Shadow and de facto directors – a hidden liability for your company?

Whether it’s a small business with just a few employees, or a corporate giant that stretches across states, a company’s operations are overseen by its directors. Depending on the size and stage of the growth of the company, the directors may be heavily involved in day-to-day operations or play a more overarching and supervisory role determining the strategic direction of the organisation and overseeing management’s implementation of that strategy.

Given the importance and responsibilities faced by these directors, they must be formally appointed in accordance with the Corporations Act 2001 (Cth). One might think that these visible figures are the only individuals in charge. In reality, businesses may have people who perform the same or similar function as company directors but are not formally appointed and there are several risks associated with that.

Those that act like a director but are not formally appointed can be classified into two categories – shadow directors, and de facto directors.

De Facto Directors

De facto directors are individuals who are not formally appointed, yet they act in the position of a director. There are a variety of factors to determine if they are “acting” in this way including:[1]

  1. The nature and extent of the functions and powers exercised by the individual;
  2. How outsiders who deal with the company perceive the individual and their authority;
  3. The internal practices or structure of the company, and whether the work done was characteristic of a director or not; and
  4. The size of the company and their management procedure.

What is not relevant is the title within the company that the alleged director adopts.

Shadow Directors

Shadow directors are people whose instructions or wishes the formally appointed directors are accustomed to follow. A decision in the NSW Court of Appeal, Buzzle Operations v Apple Computer Australia,[2] provides clarification on who is likely to be a shadow director. There must not only be a pattern of habitual compliance by the Board over a period of time, but there must also be a causal connection between the instructions or wishes, and the acts actually taken by the directors. It is not sufficient that the Board would have taken the act regardless of the instructions or wishes – the Board needs to be choosing to follow those instructions or wishes.

People who are not necessarily shadow directors:

  1. Those that have a genuine interest in providing professional advice to directors (for example, consultants, accountants); and
  2. Third parties who have a commercial relationship with a company even if they are able to insist on certain terms because of their bargaining position (for example, financiers).

Duties & Risks

De facto and shadow directors must comply with the same duties as a validly appointed director. These duties include:[3]

  1. Being honest and careful, and exercising their duties in good faith,
  2. Discharging their duties with care and diligence as a reasonable person in a director’s role would,
  3. Exercising their power for a proper purpose in the best interests of the company,
  4. Not improperly using their position or information for personal gain or to cause detriment to the company, and
  5. Ensuring the company does not trade whilst insolvent.

There are various consequences that stem from a breach of these duties under the Corporations Act, both criminal and civil. A Court may order a person to pay a penalty, disqualify the person from being a director, or hold them personally liable for any loss caused. Criminal charges may also apply for certain breaches.

If this occurs, shadow and de facto directors may not be covered on the Directors and Officers Liability Insurance, and suffer personal risk or exposure for the individual, as well as the company. Furthermore, the company may still be bound by the decisions of the shadow or de facto director despite the lack of formal authority, and thus incur liability through contracts or breaches of law.

Real-life examples – everything comes down to the facts

In Grimaldi v Chameleon Mining NL (No 2) [4] an employee of Chameleon Mining NL, Mr Grimaldi, assisted to broker the acquisition of mines in Western Australia. Mr Grimaldi diverted funds from that acquisition to pay a commission to himself. The key facts considered were that Mr Grimaldi had been authorised by the Board to negotiating the acquisitions of various overseas mining interests, fund raising and share placements, Mr Grimaldi was present in all the board meetings, and Mr Grimaldi was the main source of information for the company’s auditors who believed he was a ‘manager’. The Court determined that through these actions and the power granted to him, Mr Grimaldi was a de facto director, and hence he had dishonestly diverted those funds in breach of his director’s duties.

In Yeo, in the matter of Bradi Transport Pty Ltd (in Liq) v Sklenovski[5], the Court considered whether Mr Sklenovski was a de facto director who had failed to prevent the company (Bradi Transport) from trading while insolvent. The Court considered the fact that Mr Sklenovski was the sole representative for the company’s sole client and the only other employee took instructions from Mr Skelnovski rather than the formal director (who happened to be Mrs Sklenovski). From the evidence put before the Court by the company’s accountant, Mr Skelnovski was in effect controlling the company and the other director had little to no involvement. As a result, the Court held Mr Sklenovski was a de facto director.

In Re Akron Roads Pty Ltd (in liq) (No 3)[6]Akron Roads hired Mr Crewe’s company Crewe Sharp to provide consultancy services. Crewe Sharp was responsible for obtaining financing and directing financial related matters for Akron Roads, and Mr Crewe would thus regularly put his proposals to the board of Akron Roads. Mr Crewe also oversaw Akron Roads’ WH&S and HR department, had an office, and attended the company’s executive meetings. It was held that Crewe Sharp and Mr Crewe were not shadow directors of Akron Roads, as his actions fell into the normal bounds of a managerial role, and the board exercised their power and discretion in a manner that was not just habitual compliance with Mr Crewe and Crewe Sharp’s wishes.

Given the serious consequences that may stem from the actions of shadow or de facto directors, it would be prudent for all companies to review their internal management structures and ensure that all individuals who would be or might be classified as directors are either appointed as such and understand their duties, or the company takes steps to manage their involvement in the business so that they are not seen as directors. Staff should understand the limitations of their role to avoid accidentally acting as a director.

If you have any queries or require further advice, please don’t hesitate to contact our Business & Commercial team on 02 6274 0999 to discuss further.

This article was first published on 11 May 2023..

[1] [2012] FCAFC 6

[2] [2020] FCA 1540

[3] [2016] VSC 657

[4] Deputy Commissioner of Taxation v Austin [1998] FCA 1034, Chameleon Mining NL v Murchison Metals Ltd [2010] FCA 1129

[5] Buzzle Operations Pty Ltd (In Liq) v Apple Computer Australia Pty Ltd [2010] NSWSC 233, 247.

[6] See Division 1, Part 2D.1 of the Corporations Act

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