Shadow and De Facto Directors: a Reminder of the Risks

Shadow and De Facto Directors: a Reminder of the Risks

Some sectors of the  UK economy are struggling – in part perhaps due to the uncertainty surrounding Brexit – and there are almost daily reports that many businesses, particularly in the retail and construction sectors, are on the verge of collapse. News this week that retail giant M&S is likely to be demoted from the FTSE100, half of Chiquitos restaurants facing closure, and construction orders in their sharpest fall since 2009; all further evidence of this decline. It begs the question – who within a business can be held to account if they fail?

It will come as no surprise that company directors – those appointed by law and registered accordingly at Companies House, a so called "de jure director" – can be found liable for their conduct in the day-to-day running of a business. Far fewer know, however, that individuals who are involved in a company's business can, in certain circumstances, be found liable for breach of directors' duties without being formally appointed as a director.

When businesses are in survival mode, a director's compliance with their duties will come under increased scrutiny – the fundamental duties (as set out in the Companies Act 2006 – "the Act") such as the duty to promote the success of the company and to exercise reasonable care, skill and diligence will no doubt be called into question. However, of particular importance to those involved in running a business in financial difficulty, are the duties which require directors to act in the interests of creditors, breach of which can lead to personal liability (to contribute to the debts of the company, for example). Whilst a discussion of directors' duties is outside the scope of this note, it will discuss the circumstances in which a person who isn't formally appointed as a director might be treated as one.

Certain legislation (such as the Act and the Insolvency Act 1986) creates other categories of director (beyond just the formally appointed "de jure director") to whom directors duties will apply – the intention being that those people holding influence over the directors of a company or the business of the company itself can be held to account for their shortcomings. These categories of director are known as "shadow directors" and "de facto directors".

Shadow directors are defined in the Act as "persons with whose direction or instructions the directors of a Company are accustomed to act." The Act and case law set out very broad circumstances in which a person may be found to be a shadow director . As such, the term 'shadow director' may be applicable, for example, to a person who has been disqualified from formal appointment (but otherwise continues to act like a director) and equally to a person involved in a business who exercises a particular influence over the company (perhaps taking part in board level discussions and decisions) without having been formally appointed as a director. There are, however, some specified exceptions, such as individuals advising in a professional capacity or exercising a function or role provided for by statute (i.e. administrator).

De facto directors are those individuals who behave as and are understood to be directors in practice, whilst not being formally appointed. There is no single test to identify de facto directors, however, case law provides several considerations to guide the courts. These considerations include whether a person solely directed the affairs of a company, acted on an equal footing with other directors, or has been held out as a director by the company. Historically, the term was used to denote a person whose appointment was invalid for some reason but recent case law has accepting a wider definition based on the considerations above, presenting potential overlaps with the category of shadow director.

It is important for those in management roles or senior positions within a business to minimise the risk of being considered a shadow or de facto director so as to avoid any potential liability for conduct which may not being in-keeping with the duties and responsibilities imposed on directors. As set out above, this is of particular concern where the company is experiencing financial difficulties and the actions of the board and other senior personnel will be subject to closer scrutiny. Here are some useful suggestions to avoid being categorised as a shadow or de facto director:

  • keep away from decision-making on corporate policy and implementation, or if you do get involved, disclaim that the board must exercise independent consideration, taking professional advice where necessary;
  • if possible, avoid the use of the word 'director' in your job title, e-mail signatures etc.;
  • ensure (where possible) that the directors record their considerations in explanatory board minutes;
  • similarly, when addressing directors, avoid using instructive language; and
  • avoid signing documents on behalf of the company or otherwise representing the company in negotiations and commercial discussions.

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