Law Central Legal

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. Law Central Legal recommends you seek professional advice before taking any action based on the content of this Bulletin.

by John Wojtowicz (Director - Law Central Legal)

In some circumstances, a person may wish to influence the direction of a company without actually being a director. This person may be acting as a shadow director. As a general concept, a shadow director is a person who is not a director but actively influences directors of a company. The term shadow director is defined in statute and is given further meaning by the courts in case law.

Shadow Directors in Statute

The concept of a shadow director is included in the definition of a director in the commonwealth Corporations Act. The definition of a director is contained in section 9 of the Corporations Act and shadow directors are incorporated in subsection (b)(ii).Subsection (b)(ii) states a person will be a director when ‘the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.’

This means if the directors of a company are accustomed to act in accordance with a person’s instructions or wishes, that person will be a shadow director under the Corporations Act.

Interestingly the ‘accustomed to act’ test which is used to determine if a person is a shadow director has also been applied in other areas of law. The Administrative Appeals Tribunal has explicitly referenced the shadow director ‘accustomed to act’ test as the appropriate test for determining who controls a Trust in Gutteridge and Commissioner of Taxation.

Shadow Directors in Case Law

The meaning of a shadow director has been further refined in case law. The leading case on shadow directors is Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd. In that case, Young JA states the following in relation to shadow directors:

“However, it seems to me that various principles emerge from the leading authorities.

First, not every person whose advice is in fact heeded as a general rule by the board is to be classed as a de facto or shadow director.

Secondly, if a person has a genuine interest of his or her or its own in giving advice to the board, such as a bank or mortgagee, the mere fact that the board will tend to take that advice to preserve it from the mortgagee's wrath will not make the mortgagee, etc a shadow director.

Thirdly, the vital factor is that the shadow director has the potentiality to control. The fact that he or she does not seek to control every facet of the company or the fact that from time to time the board disregards advice is of little moment.

Fourthly, Millett J's proposition that the evidence must show "something more" than just being in a position of control must be shown. The whole of the facts of the case must be shown to see whether that power to control was put into practice. The emphasis that one must judge on the whole of facts and circumstances is made many times over in the leading cases.

Fifthly, although there are problems with cases where the board of the company splits into a majority and minority faction, so long as the influence controls the real decision makers, the person providing the influence may be a shadow director.”

The Corporations Act and Buzzle make it clear that in order to be a shadow director, there must be more than the mere potential to control. The Act stipulates that someone is a shadow director when the directors ‘are accustomed to act in accordance with the person’s instructions’. There are two aspects to this definition: the person must issue instructions and the directors must be ‘accustomed’ to act in accordance with those instructions. To meet this definition of shadow director, a person must actively issue instructions to directors. This interpretation is supported by Buzzle. Young JA stated ‘the evidence must show "something more" than just being in a position of control...The whole of the facts of the case must be shown to see whether that power to control was put into practice.’

Young JA also makes it clear in his first principle in Buzzle that giving advice will not by itself suffice to make someone a shadow director. He further expanded on this and stated a person may not necessarily be a shadow director even if that advice is generally followed by the board. Young JA provides an example where a party may give advice and generally have it followed without that party being deemed a shadow director. He uses the example of a mortgagor and a mortgagee. A company may act in accordance with the banks instructions, perhaps regularly, without the bank being deemed a shadow director.

The Corporations Act states that in order to be a director you must be an individual. This means that a company cannot be the director of another company. Yet, case law has held that it is possible for a company to be a shadow director of another company. This suggests that companies can be shadow directors but not directors.

Implications of being a Shadow Director

A shadow director has the same duties and responsibilities as an officially appointed director.

As shadow directors are contained in the definition of director in the Corporations Act, a shadow director is subject to all the liabilities and duties imposed on directors by the act. The duties imposed by the act include but are not limited to: the duty to exercise powers with due care and diligence; the duty to exercise powers with good faith; the duty to not improperly use your position to gain an advantage for yourself or someone else; and the duty to not trade while insolvent. A shadow director will be liable for the same penalties as an official director if they violate these duties.

In addition to duties imposed by statute, the common law also imposes fiduciary duties upon directors. The common law fiduciary duties have been substantially incorporated into the Corporations Act. Despite this, the U.K. case of Vivendi SA and Centenary Holdings III Ltd v Murray Richards and Stephen Bloch found that a shadow director is still liable for all breaches of common law fiduciary duties.

Note should be made that liabilities as a shadow director will only arise in connection with legal proceedings. It is only in legal proceedings that the Court will deem someone a shadow director. Once it is established they are a shadow director, it must then be proved that the person has actually breached one of the duties.

Gold and Platinum members read on for a discussion on whether shareholders can be deemed shadow directors.