Do you provide advice or influence decisions in a company without a formal director title? You could be a ‘shadow’ or ‘de facto’ director, exposing yourself to significant personal liability that could jeopardise your asset protection strategies.
Many individuals carefully structure their assets to protect them from potential business risks. However, what many don’t realise is that acting as a shadow or de facto director can inadvertently undermine these safeguards.
Both shadow directors and de facto directors are individuals who can be held accountable for director duties under Australian law, even though they are not formally appointed as directors. The distinction between the two lies in how they exert influence over the company.
A de facto director is a person who acts as a director in practice, performing functions and making decisions that would typically be reserved for a formally appointed director. For example:
- Performing functions exclusive to directors, such as making strategic decisions or signing significant contracts;
- Operating with a high degree of autonomy, making independent decisions without board approval;
- Being perceived by third parties as a director, representing the company in external dealings; and
- Participating in board meetings, offering input, and potentially even voting on matters, despite not having an official seat on the board.
The substance of your actions, not your official title, determines your status.
A shadow director exerts control by influencing the decisions of formally appointed directors, who are accustomed to acting in accordance with their instructions or wishes, for example:
- Issuing instructions or expressing wishes to the board on a regular basis over a period of time;
- The board demonstrating a pattern of habitual compliance with these instructions or wishes;
- A causal connection existing between the shadow director’s instructions and the actions taken by the board; and
- The shadow director having the potential to control the board, even if they don’t seek to control every aspect of the company.
In essence, a de facto director acts as a director, while a shadow director directs the actions of the actual directors.
Here are some examples of how these rules have been applied in real case scenarios.
Examples
- De Facto Director: In the case of Hayes (liquidator), in the matter of Container Freight Services Pty Ltd (in liq) v Sinadinos FCA 885, Ms Kalantzis was the sole appointed director of the company. However, her husband, Mr Sinadinos, gave evidence that he and Ms Kalantzis “ran the business together” and “[w]e made all decisions together unless it was something that was vital that had to be done straight away, with drivers’ trucks, repairs, deliveries”. He further admitted that all decisions were made jointly, but there were some more “logistics-based” decisions that he would “solely look after.” The Court found Mr Sinadinos was a de facto director due to his significant influence and authority within the company, despite not being a director. His actions as a primary decision-maker demonstrated that he acted in a directorial capacity and owed the company the same fiduciary duties as his spouse.
- Shadow Director: In Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR 410, the court recognised that a holding company might act as a shadow director of a subsidiary if the subsidiary’s board is comprised of directors who habitually comply with the holding company’s instructions or wishes. This scenario arises when the holding company has significant influence over the subsidiary’s board, causing them to simply act on the holding company’s directions rather than exercising independent judgment. This can manifest through the holding company’s control over key financial and operational decisions, effectively dictating the subsidiary’s actions. The parent company’s control may extend to managing the subsidiary’s assets, financial reporting, or even negotiating loans and borrowings on its behalf. This “atmosphere of dominance” prioritises the holding company’s interests, potentially leading to the subsidiary’s directors acting in accordance with those interests, even if they conflict with the subsidiary’s own.
Exclusions
There are some exclusions that apply to the application of the shadow director and de facto director rules.
- Professional Advisors: Individuals providing advice in a professional capacity, such as lawyers, accountants, and consultants, are not considered shadow directors simply because the board acts on their advice. However, if an advisor exerts control over the board’s decision-making, they may be classified as a shadow director.
- Lenders and Shareholders: Lenders and shareholders who exert influence due to their financial relationships with the company are not automatically considered shadow directors. The key factor is whether they cross the line from protecting their interests to controlling the company’s affairs.
If you need assistance with your company’s governance structure, call us on 1300 654 590 or email us.
Consequences of Being Deemed a Shadow or De Facto Director
Both shadow and de facto directors are subject to the same duties and liabilities as formally appointed directors.
These include duties such as:
- Duty of care and diligence: Acting with the same level of care and skill as a reasonable person in their position.
- Duty to act in good faith and in the best interests of the company: Making decisions that benefit the company as a whole, not for personal gain or to favour specific individuals.
- Duty to avoid conflicts of interest: Not using their position for personal advantage or to the detriment of the company.
- Duty to prevent insolvent trading: Not allowing the company to incur debts if it is insolvent or likely to become insolvent
Penalties for breaching these duties can be severe, including:
- Civil penalties, such as fines of up to $200,000.
- Criminal penalties, including imprisonment for up to five years.
- Personal liability for company debts.
- Disqualification from managing companies.
Therefore, understanding whether your actions amount to being a shadow or de facto director is crucial for an individual involved in the management of companies, as the legal consequences of being classified as either can be significant.
Protecting Yourself: Avoiding Unintentional Shadow or De facto Directorships
When determining whether an individual is acting as a shadow director, the focus is on the causal connection between the shadow director’s instructions and the board’s actions. If you’re involved in a company’s management but don’t want to be exposed to the risks of a shadow directorship, consider these steps:
- Formalise your role: If you’re performing director-like functions, consider seeking formal appointment to the board. This ensures you’re aware of your responsibilities and have the necessary protections (for example, director’s insurance).
- Clearly define your involvement: Ensure your role is documented in writing, specifying your responsibilities and limitations. This can help demonstrate that you’re not acting as a director.
- Avoid giving binding instructions: Frame your advice as recommendations rather than directives, allowing the board to exercise independent judgment.
- Ensure robust corporate governance: Encourage the company to implement clear governance policies and procedures that delineate roles and responsibilities.
- Seek legal advice: If you’re unsure about your position or the implications of your involvement, consult with a lawyer specialising in corporate law.
How we can help
To understand more about when individuals involved in the management of a company can be held liable, call us on 1300 654 590 or email us.
The information contained in this post is current at the date of editing- 12 December 2024.
