institution or the Government in case of oppression and mismanagement being ruled out in a company.

Shadow Director- A person, not officially appointed a Director in the company, but the Board generally acts on his directions, he is known as a “Shadow Director” of the company and is made liable as a director, if need be. This shall not apply to those people who are serving the company or tendering the advice in a professional capacity, such as a CA, or a Legal Counsel.

The above mentioned are the types of Directors recognised under the Act and in practice. We shall talk in detail about Shadow Director hereunder.

Who is a Shadow Director?

The Board of Directors in a company holds the maximum powers of the company. Their powers are parallel to that of the company itself. Therefore, there must be certain collateral limitations put on the powers that they can assert. For this purpose, the Act provides for the limitations on the powers of the Directors in the form of duties that are bestowed upon them.

However, there exists a class of persons who hold the authority who manage to exert the influence like a Director in a company but successfully avoid any liability arising whereof because they aren’t Directors. They are the people who maintain control over the daily business management of the company like a Director but hold no managerial position in the company. It’s imperative to catch hold of such persons and put the liability on them for the benefits they are extracting. Therefore, in the corporate jurisprudence, these people are termed as “Shadow Directors”.

Legal Status

The term ‘Shadow Director’ per se, is not mentioned anywhere in the Act but a similar position has been categorised. The Act classifies a person “in accordance with whose instructions the Board is accustomed to act” to be a shadow director, who shall be the Deemed Director of the company.

The term “officer” is defined under Section 2(59) of the Act which encompasses the position of a‘shadow director’ in essence. It means “any person in accordance with whose directions or instructions the Board of Directors or any one or more of the Directors are accustomed to act”. Further, Section 2(60) (v) defines the phrase “officer who is in a default” to mean and include any person who, not being an officer in the company, still has the authority that the Board acts under his directions. Therefore, the definition shall include a Shadow Director and a shadow director will be booked for any irregularity in the company-sponsored by him even though he holds no official position in the company.

Moreover, Section 219(c) of the Act empowers investigation of affairs of the company which is found to be acting under the directions of a director (including a shadow director) who himself is under an investigation.

Additionally, Explanation I to Section303(1) of the Companies Act of 1956 (hereinafter referred to as the ‘Previous Act’) states that details of any person under whose directions the Board generally functions shall be registered with the company, in the Register where the details of other Directors are recorded.

Lastly, Section 307(10) (a) of the previous Act provided that the details of the shareholding of a shadow director shall be recorded along with the regular directors.

Therefore, it is safe to conclude that the position of a shadow director is recognised and given legal status in a company under the Company law of India. It is imperative to do so to curb their rampant power and no liability advantage that they earn by not holding an official position in the company.

The following are leading cases with regards to the disputed position of a ‘Shadow Director’:

Re Hydrodan (Corby) Ltd[9]– In this case, it was held that the following ingredients are necessary to prove whether a person is a shadow director in a company or not?-

  • That he is not a director in the company.
  • That he instructs and directs the Directors appointed by law on the matters relating to management in the company.
  • That the appointed Directors act based on the advice tendered by such a person.
  • This is a regular practice i.e. they act under the directions of such a person.

Only on proving of above-mentioned ingredients a person can be declared as a Shadow Director. The process of acting in accordance with one’s advice or instructions must be a behavioural pattern; the Board should not be exercising any of its discretion and purely act in furtherance of whatever is communicated by the shadow directors.

Secretary of State for Trade and Industry v. Deverell[10]The intention of the lawmakers here is to encircle such persons, other than the advisors hired by the company in a professional capacity, who exert real influence in the management of the affairs of a company. When the validly appointed directors rely on these persons for their decision making, they shall be considered as shadow directors.

Re Kaytech International plc[11]In this appeal, it was held that the test of shadow directorship lies on the control that is alleged to have been influenced by the person. Sometimes the influence may be open, sometimes it may be concealed. Sometimes, it is a mixture of both. Nonetheless, the existence of ultimate power to regulate the affairs of a company makes him a shadow director.

Holland v. The Commissioners for her Majesty’s Revenue and Customs and Anr[12]The Hon’ble Apex Court of the United Kingdom upheld that there isn’t an arguable difference in the concepts of ‘Shadow Director’ and ‘De-Facto Director’ under the British law, therefore, the two terms can be used interchangeably to mean the same thing.

Buzzle Operation Pty Ltd v. Apple Computer Australia Pty Ltd[13]– In this case, it was held that it’s mandatory to ensure that Directors act in accordance with the instructions of a certain person while accusing him under this. A person who somehow is in a dominant position, of imposing conditions to exert commercial pressure cannot be termed as a shadow director by virtue of that position.

