Directors: not in name only

Many limited companies have struggled to stay afloat with the decline in the economy, and ultimately have gone under. It is not only creditors who have cause for concern when this happens.
When a limited company goes into administration or is wound up, the administrator or insolvency practitioner makes a report on the directors’ conduct in the three years prior to the insolvency to the Department for Business, Innovation and Skills. Their behaviour will be scrutinised to see if it is in the public interest to seek a disqualification order under the Company Directors Disqualification Act 1986 (“CDDA”).

Directors are also vulnerable under ss 212-214 of the Insolvency Act 1986, which enables liquidators, creditors and others to bring an action against a director for breach of duties.

However, it is not only those officially appointed as directors by the company who are vulnerable to scrutiny. Shadow and de facto directors are caught as well. These terms are often used, but it is not always clear what they mean.

Definitions, or not

CDDA defines a shadow director as “a person in accordance with whose directions or instructions the directors of the company are accustomed to act (but so that 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 literal meaning of “de facto” is exercising power or serving a function without being legally or officially established. How that applies to ascertaining whether someone who has not been appointed as a director, is in reality a director of a limited company, is not set out in any statute. However, the recent English decision in Re UKLI Ltd, Secretary of State for Business, Innovation and Skills v Chohan [2013] EWHC 680 (Ch) is very helpful in summarising criteria to be applied in determining de facto directorship.

Ten characteristics

Under CDDA, s 6 a defendant may be disqualified by the court if they are a director of a company that became insolvent and their conduct as director makes them unfit to be concerned in the management of a company. The court in this case was satisfied that both of these tests applied to Mr Chohan. However, he was not a formally appointed director of the company in the time frame in question. Section 6 expressly extends to shadow directors, and case law has also applied it to de facto directors. So, the question here was whether Mr Chohan was a shadow director, de facto director or both.

The court ultimately decided he was a shadow director or de facto director, and disqualified him for 12 years. What makes this decision useful is that the court summarised the criteria for determining de facto directorship. The court said that each of the following characteristics is relevant in determining whether someone is a de facto director, but not all need to be established:

(1) they must act as if they were a director;

(2) they must be part of the corporate governing structure and participate in directing the affairs of the company in relation to the acts or conduct complained of;

(3) they must be either the sole person directing the affairs of the company, or a substantial or predominant influence and force in doing so relating to the matters complained of – having influence is not enough;

(4) they must undertake acts or functions which suggest that their remit to act is the same as if they were a director;

(5) the functions they perform and the acts complained of must only be capable of being performed by a director;

(6) it is relevant whether they are held out as a director or claim to be one;

(7) their role may relate to part of the affairs of the company only, so long as that part is the one complained about;

(8) their lack of accountability to others and involvement in major decisions point towards de facto directorship;

(9) if they have the power to intervene to prevent some act on behalf of the company, that might be sufficient; and

(10) they must be more than a mere agent, employee or adviser.

Advice for solicitors

Solicitors advising directors of limited companies who are in financial difficulties should remind them that the spotlight will be firmly upon their actions in the run-up to insolvency.

Solicitors should also be vigilant when advising those who could be deemed to be shadow or de facto directors. To avoid any comeback against themselves, solicitors should flag to such individuals that they could be held to be acting in that capacity and what their duties are, and highlight the potential consequences of non-compliance with those obligations.