Is the Interpretation of the Expressions ‘De Facto Director’ and ‘Shadow Director’ Sufficiently Certain in the Light of Smithton Ltd Case?

Is the Interpretation of the Expressions ‘De Facto Director’ and ‘Shadow Director’ Sufficiently Certain in the Light of Smithton Ltd Case?

The aim of this article is to discuss the certainty of the expressions ‘de facto director’ and ‘shadow director’following the case of Smithton Ltd.1 In order to establish this, the interpretation of the two terms prior to Smithton would be examined and compared with Mrs Justice Rose’s recent judgment.

Directors are essential to every company. According to s.154 of the Companies Act 2006 (CA 06), there must be a minimum of one director in private companies and a minimum of two directors for public companies. Director as such is not defined in the CA 06, which states that ‘director’ includes any person occupying the position of a director, by whatever name called.2 Legally, there are three classes of directors: de jure, de facto and shadow directors.

A de jure director is one who has been formally and legally appointed as a director in accordance with the articles of association and derives authority from his or her office as director.3 A de jure director enjoys the full rights of a director but is also held liable for acts of negligence of the company.

On the other hand, de facto and shadow directors are not formally appointed as directors, but are individuals who act as though they are directors of the company. The purpose of the broad definition of ‘director’ is so that everyone acting as a director of a company would be liable, regardless of whether the formalities in appointment have not been complied with.4 According to Sir Nicholas Browne-Wilkinson V-C, ‘director’ includes ‘validly appointed, invalidly appointed, or assuming to act as a director without any appointment at all’.5

A de facto director exercises the duties of a director but is not properly appointed as such. Lord Collins of Mapesbury noted that prior to the 1980s the term was used only in cases where the appointment requirements had not been complied with or where someone had been, but ceased to be, a formal director. 6 Since, as the definition expanded, judges have been reluctant to formulate a single test, as the circumstances vary in every case.7 At present, the leading case on the matter is Supreme Court in HMRC v Holland and another.8 Lord Hope of Craighead reviewed the authorities and concluded ‘It is plain from the authorities that the circumstances vary widely from case to case’.9 Further, Lord Collins summarized the three most influential factors when interpreting ‘de facto director’.

Firstly, whether the person was the sole person directing the affairs of the company (or acting with others equally lacking in a valid appointment), or if there were others who were true directors, whether he was acting on an equal footing with the others in directing its affairs.10 Secondly, whether there was a holding out by the company of the individual as a director, and whether the individual used the title.11 Thirdly, taking all the circumstances into account, whether the individual was part of ‘the corporate governing structure’.12
Reviewing the authorities, even early cases such as Re Hydrodam (Corby) Ltd  stated that the de facto director must have presented himself to third parties as being the director of the company, or to have been held out by management as being a director.13 However, that is now one of a number of factors considered rather than a decisive element in the test.

Conversely, a shadow director is defined in s.251 CA 06 as a person in accordance with whose directions or instructions the directors of the company are accustomed to act. However, a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity. The definition is also followed in s.251 of the Insolvency Act 1986 and s.22(5) of the Company Directors Disqualification Act 1986.
The leading case in regards to shadow directors is Secretary of State for Trade v Deverell.14 In his judgment, Morritt LJ laid out the following principles in defining a shadow director. Firstly, effect must be given to the parliamentary intention and the statutory definition must be followed, however it should not be strictly construed. Hence, the legislation aims to identify those with actual influence on the corporate affairs, other than professional advisers. Such influence need not be exercised in the entire field of the corporate activity. Furthermore, communication regarded as ‘direction or instruction’ by the purported shadow director, should be objectively ascertained by the court in the light of all the evidence. It may be sufficient to show that some of the de jure directors surrendered their respective discretions in light of his ‘directions or instructions’ but this is not necessary in all cases. In addition, non-professional advice may fall within the statutory definition, because the concepts of ‘direction and instruction’ do not exclude the concept of ‘advice’ and all three share the common feature of ‘guidance’. Morritt LJ also noted that the shadow director does not need to ‘lurk in the shadows’.

