Shedding some light on shadow directors: when is an individual considered a shadow director?

By Alicia Hill, Principal and Helena Swidron, Law Clerk

Often when a company is established, directors will be appointed to manage the affairs and operation of the company. Throughout the existence of the company, new directors may be appointed, or some removed as required. However, issues arise where unappointed individuals begin to act like or are treated as directors without being officially appointed as such.

This article discusses when persons will be considered shadow directors and what factors the court will look for to establish this. Such a finding often has financial liability exposure for those identified as shadow directors.

What is a shadow director?

Generally, a shadow director is an individual that is effectively considered a director due to the control and influence they have over a company, despite their lack of appointment.[1]

The phrase ‘shadow director’ is not expressly defined within the Corporations Act 2001 (Cth) (‘Act’). However, it is captured within the broad section 9 definition of ‘director’ under subsection (b)(ii) as ‘a person who the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes’.

Contained in section 9(b)(i) is a similar notion of de facto directorship, whereby it includes ‘a person who acts in the position of a director’. De facto directors also differ from actual directors as they are not validly appointed.

Despite the informality of shadow directors, they are not precluded from liability under the Act. Directors and shadow directors, for the most part, share the same liability and obligations under the Act. However, it is important to distinguish mere advisors or consultants from shadow directors, as liability will not extend to advisers or consultants.[2]

When is an individual considered a shadow director?

The answer to this question requires an examination of substance that turns on the nature and structure of the corporation and the extent of the functions performed by the individual and any associated constraints.

Shadow directorship is determined on a case-by-case basis. The court will take into consideration factors established in case law in determining whether an individual is a shadow director. This commonly, but not exhaustively, includes:

• the size of the company;[3]
• the person’s discretion or powers of delegation;[4]
• who represents the company before external third parties;[5]
• the nature of the person’s conduct and whether it is of a kind expected of a director to perform;[6]
• whether the person’s decisions affect the whole or substantial part of the business of the company;[7] and
• whether there is a causal connection between the instruction or wish of a potential shadow director and the actions taken by the directors.[8]

Recent case examples

Below are a few examples of recent cases where the Court has determined whether an individual or company is a shadow or de facto director.

In Blakeley, Ryan and Olde v CGU Insurance Ltd (2017) 53 VR 733, Arkon Roads Pty Ltd (in liq) and its liquidators brought an insolvent trading claim against three of its Directors and a consultancy company, Crewe Sharp Pty Ltd (‘Company’).

The director of the Company was Mr Trevor Crewe.

The Arkon and its liquidators alleged that the Company, through the actions of Mr Crewe, was the shadow director of Arkon. They alleged this for the following reasons:

• it was suggested that in a mandate letter in June 2001 the Company was to be a director without formal appointment. The passage in the letter read “[the Company] is engaged to provide advice and to act in the capacity as either chairman/director of nominated operating companies’;
• the Company represented Arkon in meetings with financiers;
• the Company forced the CEO of Arkon to stand down;
• the Company actively participated in strategic decision-making processes of Arkon for important matters; and
• It acted as a ‘captain’ of Arkon.

The Court ultimately ruled that the Company was not a shadow director as these alleged actions of the Company were ultimately caused and enacted by Mr Crewe.

The Court found that there was very little activity separate from Mr Crewe that indicated the Company would be a shadow director on its own. The mandate letter was ultimately relied upon by Mr Crewe to appoint himself as Director as opposed to the Company as Director. Mr Crewe also acted to further the interests of Arkon over the interests of the Company. This it was more appropriate to consider Mr Crewe as a director and not the Company.

In Yeo, in the matter of Bradi Transport Pty Ltd (in liq) v Sklenovski [2020] FCA 1540, Brandi Transport Pty Ltd (Brandi) operated a business which provided concrete cartage services to a single customer, Boral Resources (Vic) Pty Ltd (Boral). Mrs Sklenovski was the director of Brandi since June 2005. Brandi was wound up in insolvency in late 2018. The liquidators of Brandi argued that Mr Sklenovski, Mrs Sklenovski’s husband, was during June 2013-December 2018 a de facto director under s 9 of the Act.

The Court took into consideration the factors established in Grimaldi v Chameleon Mining NL (No 2) (2012) 200 FCR 296 and determined that Mr Sklenovski was indeed the ‘controlling mind’ of Brandi and thus, a de facto director under s 9(b)(i) of the Act.

The Court concluded so on the basis that, Mr Sklenovski controlled the day-to-day operations of Brandi. Further, Mrs Sklenovski’s involvement in the management of Brandi was very limited and accordingly, the sole employee of Brandi other than Mr Sklenovski only took instruction from Mr Sklenovski and not Mrs Sklenovski. Mr Sklenovski also was the sole representative of Brandi before their single client, Boral. Ultimately he exhibited conduct of a de facto director.

In Walsh Engineering Services Pty Ltd (in liq) v Walsh Group (Aust) Pty Ltd [2021] VSC 206, Walsh Engineering Services Pty Ltd (‘Walsh’) was registered in 2014 and provided engineering services, including labour, design and fabrication of equipment. Shortly after its registration, Walsh was placed into voluntary administration in 2017. Walsh sought declaration that the director, Mrs Alissa Walsh, and her husband, Matthew Walsh (former director of the Company), were engaged in insolvent trading pursuant to section 588G of the Act. They sought compensation from Mr and MRs Walsh as directors.

The point to be considered by the Court was whether Mr Walsh was a shadow or de facto director, as he was no longer formally appointed as director.

Here, the Court found that Mr Walsh was in fact a de facto director as his conduct and effective control over Walsh was more than merely advisory. His conduct included being a signatory for Walsh’s bank account, where Mrs Walsh was not. Further, he managed Walsh’s financing and day-to-day activities on a full-time basis exclusively, whereas Mrs Walsh had paid employment external to Walsh. Mr Walsh was also held out to be the managing director of Walsh. Finally, the decision for Walsh to appoint voluntary administrator’s was Mr Walsh’s decision.

Take-aways

It is important to be conscious that unappointed people can still assume liability under the Act where they are found through their conduct to have been shadow or defacto directors of a company.

Advisers and consultants need to be conscious of the purpose for which they are engaged and have a clear delineation or retainer that sets this out and does not provide the appearance that they have control over a company and that ultimate responsibility for decision making is left with the directors of a company.

It is crucial to assess your position and effective control within a company and subsequently evaluate whether you may be found to be a shadow or defacto director. If so, it is vital to ensure that you adhere to your shadow director duties under the Act so as to avoid the associated penalties.

 Please contact Alicia Hill on (03) 8540 0200 or Alicia.hill@mst.com.au if you have any queries arising from this article.

[1] Buzzle Operations Pty Ltd (in Liq) and Another v Apple Computer Australia Pty Ltd and Another [2010] NSWSC 233; and [2011] NSWCA 109 (‘Buzzle’).

[2] Australian Securities and Investments Commission (ASIC) v King (2020) 376 ALR 1.

[3] Walsh Engineering Services Pty Ltd (in liq) v Walsh Group (Aust) Pty Ltd [2021] VSC 206.

[4] Ibid.

[5] Ibid.

[6] Grimaldi v Chameleon Mining NL (No 2) (2012) 200 FCR 296.

[7] Buzzle (n 1).

[8] Ibid.