Shadow Directors, De Facto Directors, and the legal implications of both

As a general overview, a company director oversees the affairs of a company and plays an integral role in the management and supervision of the company’s business activities.

Sometimes a person is not officially recognised as a director of the company but has the potential to control company decisions. As a result of this control, de facto directors, or shadow directors under the Corporations Act 2001, owe the same duties to the company and face the same consequence for breaching those duties as a formally appointed director. This is true regardless of whether you are a sole of a small start-up or are on the board of an ASX listed company.

What are shadow and de facto directors?

De facto director

A de facto director is a person who acts in the position of a director of a company but has not been officially appointed. This term can also refer to a person who has previously been a director, but in practice uses a different job title or description. A person or people who play an advisory role of a company may fall into the definition of a de facto director, however this is dependent on the types of duties they perform in the context of the company.

Shadow director

A shadow director is a person not validly appointed as a director, but who the other directors are accustomed to following. To establish if a person is a shadow director: on a regular basis and over a period time, the majority of the directors of the company must perform positive acts in accordance with the alleged shadow director’s instructions. If that test is met, the person is likely to be found to be a shadow director. A causal connection must also exist between the instructions given by the shadow director and the actions taken by the other directors.

In simple terms, a de facto director acts as if they are a director of a company. A shadow director makes decisions and commands the appointed directors.

What duties does a shadow director and de facto directors have?

De facto directors and shadow directors are subject to the same duties as a validly appointed director.

Some of the most significant director duties are contained in Chapter 2D of the Corporations Act 2001, including exercising the degree of care and diligence that a reasonable person would exercise in the role (s180), acting in good faith in the best interests of the company and for a proper purpose (s181), not improperly using their position to gain an advantage for themselves or someone else, or to the detriment to the company (s182), not improperly using the information they gain in the course of their director duties to gain an advantage for themselves or someone else, or to the detriment to the company (s183) and lodging information with the ASIC (s188).

Breach of duties

If a shadow director or a de facto director breaches their duties, the penalties are the same as those of an ordinary director if they are found to be in breach of their directors’ duties, including pecuniary and criminal penalties.

Civil Penalties, Criminal Penalties and Compensation

If a Court is satisfied a shadow director or de facto director has breached their duties, the Court can make a declaration pursuant to Section 1317E of the Corporations Act 2001. The result includes the Court imposing a fine of up to $200,000.00 for contravention of a civil penalty and disqualifying the person from being a director or managing companies.

The Australian Securities and Investment Commission (ASIC) can also pursue shadow directors and de facto directors in their personal capacity if the company has committed any serious breach under the Corporations Act 2001 or other relevant legislation.

Further, under s1317H of the Corporations Act 2001, the Court is granted powers to make compensation orders against directors who have breached their duties. This means that a breach of directors’ duties could also result in the person being held personally liable to pay any compensation and damages to not only the company, but also to any person who may have suffered a loss as a consequence of the breach.

Depending on the seriousness of the breach. criminal penalties may also apply under s184 of the Corporations Act 2001, if a shadow director or de facto director is reckless or dishonest and has breached their duty to act in good faith in the best interest of the corporation or for a proper purpose.

So, back to the beginning…

De facto directors and shadow directors can play a significant role in a company’s affairs and are held to a high standard.

If you haven’t taken a formal appointment as a company director but have taken on a role assisting or guiding the company, you should consider whether there is a risk that you could be pursued for breaching your directors’ duties.

*This article was prepared with the assistance of Andrea Hucke*

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