Directors of companies are empowered to make important decisions concerning the running of their organisation and are therefore entrusted with a great deal of responsibility. This means that directors not only possess certain rights but also undertake a certain degree of risk in case of serious mismanagement or misconduct. It is therefore important that directors be clearly identifiable in case of regulatory action. Where an individual is not held out to be a company director but effectively exercises the authority of one, the law demonstrates its commitment to substance rather than form and declares such persons “shadow directors”. This article outlines what a shadow director is and what responsibilities shadow directors may, even unknowingly, undertake.
A. What is a Shadow Director and How Do They Differ from Ordinary Directors?
Section 9 of the Corporations Act 2001 (Cth) provides the definition of a director. Relevantly, the section states that a person who does hold the title of director will still be considered to be so if “they act in the position of a director” or “the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes”. In other words, taking on the rights and responsibilities of a director brings with it the commensurate legal liabilities. It is important to note that merely giving advice that is acted on does not necessarily make an individual a director (for example, a consultant or professional services advisor), but courts will be mindful of considering the circumstances as a whole before making a determination.
B. What Duties Does a Shadow Director Undertake?
Where an individual is found to be a shadow director, they are held to owe the same fiduciary duties to the company as other directors and are just as liable in the event of misconduct or serious mismanagement. Fiduciary duties import significant standards of conduct onto the director and breach can attract serious consequences. These duties include traditional fiduciary obligations, such as acting in good faith and avoiding conflict of interest, but also include more specific duties such as avoiding insolvent trading. Breach of fiduciary obligations enables the beneficiary of the trust (generally the company members) to take action against the party in breach personally. Further, in some circumstances where the company is guilty of misconduct, the corporate veil can be pierced and action can be taken against individual directors. Such penalties can, depending on the breach, include fines, bans on directing companies and imprisonment.
C. How Does One Avoid Being Labelled a Shadow Director?
In order to avoid unexpected enforcement action in the event of company misconduct or mismanagement, one should be clear on what their role within a company is and ensure that their job title and description matches their actual role within the organisation. In particular, taking on an abundance of responsibility in an organisation where it is inconsistent with one’s “on paper” role may risk a finding of shadow directorship. Companies should also avoid using individuals for director-level roles where such individuals are not held out as directors and are not informed of the magnitude of the responsibility they undertake. For proper legal advice on how to avoid becoming a shadow director or avoiding allowing such persons into your company, or for advice if you have been found to be a shadow director, seek
Individuals can be found to hold directors duties even where they are not held out to be directors and do not officially hold director-level positions within a company. Courts implementing the Corporations Act look to the nature of the individual’s role rather than the title in determining whether an individual may be subject to the fiduciary duties that the rights of a director bring.
This article was authorised by Warwick Heeson.