Companies are artificial persons

Companies are artificial persons

Companies are artificial persons and, as such, cannot conduct their businesses by themselves. They, therefore, need natural persons to operate and make decisions on their behalf. Directors form the decision- making body of a company. Directors are company as officers of a company[1]. It Shareholders of a corporation normally appoint its directors. [2]

The minimum number of directors required under statute is at least one director for private companies, and at least two directors in the case of a public company. [3]. In addition, out of all the directors of a public company, at least one must be a natural person.[4]

Definition

A shadow director is as a person who has influence on a company’s decision making and activities by giving instructions and direction to the company[5]. One can only be a shadow director if their instructions and directions are usually acted upon by the company’s directors.

However, a company is not to be regarded as a shadow director of its subsidiaries based only on the fact that the directors of its subsidiaries usually act on its instructions[6]. The parent company must meet the requirements of a shadow director for it to be regarded as such a shadow director to its subsidiaries. Individual directors of the parent company may also be shadow directors of a company’s subsidiaries.

The test for determining who is a shadow director was laid down in the case of Re Hydrodam(Corby) Ltd[7], which identified four essential requirements. First, the directors must be identified, there must be a person giving instructions or directions, the directors have acted in accordance with the instructions, and that the directors are in the habit of acting in such manner.

Shareholders do not formally appoint shadow directors, but they have indirect control over the directors appointed by shareholders[8]. The court in Ultraframe (UK) Ltd v Gary Fielding & Ors,[9] held that a person becomes a shadow director only when the directors act on the instruction or direction he has given. Also, the position of the court in Re Coroin Ltd [10] is that one can be taken to be a shadow director only if he influences the decisions made by other directors in their capacity as directors, and not while in the performance of other duties assigned to them in the company.

However, not everyone who gives direction to a company can be regarded as a shadow director. (Section 251(2) of the Companies Act). Of relevance here is the finding in the case of In the Secretary of Trade and Industry vs. Deverell [11], where the court delved into the definition of a shadow director. It was held that a shadow director is not a professional adviser. The court proceeded to state that a shadow director need not act in the shadows. His actions do not have to be covert or undercover. Further, the court observed that directions or instructions may be by word or by conduct; and that it must be shown that the directors surrendered their discretion to the instructions of the shadow director.

The criteria above show the case law interpretation moving from the strict definition under statute to a more flexible definition in light of situations not previously envisioned by lawmakers at the enactment of the Companies Act 2006.

However, a shadow director is not to be confused with a de facto director. A de facto director is a director who performs the duties of a director without a formal appointment by the company. However, a clear distinction between a de facto and a shadow director is quite difficult, as can be seen in the case of Mea Corporation Ltd, Secretary of State for Trade & Industry vs. Aviss[12]. In this case, it was held that a director was at one point acting as a de facto director, and at another point, acted as a shadow director. Thus a shadow director may be a de facto director depending on circumstances of the case.

There are situations when a de facto director’s actions meet the test of a shadow director[13]. Hannigan,[14] differentiates between a de facto and a shadow director, explaining that the difference should be made with reference to how they exercise their influence. A de facto director acts on his own, while a shadow director exerts influence on other directors.

A controlling shareholder is also in a position to be a shadow director.[15] In certain circumstances, creditors also run the risk of being seen as shadow directors in the instances where they seek to enforce their rights against a company. The court in Ultraframe (UK) Ltd[16] observed that where creditors exercise their right to enforce a contract does not mean that the creditor is a shadow director. It was further observed that holding a contrary position would result in creditors reluctance to give credit in business, which subsequently affects commercial operations.

It is, therefore, apparent that any person or any officer of the company can be a shadow director if they meet the requisite test of influence.

Degree of influence

The issue of the degree of influence required for to meet the test of a shadow director was also tackled in the case of Secretary of Trade and Industry vs. Deverell[17] where the court held that influence need not be on all business undertakings of the company and that the directors didn’t need to act on the shadow directors instructions at all times.

Further, the instructions or direction given by the shadow director need not be approved or acted upon by all the directors as long as a majority of the directors supported such action.

Responsibilities of shadow directors

All directors have a statutory responsibility to act for the benefit of the company. This duty is also imposed upon shadow directors.[18]

The responsibilities and obligations imposed upon directors under sections 171 to Section 177 of the Companies Act are also imposed upon shadow directors[19], but only to the extent to which they are capable of application. This is the position in Ultraframe (UK) Ltd, which denotes that there are instances where it is impractical to impose director duties upon a shadow director.