In the previous case of Hydrodam,  Millet J summarized the steps to establish a shadow director.15 Firstly, the de jure and de facto directors of the company must be identified. Following, the alleged shadow director must have directed the board on how to act in relation to the company. Further, those directors must have acted in accordance with those directions and they must have been accustomed to do so; hence there must be a pattern of behavior, in which the board of directors acted in accordance with the directions of others. Confirmed in Ultraframe 16, Millet J’s summary was considered recently by David Richards J in McKillen v Misland (Cyprus) Investments Limited (‘Coroin Limited’).17 He confirmed, that in his view, it is not necessary that all the directors should act in accordance with the directions of the shadow director, it is enough that a majority do so. He continues to state that, it is not necessary that the shadow director should exercise control through the instructions which he gives over all the matters which are decided by the board. Following Becker, one-off reactions by the board would not suffice.18

Mrs. Justice Rose’s judgment in Smithton examines the law on de facto and shadow directors in detail.19 Although the tests for the two terms have differences, the judge considered them simultaneously, adopting the same approach as the parties’ analysis. She accepts the previous authorities on the matter, acknowledging the difficulty of setting out a certain and reliable test, as this area of law is one varied on the circumstances of each case. Much of her judgment is based on the statement of Timothy Lloyd QC in Re Richborough Furniture Ltd  ‘if it is unclear whether the acts of the person in question are referable to an assumed directorship, or to some other capacity such as a shareholder or, as here, consultant, the person in question must be entitled to the benefit of the doubt’.20 The defendant, Mr Naggar was a large client of Hobart, chairman of DDI (which held 50.1% in Hobart) and, in addition had an interest to preserve the “Dawnay Day” brand. Based on the evidence, the judge concluded that Mr. Naggar was not a de facto or a shadow director. His interventions were readily explicable either on the basis of his role as client or Chairman of DDI or because they are one-off incidents arising from a particular unusual situation.21

Concluding, Mrs. Justice Rose noted, “It is not necessary therefore to consider the difficult legal and factual issues that would arise if my decision on this point had been different”.22 Hence, the certainty of de facto and shadow directors is no different as it was prior to the case.

1 Smithton Ltd v Naggar [2013] EWHC 1961 (Ch)

2 Companies Act 2006 s. 250

3 R Graham “Classes of Company Director” (2013) Nabbaro LLP Report

4 Supra n.2

5 Sir Nicholas Browne-Wilkinson V-C in Lo-Line Electric Motors Ltd, Re [1988] Ch. 477

6 Lord Collins of Mapesbury

7 Jacob J in Secretary of State for Trade and Industry v Tjolle [1998] 1 BCLC 333, Robert Walker LJ in Re Kaytech International plc [1999] 2 BCLC 351 , 423

8 Supreme Court in HMRC v Holland and another [2010] UKSC 51

9 Ibid.

10 Re Richborough Furniture, Ltd Secretary of State for Trade and Industry v Stokes & Ors [1996] B.C.C. 155

11 Secretary of State for Trade and Industry v Tjolle [1998] 1 BCLC 333

12 Secretary of State for Trade and Industry v Tjolle [1998] 1 BCLC 333, at pp 343–344, approved in Re Kaytech International plc [1999] 2 BCLC 351 , 423

13 Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180

14 Secretary of State for Trade v Deverell [2001] Ch 340

15 Supra n.13

16 Ultraframe (UK) Ltd v Fielding [2005] EWHC 1638 Lewison J at para [1272]

17 McKillen v Misland (Cyprus) Investments Limited (‘Coroin Limited’) [2012] EWHC 521

18 Secretary of State for Trade and Industry v Becker [2002] EWHC 2200

19 Supra n.1

20 Re Richborough Furniture Ltd [1996] 1 BCLC 507 , at p524

21 Supra n.1 para [121]

22 Supra n.1 para [126]

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