Shadow directors and de facto directors

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The definition of “director” in section 9 of the Corporations Act 2001 (Cth) (Act), goes beyond directors validly appointed, and includes de facto directors and shadow directors.  This article explores the level of involvement in the affairs of a company that a person must have to be deemed a de facto director or a shadow director.

What is a de facto director and a shadow director?

Section 9 of the Act includes in the definition of “director” (terms in bold added):

“(b) unless the contrary intention appears, a person who is not validly appointed as a director if:

(i) they act in the position of a director (de facto director); or

(ii) the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes (shadow director).”

However, section 9 also states that the definition of a shadow director does not apply:

“merely because the directors act on advice given by the person in the proper performance of functions attaching to the person’s professional capacity, or the person’s business relationship with the directors or the company or body.”

Factors that indicate a person is a de facto director

Whether a person is a de facto director requires consideration of the duties performed by that person in the context of the particular company.  Relevant factors outlined in the cases of Deputy Commissioner of Taxation v Austin [1998] FCA 1034 (Austin) and Chameleon Mining NL v Murchison Metals Ltd [2010] FCA 1129 (Chameleon Mining) include:

• the size of the company and the allocation of the responsibilities;
• the internal practices or structure of the company;
• whether those outside the company considered the person to be a director;
• the duties that would be expected to be performed by a director in the relevant company (namely, top-level management functions);
• the duties actually performed by the person;
• whether others in the company considered the person a director;
• whether the company held out the person as a director; and
• whether the person held themselves out as a director.

An appeal of Chameleon Mining was dismissed, with the Full Federal Court stating that a person may still be a de facto director even if the company has a properly constituted and functioning board, and the title of the person (for example, “consultant” or “manager”) is not determinative.

Factors that indicate a person is a shadow director

Justice White refined the definition of “shadow director” in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd [2010] NSWSC 233 (Buzzle Operations), stating:

• in some circumstances, it is possible for a person to be both a shadow director and a de facto director: at [233]–[236];
• it is not necessary that the instructions or wishes of the shadow director be given over the whole areas of corporate activity for which the directors are responsible: at [241];
• the directors must be accustomed to act as directors of the company (and not in some other capacity) in accordance with the shadow director’s instructions or wishes regarding how the directors should so act. This means that a person is not a shadow director merely because they impose conditions on their commercial dealings with the company with which the directors feel obliged to comply: at [242]-[243];
• there must be a causal connection between the instruction or the wish of the shadow director and the directors acting on it. It is not sufficient if the act that was specified in the instruction is something that the directors would do irrespective of the instruction: at [244]–[247];
• for the directors to be “accustomed to act” in accordance with the instructions or wishes requires “habitual compliance over a period of time”: at [248];
• the directors collectively must be accustomed to act on the shadow director’s instructions or wishes and it is sufficient if a “governing majority” of the board is so accustomed to act. It is not sufficient:
• if executives who are not directors are accustomed to act on a person’s instructions or wishes (although such a person might be a de facto director); or
• if the instructions or wishes are given to a director in their capacity as an executive and not in their capacity as a director: at [250]; and
• the instruction or wish need not be communicated directly by the shadow director to all or a governing majority of the directors: at [307].

This definition was upheld on appeal, with Young JA and Hodgson JA stating that where a bank or mortgagee provides advice to the board, the mere fact that the board tends to take that advice does not necessarily make the bank or mortgagee a shadow director.  While in such a case the directors may on many occasions act in accordance with the instructions or wishes of the mortgagee, this will generally be because the directors make their own decision that doing so is in the interests of the company.

Could members of an advisory board be deemed to be shadow or de facto directors?

In many growth businesses a board of advisors is engaged to advise the controller in a manner that is akin to having a board of directors.  This is often the first step before validly appointing directors.  The question for consideration in what circumstances could the members of an advisory board be liable as directors of the company because they were deemed to be shadow or defacto directors?

Applying the tests from Buzzle Operations, a member of an advisory board is more likely to be held to be a shadow director if:

• the shadow director’s instructions or wishes are given over large areas of corporate activity for which the controller is responsible;
• there is a causal connection between the instructions or wishes of the shadow director and the directors acting on it;
• the validly appointed directors collectively, or at least a “governing majority” (rather than merely the controller), are accustomed to act on the shadow director’s instructions or wishes, over a period of time;
• the shadow director gives their instructions or wishes to the controller in their capacity as director (rather than their capacity as executive), and the controller is accustomed to act on these instructions or wishes in the same capacity; and
• the validly appointed director did not merely act on advice given by the shadow director in the proper performance of functions attaching to the shadow director’s professional capacity, or the shadow director’s business relationship with the directors or the company.

Applying the factors from Austin and Chameleon Mining, a member of an advisory board is more likely to be held to be a de facto director if:

• the company is small;
• the company does not give employees great discretion to deal with significant matters;
• people inside and outside of the company perceive the person as a director;
• the person and the company hold the person out as a director; and
• the person performs top-level management functions that would be expected of a director, for example:
  • the person is authorised to negotiate on behalf of the company in regards to important transactions; or
  • the person makes high level management decisions that affect the company’s financial standing.

It is important to note, however, that none of these factors is determinative, and the classification of members of a particular advisory board will turn on the facts of the case.

Implications of being a shadow director or a de facto director?

Many of the provisions which apply to directors do not in practice apply to shadow directors (for example, the minimum number of directors required under section 201A of the Act applies only to validly appointed directors).  Nevertheless, shadow directors and de facto directors are subject to the provisions pertaining to the duties and powers of officers in Ch 2D Pt 2D.1 of the Act, including the duty in section 181 to exercise powers in good faith and for a proper purpose.  Therefore, a person acting in an advisory capacity must do so with a degree of care and diligence to ensure they are not deemed to be responsible should the company get into financial difficulties.

Links and further references

Legislation

Corporations Act 2001 (Cth)

Cases

Bluecorp Pty Ltd (in liq) v ANZ Executors and Trustee Co Ltd (1994) 13 ACSR 386 – various executives who instructed the board of the defendant about matters of management and finance were held not to be shadow directors as the directors still performed positive acts, and did not simply stand aside and allow the executives to supersede them.

Featherstone v Hambleton (as liquidator of Ashala Pty Ltd (in liq) [2015] QCA 43 – the appellant was held to both a de facto director and a shadow director as the sole director of the company was subject to his direction.

Mernda Developments Pty Ltd (in liq) v Alamanda Property Investments No 2 Pty Ltd (in liq) [2011] VSCA 392 – the respondent was held to be a shadow director as he had a crucial role as an important decision-maker for the companies and the appointed director acted under his direction in relation to all important decisions.

Further information about directors duties

If you need assistance with your obligations as a director of a company, please telephone me for an obligation free and confidential discussion.

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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