Beware the law of unintended consequences… don’t unwittingly derail your careful corporate structure, limited liability position or tax planning by acting like a director if you aren’t one.
As founder or majority shareholder, you’ve set up your company/group, established your board, appointed competent and experienced directors to manage the company’s day-to-day activities – but could it be said that there is a common understanding among those directors or a recognisable pattern of behaviour that your wishes are to be prioritised, followed and implemented, even though you have no formal role within the company or a director title? Are you exercising power, in the mistaken belief that there is no corresponding responsibility?
What’s in a name?
A shadow director is “a person in accordance with whose directions or instructions the directors of a company are accustomed to act”. Traditionally identified as someone who ‘lurked in the shadows’, a ‘puppet master’ or ‘hidden hand’. All very Bond villain-esque; but generally misrepresentative. No white cat or nefarious intent required!
As founder or majority shareholder, you may well be involved openly in the company’s affairs. You may, for example, be identified as a person with significant control on the company’s PSC register at Companies House. Regardless of role or title, context and consequences may make you a shadow director.
It is a question of fact and degree, determined objectively, depending on your words and deeds and the conduct of the official directors in response. Intent is irrelevant.
Who’s calling the shots?
If not the directors formally appointed and publicly recorded at Companies House, who, if anyone, (if not so appointed), has true control of or exercises significant influence over those directors to make company decisions?
Founders, majority shareholders, joint venture partners, investors, lenders, creditors and individual directors on holding or parent company boards may from time to time rightly be categorised as shadow directors. Equally, such persons may have legitimate reasons to be heard by the directors to protect their respective stakeholder interests.
The key is staying in your designated lane and not crossing the line. Present options that may be considered and at the directors’ discretion adopted, or not. Don’t direct or instruct the company directors to effectively submit to what you want.
It is not necessary that such direction or influence should be exercised over the whole board, a majority is sufficient.
A person is not treated as a shadow director where the directors act on advice given by such person merely in a professional capacity, such as an accountant or a lawyer.
Why does it matter?
Of itself, it is not an offence to be a shadow director. However, the consequences that flow from such a characterisation are serious. If found to be a shadow director, you will be treated as if you are an actual formally appointed director of the company and be subject to many of the same duties and liabilities, including:
- to act within the company’s powers
- to promote the success of the company for the benefit of the members as a whole
- to exercise independent judgment
- to exercise reasonable care, skill and diligence
- to avoid conflicts of interest
- not to accept benefits from third parties
- to declare interest in proposed transaction or arrangement
In an insolvency context:
- to consider or act in the interests of creditors
In cases of breach of such duties, the courts may impose the same liabilities on you as a shadow director as if you had been formally appointed, including:
- civil liability
- criminal penalties
- disqualification (prohibiting appointment as a formal director) and
- personal liability for wrongful trading.
If, however unlikely, you are an undisclosed bankrupt or have already been disqualified from being a director, it is a criminal offence (unlimited fine or up to two years’ imprisonment) to act as a director, which also includes as a shadow director. Additionally, personal liability for the company’s debts incurred during the period of such breach may apply.
Shadow directors have none of the usual protections of a formally appointed director. Any D&O insurance policy may not cover such liability if the shadow director is not otherwise named as an “Insured”. Similarly, any indemnification granted by the company may be void.
It is therefore critical for anyone who has not been formally appointed as a director to consider if they may, nevertheless, be found to be a shadow director.
The circumstances in which you may be found to be a shadow director are very broad. The following factors indicate potential red flags:
- Companies where the non-director is the driving force of the business
- Family businesses where the directors are the spouse / partner / child of the majority shareholder
- Power of veto or final sign-off of directors’ decisions
- Acting as autonomous contract signatory for the company
- Acting as the key commercial contact or negotiator for the company
- Approving company executive appointments
- Acting as signatory on the company’s bank accounts
- Having access to confidential company information generally only available to the board
- Acting as the referee to resolve board deadlocks or matters escalated by the directors
- HIPPOs – highly important persons’ personal opinions taking precedence over customary due diligence and debate
A single activity may not be decisive, but cumulatively, may point to a pattern of behaviour consistent with shadow directorship. A single act could, however, be decisive in an exceptional case.