Fiduciary duty

By looking at how a shadow director operates, it can be argued that a shadow director does not have an obligation to act for the benefit of a company, and thus, they do not usually owe any fiduciary duties.[20] However, this position can be challenged on the basis of the provisions of section 177 of the Companies Act requires a shadow director to declare any existing interest in a specific contract or agreement. In the case of Vivendi SA vs. Richards, the court held the position that by giving directions, the shadow director took up the affairs of the company, and therefore owed a fiduciary duty to the company.

Derivative claims

Section 250(5)(b) of the Companies Act holds a shadow director to liability accruing from derivative claims. Therefore, shareholders can file a derivative suit against a shadow director. This provision has the effect of imposing a duty on shadow directors not to act negligently or fraudulently to the detriment of the company. However, Hannigan[21] observes that if shadow directors are liable in fraud, negligence, and breach of duty under derivative claims, they should, therefore, enjoy the protection of the Company Act, such as that provided for other officers under Section 1157 of the Act.

In effect, shadow directors have obligations without protection. This is apparent from the various inconsistencies present in different provisions of law. For instance, section 212 of the Insolvency Act on misfeasance does not apply to shadow directors.

On the other hand, the Financial Services and Markets Act does not differentiate between shadow directors and other directors. Thus, it applies to all directors regardless of the status of directorship. There is a need to have a uniform application of statutes relating to shadow directors very much like the New Zealand Companies Act 1993, and the Australian Corporations Act 2001. There is, therefore, clearly a confusion on the duties and responsibilities of a shadow director as different statues have different provisions.

Conclusion

The definition of shadow director, as defined in the Companies Act, is narrow and has, over time been expanded, through case law to cover a broader scope of persons who must pass the test required before they can be described as shadow directors. The law is inconsistent in protecting shadow directors and imposes a degree of liability upon shadow directors. This is so because the definition, functions and responsibilities of shadow directors depend on the nature of a company, and the circumstances surrounding each case.

References

Statute

Australian Corporations Act, 2001

Companies Act 2006

Insolvency Act 1986

New Zealand Companies Act,1993,

Case Law

Mea Corporation Ltd, Secretary of State for Trade & Industry vs. Aviss[2007] 1 BCLC 618

Paragon Finance PLC vs. D B Thakerar & Co (1999) 1 All E.R. 400

Re Coroin Ltd[2011] EWHC 3466

Re Hydrodam(Corby) Ltd[1994] BCC 161

Secretary of State for Business, Innovation and Skills vs. Chohan(2015) BCC 755

Secretary of Trade and Industry vs. Deverell [2001] Ch 340 (CA)

Ultraframe (UK) Ltd v Gary Fielding & Ors [2005] EWHC 2506 Ch

Books

Alexis Mavrikakis, Helen Watson, Christopher Morris and Nick Hancok, Business Law and Practise, College of Law Publishing, 2014

Alan J. Dignam and Andrew Hicks, Hicks & Goo’s Cases and Materials on Company Law, Oxford University Press, 2011

Brenda Hannigan, Company Law, Oxford University Press, 6th Edition, 2018

Journal

Colin R. Moore Obligations in the shade: the application of fiduciary directors’ duties to shadow directors, 2016, Vol 26 No. 2, Legal Studies Journal, 326

[1] Alan J. Dignam, Andrew Hicks in Hicks & Goo’s Cases and Materials on Company Law (page 308)

[2] Hicks & Goo’s Cases and Materials on Company Law (page 308)

[3] The Companies Act 2006, s 154

[4] The Companies Act 2006, s 155(1)

[5] The Companies Act, s 251(1)

[6] The Companies Act 2006, s 252(1)

[7] [1994] BCC 161

[8] Colin R. Moore Obligations in the shade: the application of fiduciary directors’ duties to shadow directors, 2016, Vol 26 No. 2, Legal Studies Journal, 326

[9] [2005] EWHC 2506 Ch,

[10] [2011] EWHC 3466

[11] [2001] Ch 340 (CA)

[12] [2007] 1 BCLC 618

[13] (2015) BCC 755

[14] Brenda Hannigan, Company Law, 6th Edition , Oxford University Press, 2018, 169

[15] Mea Corporation Ltd, Secretary of State for Trade & Industry vs. Aviss (2007) 1 BCLC 618 and Vivendi SA vs. Richards (2013) EWHC 3006 (Ch)

[16] See note 8

[17] See note 10

[18] The Companies Act 2006, s 172(1)

[19] The Companies Act 2006, s 170(5)

[20] Paragon Finance PLC vs. D B Thakerar & Co (1999) 1 All E.R. 400

[21] Brenda Hannigan, Company Law, 6th Edition, Oxford University Press, 2018, 174