The concept of a ‘Shadow Director’ is generally only relevant when a Company is financially threatened and most often when it goes into a formal insolvency procedure, such as Liquidation or Administration. Otherwise, the issue might arise in the case of inbound litigation against a Company and its Directors or enforcement action by its regulators.
In the wider context of the corporate governance of a business, the existence of one or more Shadow Directors can create a range of problems. One way or another, understanding the implications and potential downsides of Shadow Directorship is essential for Companies, shareholders, advisers, managers, insurers and a wide range of other stakeholders.
Who can be defined as a Shadow Director?
The statutory definition in Section 251 of the Companies Act 2006 is straight forward: a Shadow Director is “a person in accordance with whose directions or instructions the Directors of a Company are accustomed to act”. In essence, this is someone who is not formally appointed, shown on the Company’s website or registered at Companies House as a Director but who exerts real and significant influence over the affairs of the Company.
Practical examples of Shadow Directors
These could include:
- A majority shareholder that takes no part in the management of the Company as such, but gives directions to the Board as to what to do
- A person who regularly negotiates on behalf of a Company, such as in securing loans or borrowing facilities for it
- An individual who takes responsibility for a significant area of a Company’s affairs, for example its finance function
- Lenders or other creditors may risk becoming a Shadow Director in certain circumstances
- Potential acquirers and investors often seek to direct the actions and strategy of a business they are targeting, particularly if it is in distress. Depending on the degree of influence and control they exert, they could be seen in law as being Shadow Directors
Notable exceptions are:
- Advice given in a professional capacity, such as by lawyers or accountants, does not fall within the Companies Act definition of “directions or instructions”
- A holding Company will not normally be held to be a Shadow Director of any of its subsidiaries, but a dominant individual at the holding Company could fall under the definition
What risks do Shadow Directors run?
A Shadow Director is considered to be bound by the exactly the same fiduciary, statutory and common law duties that apply to legal Directors. These include promoting the success of the company; exercising independent judgment; avoiding conflicts of interest; declaring any personal interest in property transactions and loans; and exercising reasonable care, skill and diligence.
If a Company is threatened by insolvency, a Shadow Director (as well as the legal Directors) must switch their priority to putting the interests of its creditors first. The outcome of this is that Shadow Directors who have breached any of their duties, are found liable for wrongful trading or fraudulent trading or are charged with a corporate offence, they are exposed to the possibility of:
- Being held personally liable to contribute towards losses or damage caused to the Company and its creditors, including following insolvency
- Criminal sanctions
- Disqualification from acting as a Director
In many Companies, there will be Directors and Offices (D&O) insurance in place, which could provide a measure of protection against the consequences of these risks. Unfortunately, this cover may not extend to a Shadow Director.
Avoiding or mitigating the Shadow Director risk
The start point for any concerned executive is finding out whether or not they have strayed into Shadow Director territory. Taking independent professional advice is the wisest strategy.
If the answer is ‘yes’, then at a bare minimum it’s vital to confirm that any D&O insurance extends to them or is amended to do so. Ensuring compliance with a Director’s legal duties should become a priority from then on.
If the answer is ‘maybe’ and if the executive wishes to make sure they cannot be categorised as a Shadow Director, there are a number of preventative steps that they need to follow:
- Having an employment agreement that explicitly states they are not to be treated as a Director;
- Avoiding Board meetings, and if their attendance is essential, only to do so to advise the Board and ensuring the minutes show them as “in attendance”;
- Making it clear (and ensuring that the Company also makes it clear) that they are not a Director of the Company; and
- Not taking any actions usually carried out by legal Directors.
We have extensive experience assisting business owners and Directors, and we will always work with you to find the best solution for you and your business.
If you would like to discuss the points in this article, one of our Partners would be more than happy to have a non-obligatory confidential chat with you. We can be contacted at rescue@opusllp.com or call us on 0203 995 6380 and we will arrange for a call with one of our specialists.