Insolvency Law Update

this article first appeared in the solicitors Journal on 12 November 2013 and is reproduced with their kind permission

The courts are directors’ liability, say Denise Fawcett

Many directors take on this role without a clear understanding of what it entails in terms of duties to be performed and liabilities if they are not. Other directors, knowing that this liability exists, may seek to avoid this risk in a number of ways. The courts have had the opportunity to consider this issue in two significant cases.

The Companies Act 2006 codified common law duties of directors of a company in sections 171-177 (see box).

A failure to adhere to these duties can lead to personal liability and disqualification as a director. Directors must also take care to ensure they do not fall foul of the provisions of the Insolvency Act 1986. For example they must not be involved in fraud in anticipation of winding up; transactions to defraud creditors; misconduct in the course of winding up; falsifying the company’s books; material omissions from statements relating to the company’s affairs; false representation to creditors and misfeasance.

Further, under sections 213 and 214, directors may be liable for fraudulent trading and wrongful trading respectively. Statute and case law both recognise the position of de facto and shadow directors and any individual fulfilling these roles has responsibility as a director.

Abrogation of responsibility

In Madoff Securities International Limited (In Liquidation) v Raven and others [2013] EWHC 3174 (Comm) the duties of directors were closely considered. The case centred on claims arising from the management of Madoff Securities International Limited and whether payments made by the company to Bernard Madoff and another individual were necessary payments and also, if these payments amounted to a breach of a director’s duties.

Two notable conclusions were drawn. Firstly, it is possible to divide and delegate a director’s duties in regard to particular aspects of the management of a company. Secondly, such delegation does not remove the inescapable personal responsibility that each director owes. A director owes the company a duty to inform himself of the company’s affairs and join with his fellow directors in supervising them. Importantly, it is therefore a breach of a director’s duties if a director allows himself to be dominated, bamboozled or manipulated by
 a fellow director where doing 
so involves a total abrogation of this responsibility.

However, a director, holding 
a minority view and in disagreement with fellow directors where the board have considered a proposal and believe it to be in the company’s best interests, would not place the director in breach.

The case of Re UKLI Ltd Secretary of State for Business, Innovation and Skills v Chohan and others [2013] EWHC 680 Ch has served as a reminder that those who act as directors of companies cannot avoid the duties and liabilities imposed on directors just because they are not formally appointed. Chohan has revisited the role of de facto and shadow directors and the interaction between the two.

Chohan concerned a company, UKLI, that had offered two land banking schemes to investors. The land was purchased on the speculation that planning permission might at some point be granted on the land, thereby increasing its value.

The schemes were unauthorised and prohibitive investment schemes under the Financial Services and Markets Act 2000 and the Secretary of State sought to disqualify the directors for unlawful operation of the schemes.

Action was also brought against Chohan for procuring improper loans and dividends that UKLI could not afford. Chohan had taken steps to ensure he was not a registered director. The court considered 
if his actions amounted to those of a shadow or de facto director and if he would therefore 
remain liable.

What constitutes a de facto director has been developed through case law. Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180, 
183 established that influence over a company’s affairs is not sufficient grounds to deem an individual to be a de facto director. Re Richborough Furniture Ltd [1996] 1 BCLC 507 provided further guidance as to what is a de factor directorship.

A de facto director must be shown to have acted on an equal footing with those directing the affairs of the company.

Third-party actions

The court also considered that where there is uncertainty as to assumed directorship and whether an individual’s actions could be considered to have been in some other capacity, such as shareholder or consultant, the individual should be given the benefit of the doubt.

Chohan has now provided the most recent and comprehensive guidance on de facto directorship. The case emphasised that in determining whether or not a person has acted as a de facto director, the ultimate question is one of fact and set out the following criteria to be taken into account: a de facto director must presume to act as if he were a director; he must be or have been, in point of fact, part of the corporate governing structure and participated in directing the affairs of the company in relation to the acts or conduct complained of; he must be either the sole person directing the affairs of the company or a substantial or predominant influence and force in so doing as regards the matters of which complaint is made ‒ influence is not otherwise likely to be sufficient; whether the person concerned has undertaken acts or functions such as to suggest that his remit to act in relation to the management of the company is the same as if he were a de jure director; the functions he performs and the acts of which complaint is made must be such as could only be undertaken by a director, not ones which could properly be performed by a manager or other employee below board level; it is relevant whether the person was held out as a director or claimed or purported to act as such: but 
that, and/or use of the title, is not a necessary requirement, and even that may not always be sufficient; his role may relate to part of the affairs of the company only, so long as that part is the part of which complaint is made; lack of accountability to others may be an indicator; so also may the fact of involvement in two major decisions;

the power to intervene to prevent some act on behalf of the company may 
suffice; and

the person concerned must 
be someone who was more than a mere agent, employee or advisor.

Significantly, it is to be noted that not all of these criteria need to be present to establish a de facto directorship and the court recognised that overlap between these criteria would be inevitable.

Unregistered directors

In contrast, the definition of a shadow director is entirely derived from statute. Both sections 251 and 22(5) of the Company Directors Disqualification Act 1986 state:

“Shadow director”, in relation to a company, means a person in accordance with whose directions or instructions the directors of the company are accustomed to act (but so that 
a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity).

The court considered that Chohan continues the thinking in a growing number of cases that have eroded the view that there is a complete distinction between the two categories of unregistered director.

The cases of Re Euro Express Ltd, Secretary of State for Trade and Industry v Deverell [2001] Ch 340, re Kaytech International plc [1999] BCC 390, 402 and Re Paycheck Services 3 Ltd, Revenue and Customs Commissioners v Holland [2010] UKSC 51 have all established that the distinctions between the two are not necessarily absolute.

Notably, Chohan has 
continued this erosion identifying that “a person may act as both [de facto director and shadow director], the one in fact shading into the other”.

Chohan also identified that the same evidence is likely to be relevant to the question of whether a person is a de facto director and/or shadow director.

Potential associate liabilities

As stated by Justice Hildyard, in Chohan, the CDDA would be frustrated if an individual could “escape disqualification by the simple expedient of never formally being appointed as a director”. The fact that an individual was the 100 per cent owner of a company and was therefore in a position to exert control over the company, was a consideration in identifying a de facto or shadow director.

The individual’s reliance on being recognised solely in their capacity as shareholder did not act as a barrier to prevent them from also being recognised as a de facto or shadow director.

Similarly, resigning from the position of a registered director did not automatically remove the associated potential liabilities for future actions. Where the individual still retains influence over the company following resignation they still have the duties set out above.

Madoff and Chohan highlight the considerable responsibilities that a director holds. As the courts adopt an increasingly broad scope to de facto and shadow directorships, care should be taken.

Those exercising an element of control over the company while not registered as a director may well find themselves taking on more than they had bargained for. The ten points set out in Chohan could prove a helpful guide for those looking to shed light in the shadows. SJ