Shadow Directors: What are they and what liability do they have?

What is a shadow director?

A shadow director is defined in company law as “a person in accordance with whose directions or instructions the directors of a company are accustomed to act” [1] i.e. they are someone who is not listed or formally appointed as a director but exerts real influence over the affairs of the company (in the form of directions or instructions).

 Examples of shadow directors include:

• A majority shareholder that gives directions to the board as to what to do but takes no part in the management of the company as such.
• Someone who regularly negotiates on behalf of a company, e.g. securing loans or borrowings.
• A person who takes responsibility for an area of a business, e.g. the finance function.

Note that:

• Someone will not be considered a shadow director simply because directors act on advice given by them in a professional capacity (e.g. advice from lawyers and accountants).
• A holding company will not usually be seen as a shadow director of any of its subsidiaries, but a ‘dominant individual’ at the holding company might be.
• In certain circumstances lenders or other creditors may risk becoming shadow directors.

What is the risk?

Company law does not prohibit someone from being a shadow director. However, they are treated as being bound by the same fiduciary, statutory and common law duties that apply to legal directors (including, the duties to: promote the success of the company; exercise independent judgment; avoid conflicts of interest; and, exercise reasonable care, skill and diligence). In the event of insolvency, shadow directors also owe a duty to a company’s creditors.

This means that if the directors (including any shadow directors) are (a) found to have breached any of their duties, (b) found liable for wrongful trading or fraudulent trading or (c) to be charged with a corporate offence, they may be:

• held personally liable for any losses or damage caused to the company, including following insolvency (and a shadow director may not be covered by a company’s directors and officers (“D&O”) liability insurance or company indemnities in favour of directors);
• subject to criminal sanctions; and/or
• disqualified from acting as a director.

Under company law, a number of provisions expressly apply to shadow directors, including the requirements relating to director’s service contracts and to declare an interest in property transactions and loans.

How to mitigate risk

Step one is to understand whether you are a shadow director. Other protective actions include:

• insisting on being covered by D&O liability insurance;
• having an employment agreement that explicitly states you are not to be treated as a director;
• understand and comply with your legal duties;
• avoiding board meetings, and if required to attend, only do so to advise and ensure the minutes show you as “in attendance”;
• make it clear (and ensure that the company makes it clear) that you are not a director of the company; and
• avoid actions usually associated with formal directors.

Comment

It is not uncommon for potential acquirers and investors to seek to direct the actions of a target business, particularly when a target is in distress. However, they should note that such influence and control might lead to them being recognised by law as directors, bringing with that certain obligations and duties without the protections of being a listed or formally appointed director.

If you would like advice about shadow directors and their liabilities, please contact our Corporate & Commercial team for assistance. 

[1] Section 251 of the Companies Act 2006