Who is considered a shadow director of a company?

A shadow director is a person who is not validly appointed as a director, but the directors of the company are accustomed to act in accordance with the person’s instructions or wishes (excluding advice given by the person in the proper performance of functions attaching to the person’s professional capacity or their business relationship with the directors or the company).[1]

One of the best summaries of the legal principles in relation to shadow directors is found in the judgment of In Re Akron Roads Pty Ltd (in liquidation) (No 3) [2016] VSC 657. The principles are:

• There must be a pattern of behaviour in which the directors did not exercise any discretion or judgment of their own, but acted in accordance with the instructions or wishes of others, where such instructions or wishes were given or made known. 
• There must be a causal connection between the instructions or wishes of the shadow director and the acts taken by the directors. In other words, it is not sufficient if the directors, after considering a request, decide to follow it because they consider it is in the best interests of the company. A corollary of that is that not every person whose advice is in fact heeded as a general rule by the directors is to be classed as a shadow director. It may be that their advice is sound advice that the directors follow because it is in the best interests of the company.
• Similarly, the fact that the governing majority of the directors accept the views and wishes of a nominee director does not by itself make the company the nominee represents a shadow director. The views or wishes of that nominee director may be sound advice that the governing majority may consider should be adopted because it is in the best interests of the company.
• On the other hand, if the instructions or wishes of the nominee director were to carry out acts not in the best interests of the company, such as a decision to give a benefit to a company who appointed the nominee to the detriment of the company, that might support the conclusion that the directors deferred to the decision making of the nominee director and were thus deferring to the decisions of the company who appointed the nominee.
• It is not necessary that the instructions or wishes be given over the whole field of corporate activity for which the directors are responsible, and directors may retain some discretion of their own. Rather, the test for a shadow director only requires that when the directors are given instructions or wishes, they are accustomed to act in accordance with those instructions or wishes.
• The directors of the company must be accustomed to act as directors in accordance with the person’s instructions or wishes as to how they should act. There are two elements to this. 
  1. Firstly, the actions must be things reasonably regarded as being a responsibility of a director for the relevant company, and not of management. As we mentioned earlier, what is properly the responsibility of management rather than the directors will depend on the company.
  2. Secondly, there must be habitual compliance over a period of time. The corollary of this is that even though the directors start acting in accordance with the person’s instructions or wishes, the person won’t be a shadow director until that becomes habitual. There is no general rule as to how long is required before it becomes habitual compliance. 
• The directors who must be accustomed to act need not be all of the directors, but should be a governing majority of the directors. 
• And lastly, but very importantly, the fact that a person has a genuine self interest in giving advice to the directors, such as a bank or mortgagee, the mere fact that the directors will tend to take that advice to preserve it from the bank or mortgagee’s wrath will not make the bank or mortgagee, etc, a shadow director. 

When a company is in financial difficulty, it is likely to breach some covenants under its finance arrangements. Sensible directors and officers will engage with major financiers early. A financier’s response may range from doing nothing, to becoming very involved and seeking to influence the board’s and management’s actions, or something in between. 

Where a financier becomes heavily involved and seeks to exert a lot of influence, it is common for directors and officers to assert that the financier became a shadow director. In relation to such assertions, Justice Hodgson in Buzzle Operations Pty Ltd (In liq) v Apple Computer Australia Pty Ltd [2011] NSWCA 109 at [9] said:

[9]      I agree that influence exercised on directors of a company by a mortgagee acting in its own interests, particularly if supported by contractual rights in its mortgage documents, would not generally constitute the mortgagee a shadow director.  While in such a case the directors may on many occasions act in accordance with the instructions or wishes of the mortgagee, this will generally be so because the directors make their own decision that to do so is in the interests of the company, rather than because they defer to decision-making by the mortgagee on behalf of the company.  …

• What the above paragraph and other cases make clear is that unless you can show that the directors followed the instructions or wishes of the financier without any independent thought (which will be easier to prove if it can be shown the directors followed the instructions or wishes despite it not being in the best interests of the company to do so), the secured creditor won’t be found to be a shadow director, even if they get heavily involved in a workout situation.
• Back in 2003 in Emanuel Management Pty Ltd (In liq) v Foster’s Brewing Group Ltd [2003] QSC 205, Justice Chesterman said:

‘It is, I think significant that there is no reported case in which a secured creditor has been held a de facto or shadow director of the borrowing company despite there being innumerable examples over the decades of creditors who have taken a keen interest in, and exercised a marked degree of supervision over, the affairs of their debtors.’

• Twenty-one years later and the situation remains the same.

[1] See section 9AC(1)(b)(ii) of the Corporations Act.