Menu

Identification of shadow directors and de facto directors

Print publication

15/10/2014

A shadow director is defined in section 251(1) of the Companies Act 2006 as a person in accordance with whose directions or instructions the directors of the company are accustomed to act. There are limited exceptions for those who act purely in a professional capacity when providing advice – such as lawyers. A de facto director on the other hand is a person who performs the functions of a director but who has not been formally appointed as a director.

The question before the Court of Appeal in Smithton Ltd v Naggar [1] was the not uncommon one of whether the director of a holding company had become a shadow or de facto director of a subsidiary.

In this case, the claimant company (Hobart) claimed for loss suffered when two companies, Insureprofit and Mariona, defaulted on obligations under contracts entered into with Hobart. Insureprofit and Mariona were insolvent and the claim was brought against a Mr Naggar personally. Naggar was the director of a company called Dawnay Day, itself the majority shareholder of Hobart. Dawnay Day’s business model was to “incubate” new businesses and then spin them off in joint ventures should they prove successful. Directors were appointed to the new companies by Dawnay Day to protect its interests. Naggar directly and/or indirectly owned both Insureprofit and Mariona. The first part of the claim against Naggar was that he was a de facto or shadow director of Hobart and had breached his statutory duties to Hobart.

The High Court found that Naggar was neither a shadow nor a de facto director of Hobart. Its approach was to identify what “hat” he was wearing in his dealings with Hobart. The facts indicated that his involvement in Hobart’s business did not extend beyond what one would expect of a major shareholder and client and there was no evidence that a majority of the Hobart board were accustomed to act in accordance with Naggar’s instructions.

That decision was upheld on appeal. The Court of Appeal applied the leading case in this area, HMRC v Holland [2] which held that the sole director of a number of trading companies was not a de facto of those companies. The Court stated that there was no single determinative test as to whether someone was a de facto director and identified the following as relevant considerations:

  • the concepts of a shadow director and a de facto director are separate but overlap
  • the key consideration in determining whether someone is a de factor director is to ask whether they have assumed a responsibility to act as a director
  • this is to be determined objectively. The individual’s own thoughts on the matter are irrelevant
  • it is relevant however, whether or not the company considered the individual to be a director and held them out as such and whether third parties considered that person to be a director
  • the court must look at the acts in context and consider their cumulative effect
  • the fact that a person is consulted about directorial decisions, or asked for approval, does not, without more, make them a director.

The Court of Appeal emphasised that ordinarily the court will need to review the company’s corporate governance system before making its decision. The Court considered the argument that the High Court’s focus on “hat” identification had obscured its assessment of the corporate governance structure; however, that was not enough to justify reversing the High Court’s finding. On the evidence, there were no grounds for interfering with the High Court’s decision.

Cases on shadow and de facto directors come before the courts on a fairly consistent basis and in each case context is all-important. The lesson from this case is the importance the courts will attach to the corporate governance system of the company in question.

[1] [2014] EWCA Civ 939

[2] [2010] 1 WLR 2793