Position in a Company

Law puts a shadow director in the same position as an actual director, appointed by law. A Shadow Director is equally liable for his stint in the company, irrespective of the fact that he does not hold any position in the company. This scenario generally arises in a private company, where a person owns the majority share but does not hold any official position in the company. A person who practically is the owner of the company has the ultimate control and he shall be expected to exert control. In such a case, he must be declared a deemed director, i.e. the duties of a Director shall apply to him.

Firstly, the claim whether a person is a shadow director or not in a company is subject to a proof of the fact that one or more Director or the Board is accustomed to act based on the advice, directions or orders of such a person. It’s an extremely circumstantial matter and cannot be easily proved; therefore, the following parameters have been made to determine the position of a shadow director-

  • There must be continuity in the actions of the board being in accordance with the advice of that person. Therefore, one casual direction or advice of a person will not make him a shadow director.
  • There must be an apparent intention on the part of the person as well as the Board to hand over the control of affairs on his hands.
  • The orders passed by the shadow director must be duly executed. However, not all directors need to act according to the said directions. If the majority of the directors are following the actions, the claim for a shadow director shall succeed.
  • The role of the person must not be in an advisory capacity. A person can be called a shadow director only if he is assigned a decision making role. Advice tendered by a person in a professional appointed by the company for that purpose shall be excluded from the application of this law.

Role of a Shadow Director

A shadow director plays an important role in managing a company and holds a lot of power. It is therefore necessary that his duties as a shadow director are laid out. In the case of Ultraframe Ltd v. Fielding[14], following limitation and duties are bestowed on a director-

  • A shadow director has no fiduciary liability towards the company.
  • He cannot deal with the properties or the capital of the company.
  • He must declare his interest in any transaction that the company undertakes which is entered into by the company in furtherance of the advice tendered by him.
  • He is bound to disclose all the holdings he has in the shares or debentures of the company.
  • Any transaction related to transfer of capital or property between the company and shadow director is strictly prohibited.

Law of United Kingdom on Shadow Directors

Indian law on the status of a shadow director in a company is rudimentary. Therefore, for certain aspects, we can refer to laws from other countries.[15]  The law of the United Kingdom in this regards is established, therefore, we can safely conclusively make a study of it.

The Companies Act, 2006 of the British Parliament defines a shadow director as a person ‘in accordance with whose directions the Directors are accustomed to act.’ There’s no problem in daily matters related to the shadow director as it is an internal matter and the issue generally comes into picture when the financial health of a company is at risk.

Actions of a shadow director are scrutinised thoroughly during an insolvency proceeding for any misconduct or unlawful gains accrued by him. If a shadow director fails to put the interest of a secured creditor first, then also, he might have to go through penalties.

Though a shadow director is considered at par with a real director and bound by same obligations, yet if he can successfully prove that he was unaware of any liability to comply with the laws related to directors.

What kind of penalties can be imposed on a shadow director? He can be asked to pay a share in the assets of the company in case of insolvency. He may be disqualified from being a director. Further, criminal sanctions for breach of the duties can be bestowed on a director. Shadow directors can be made held under the Insolvency Act, 1986 under which criminal sanctions are provided. Lastly, it is necessary to mention that a person disqualified to be a director cannot act as a shadow director as well. It is a criminal offence as per the British laws.

Conclusion

The object behind putting the provision for legal recognition to the position of shadow director in the Company Law is to avoid a situation where a person is controlling the affairs of the company but gets to deny his liability because he does not hold an official position in the company. If the Board is acting in furtherance of the directions of a person, he must be considered as a Director and must be subjected to the liabilities as of a director. The decisions of the Board must be directly based on the directions of the shadow director to an extent that it’s apparent that the Board has not applied an independent judgment at all while reaching the decision. The position of a shadow director is a gateway to the assets of the company which is why it is imperative for the law to put such stringent liabilities on shadow directors as is equivalent to a real director.


[1] Lennard’s Carrying Co Ltd v. Asiatic Petroleum Co Ltd, 1915 AC 705.

[2] Coal Mining Co, Re, (1878) 10 Ch D 450.

[3] Moriarty v. Regent’s Garage and Co, (1921) 1 KB 423.

[4](1866) LR 2 Ch App 77.

[5] Indian States Bank Ltd v. Sardar Singh, AIR 1934 All 855.

[6]Section 152(3) of the Act.

[7]Section 151 of the Act.

[8] Rule 4 of the Companies (Appointment and Qualification of Directors) Rules, 2013.

[9] (1994) BCC 161.

[10] (2001) Ch 340.

[11] (1999) BCC 390.

[12] (2010) UKSC 51 (Re Paycheck)

[13]  (2010) NSWSC 233.

[14] 2005 EWHC 1638  (ch).

[15] Company laws are similar in most countries. Therefore, precedents from foreign laws have a very high persuasive value in corporate jurisprudence.

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