What is a shadow director and what are the risks?

Recent economic conditions have resulted in increased insolvencies in Australia. As interest rates remain higher, combined with ATO and debt recovery activities, it is likely that the level of insolvencies will continue to increase.

When a liquidator is appointed to a company, they are obliged to investigate whether any of the director/s’ actions are likely be deemed breaches of their duties to the company.

Sometimes, this will extend to a “shadow” director who is someone that the law considers is a director due to the control or influence they have over the company. And there can be serious consequences for shadow directors.

Similarly, following a recent decision of the High Court, a person can be determined as acting as an officer of the company, even if that person does not have a formal title of an office holder, or if they do not have a functional role or position within the management of the company. We explain this further below.

 

What is a shadow director?

Being in a fiduciary relationship with the company, directors are subject to a number of duties both at common law (such as a duty not to place themselves in a conflict of interest with the company) and under the Corporations Act (such as the duty to prevent insolvent trading). Read more on company director obligations.

A person will be deemed to be a shadow director under the Act in circumstances where that person is not validly appointed as director but the directors of the company are accustomed to act in accordance with their instructions.

The key factors as to whether a person is a shadow director are:

• that person has the power to control the directors of a company; and
• this power was put into practice.

However, the Act expressly provides that a person will not be deemed to be a shadow director where the directors of a company are acting on advice given by the person in the proper performance of their functions attaching to that person’s professional capacity, or that person’s business relationship with the directors or the company.

Given this express exception in the Act, professional advisors such as lawyers and accountants, acting in their capacity in advising a company, will not ordinarily be deemed to be shadow directors of that company.

Nonetheless, serious consideration needs to be given as to the nature of the relationship between the advisor and the company such that the relationship is not likely to give rise to a determination that a person is acting as shadow director.

 

Can a company be a shadow director?

Although a corporation or other body corporate cannot formally be appointed to the position of a director, companies can still be considered shadow directors. For example, a parent company may be deemed a shadow director of its subsidiary.

Another example where a company was held to be shadow director of a related company, is when it had effective control of the related company by virtue of:

• its shareholding;
• its willingness and ability to exercise control over the related company; and
• an actuality of control over the management and financial affairs of the related company, such as its assets and its financial reporting requirements.

 

What are the consequences of being a shadow director?

A company, or individual, who is a shadow director of a company will be required to comply with the duties of a director under the Act.  If a person is held to be a shadow director, this can mean that an action can be brought against the person for breaching their duties as a director.

As an example, a liquidator/administrator can bring an action against a shadow director to recover loss suffered by the insolvent company as a result of the breach of duties. In that scenario, a Court may make an order directing the shadow director to pay money or transfer property to the company and/or an order directing the director to pay to the company the amount of the loss or damage suffered.

In addition, a shadow director may be liable for insolvent trading of a company under the Act. This was the case in the example above where the controlling company held to be a shadow director of the related company and was consequently liable as a director for insolvent trading of the related company.

As such, the consequences of being deemed a shadow director can be serious.

 

Am I an officer of the company?

As with directors, officers of a company also have duties to the company both at common law and under the Act.

For example, under the Act, an officer of a company must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

(a) were a officer of a company in the company’s circumstances; and

(b) occupied the office held by, and had the same responsibilities within the company as, the director or officer.

In the recent High Court judgment of Australian Securities and Investments Commission v King [2020] HCA 4, the High Court unanimously held that the definition of officer is not limited to those who hold or occupy a named office in a corporation or a recognised position with rights and duties attached to it.

The Act provides that an officer is an officer of the company if they are a person who has the capacity to significantly affect the company’s financial standing.

In the case of King, the Court extended the scope of the definition not just to office holders in the company but also persons involved in management decisions that have a substantial impact on the company, including after resignation from official capacities.

This is significant because the definition is said to capture persons “involved in policy making and decisions that affect the whole or a substantial part of the business of the corporation” noting that a person’s effect will not necessarily be uniform across the group and may change as the size and structure of the group changes over time. The Court formed a view that this approach is consistent with the broader context of the Act and officers’ duties under the Act.

The Court also noted that, whilst the issue did not arise in the litigation, it did not accept that bankers and other third parties could never fall within the reach of the definition of officer in the Act.

As such, the broad definition of officer could capture a wide range of shadow officers such as professional advisors, consultants or accountants who make, or participate in making decisions that affect the whole, or a substantial part, of the business of the company or whose instructions or wishes the board are accustomed to follow. Having said that, a manager or advisor, who only reports or advises a board in their usual capacity and who has no influence over board decisions or the company’s financial standing, is unlikely to be deemed a shadow officers.

 

What are the consequences of being a shadow officer?

As with shadow directors, there can be serious consequences if a person is deemed an officer of the company and found to have breached their duties as officers to the company.

These include the possibility of being personally liable for any breaches of officers’ duties to the company under the Act and penalties being imposed under the Act.

 

Key takeaways

Determining whether a person or corporation will be deemed a shadow director or an officer of the company is not a straightforward exercise. All of the facts will need to be taken into consideration and as such, the determination will be on a case-by-case basis.

The recent broadening of the definition of who may be considered an officer of a company should provide an opportunity for anyone involved in the management of a company to assess their role and make themselves aware of their responsibilities and the consequential liabilities that may arise.

Given the serious consequences which can result when being held to be a shadow director or an officer of a company, it is important that any person, such as professional advisors like accountants or lawyers, be acutely aware of their role in connection with the company. Failure to do so runs the risk of a Court determining that a person has acted outside their ordinary professional capacity and into the territory of acting as the directing mind of the company or substantially influencing the management decisions of a company.

Setting clear engagement boundaries between the professional advisor and the board’s decision making can assist in reducing the risk of being considered a shadow director or an officer of a company.

 

How can we help?

Marsh & Partners are committed to working with company directors to help them meet their goals and stay compliant.

You can contact a Marsh & Partners advisor for clarification on any information in this article. You can reach us on (07) 3023 4800 or at mail@marshpartners.com.au

This article is intended to give an overview and is not a substitute for legal advice.

You can find out more about working with Marsh & Partners here. As your Absolute.Account.Ability partner we’re on a mission to make your business life better. If you need high-level support for your business, get in touch with our specialists on 07 3023 4800 or at mail@marshpartners.com.au.