In this article, I try to explain the principles applicable to a shadow director and the consequences that follow.
In law, the term de jure director means a ‘director as of right’ and is an individual who has been formally appointed as a director of a company. So, the individual’s office as a director is of public record.
However, there may be instances where an individual is not formally appointed as a director. But this individual is still able to wield influence over the company’s affairs. The law may find that the individual is a shadow director. This would mean this individual attracts all the duties and liabilities as a director of the company.
A director is therefore not necessarily defined by his designation alone but rather by the dominant or controlling role that the individual plays, often behind the scenes, in running the company.
Before delving into the legal principles, let us set out the brief facts of the hypothetical situation involving a company called 1ABC. We will then see how the legal principles apply to these facts.
Facts on 1ABC
Let us take a fictional country called Malovia. A strategic development company called 1 Air Batu Campur (1ABC) was set up. 1ABC is a wholly-owned subsidiary of Malovia’s Ministry of Finance.
The President of Malovia (who is also the Minister of Finance), Mr President, sits as the Chairman of the Board of Advisors of 1ABC. Like all companies, 1ABC has its Board of Directors.
A whistleblowing news portal starts to publish various reports detailing the relationship between Mr Jello and 1ABC. In particular, the reports set out how Mr Jello advised and influenced 1ABC’s Board of Directors into entering a joint venture with another foreign company called Pepper Soda International. Certain leaked minutes of Board meetings seem to show that the joint venture was rushed into and where 1ABC paid out of a total of USD1.83 billion in cash.
Additionally, news reports also suggest that Mr President is the final approving authority of all of 1ABC’s deals. After all, Mr President is the Minister of Finance, and in charge of the sole shareholder of 1ABC.
Legal Ingredients to Establish a Shadow Director
The term “shadow director” has been used to describe “a person in accordance with whose directions or instructions the directors of a corporation are accustomed to act.”
In turn, there have been sinister images imputed on the title of a shadow director: a puppeteer manipulating the board, or that the board of directors is the cat’s paw or that the board dances to the tune of the shadow director.
These descriptions may be a slight over-exaggeration. The test to establish a shadow director is simply whether there is sufficient evidence showing that the directors are accustomed to act on the directions or instructions of that person.
By “accustomed to act”, there must be a pattern of behaviour on the part of the rest of the directors in complying, rather than instructions or directions for a single event. If yes, then the status of a shadow director may be imputed to him.
Certain scenarios which can bring about a strong case of establishing a shadow director:
- A parent company, or even the controller of the parent company, giving instructions to the directors of a subsidiary;
- A non-director who influences and takes control of the financial affairs of the company;
- Exercising any power of veto over the de jure directors’ decisions or even making or influencing major decisions of the company;
- Negotiating with third parties on behalf of the rest of the Board; or
- Controlling the appointment of senior management of the company.
Applying it to the facts of 1ABC, the question to be asked is therefore whether Mr Jello or Mr President has carried out any such behaviour such that the directors of 1ABC are accustomed to act on their directions or instructions. If the answer is yes, then there could be a case that either Mr Jello or Mr President could be found to be a shadow director of a company like 1ABC.
Consequences of being a Shadow Director
What are the consequences of being a shadow director of 1ABC?
As stated earlier, being a shadow director merely means that such an individual is treated in law as a director, and the law would impose all the duties and liabilities on such a shadow director. There is nothing wrong per se about being a shadow director.
Nonetheless, there are some significant consequences that can flow from being a shadow director. Let us apply it to the situation of 1ABC:
- A shadow director can owe fiduciary duties to 1ABC to act in the best interests of 1ABC. More so, if the shadow director dealt directly with 1ABC’s assets. If 1ABC were to be under a new management looking into historical transactions, 1ABC could look into whether there were any breaches of duties owed by any shadow director to 1ABC.
- A company like 1ABC would under the oversight of a regulator like the Companies Commission of Malovia (CCM). CCM would have the power to investigate any director, including a shadow director, as to whether there are any breaches under the Companies Act of Malovia. Some of these breaches can include a director’s breach of fiduciary duties and failure to disclose his interest in a contract.
- If 1ABC is wound up, the liquidator of 1ABC could look into the historical transactions and investigate whether there were any breaches of the directors, and this could possibly extend to the acts of any shadow director as well. A liquidator or even creditor of 1ABC can apply to the Court under the fraudulent trading provisions. This is essentially where the business of the company has been carried on with the intent to defraud creditors of the company.
- When any other law enforcement agencies or regulators look into the conduct of the directors of 1ABC, such an investigation could also extend into examining the conduct of any possible shadow directors.