Be aware, that where problems arise, such as disputes or where the company is experiencing financial difficulties or indeed fails, those seeking some form of redress (for example minority shareholders, unpaid creditors, insolvency practitioners, employees, tax authorities and other government agencies) will invariably closely scrutinise past conduct and cast a wide net of blame to seek to identify all those responsible and hold them accountable for their conduct – whether the official directors of record or those who have unofficially exercised influence or control over the management of the company’s affairs.
Recollections may differ, so it is important to be aware of the distorted nature of hindsight, take reasonable precautions and ensure (where possible) that the directors maintain a real-time record of significant decisions, including minutes which set out the considerations or rationale for their decisions.
Reality check time
Regardless of intention, ask yourself two questions:
- In the absence of other evidence, is it possible observed objectively, that words or actions (explicit or implicit) could be construed as directions or instructions to the company directors to do, or not do, what you have communicated or otherwise indicated you want?
- Does the decision-making track record of the company directors show reliance on or clear bias towards your preferred position on matters they have considered and determined?
Precautionary To do’s
If you are not a formally appointed company director publicly recorded at Companies House, but are actively involved in the management of the company, customarily consulted on company matters or have regular interactions with the directors making decisions affecting all or any part of the activities of the company:
- Avoid the Red Flags
- Be mindful of the context, your status, words, tone, facial expressions and body language, which may convey a ‘do it my way’ expectation
- Avoid using commanding, directive or instructional language
- Present perspectives and any case for or against a proposition as advice or recommendation only
- Avoid back-room pacts and matters being presented to the directors as ‘done’ deals for rubber-stamping rather than discussion and decision
- Allow proper time for discussion and encourage robust debate, devil’s advocate challenge and alternate viewpoints, including professional evaluations or assessments, especially for complex, contentious or business critical issues
- If invited to directors’ meetings, ensure that the minutes record you as “in attendance” rather than “present”
- If attending directors’ meetings, consider participating only in general discussion of matters debated, and leave the meeting before the decision-making part of the directors’ proceedings
- Consider a company decision-sequencing policy or checklist, clearly identifying how informed decisions will be made, the required inputs from the relevant company functions, wider stakeholder submissions and decision points
- Encourage the directors to maintain a real-time record of significant decisions, including minutes which set out why they made such decisions
- Put simply, don’t tell the board what to do; let the directors exercise their own judgment and decide
However meticulously these recommendations are followed or documented, it remains, at the end of the day, a question of fact to be determined by a court in all the circumstances as to whether in practice there was actual direction, real influence or control or conduct sufficient to meet the shadow director test.
If you think that you may be at risk of being characterised as a shadow director, we can help. Be proactive! There is no release of or relief from directors’ duties or liabilities because you were unaware of shadow directorship. Ignorance is no defence. The consequences can be significant, including personal bankruptcy.
Get in touch for more information about the general duties and liabilities of directors, good corporate governance practices and the additional risks and liabilities posed by potential or actual insolvency.
Written by Kelli Read
Principal at My Inhouse Lawyer
One of our values (Growth) is, in many ways, all about cultivating a growth mindset. We are passionate about learning, improving and evolving. We learn from each other, use the best know-how tools in the market and constantly look for ways to simplify. Lawskool is our way of sharing with you. It isn’t intended to be legal advice, rather to enlighten you to make smart business decisions day to day with the benefit of some of our insight. We hope you enjoy the experience. There are some really good ideas and tips coming from some of the best inhouse lawyers. Easy to read and practical. If there’s something you’d like us to write about or some feedback you wish to share, feel free to drop us a note. Equally, if it’s legal advice you’re after, then just give us a call on 0207 939 3959.
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