The Hidden Influencers: Shadow Directors and De Facto Directors in Corporate Governance

What is a Shadow Director and De Facto Director

Shadow directors and de factor directors give rise to unique regulatory challenges as a person who may not be officially recognised (or appointed) as a director of a company has the potential to exert significant influence over a company’s management and control company decisions.

As a result of the control and influence, under the Corporations Act 2001 (Cth) (Corporations Act), de facto directors and/or shadow directors owe the same duties, and face the same consequences for breaching those duties, as a formally appointed director of a company. This applies to all persons acting as a de facto or shadow director, regardless of whether the company is a small business or an ASX listed company.

Accordingly, it is important to consider when a person who is involved in the management of a company may be considered a de facto or shadow director under the Corporations Act and owe duties to the company (and also be liable for any breach of those duties).  

What is a Shadow Director and De Facto Director?

Due to a lack of formal appointment of shadow directors and de facto directors, it is often unclear as to whether a person may be a shadow director or de factor director and a detailed analysis is required to consider the circumstances in each case.

The term shadow director is not expressly defined in the Corporations Act but it is captured under the broad definition of ‘director’ in the Corporations Act. Section 9AC(1)(b)(i) of the Corporations Act provides that the term ‘director’ also includes a person who is not validly appointed as a director if:

     i. they act in a position of a director; and 

    ii. the directors of the company are accustomed to act in accordance with the person’s //
        instructions or wishes.[1]

Section 9AC(1)(b)(i) is often referred to in situations where a person is a de facto director and section 9AC(1)(b)(ii) is often referred to in circumstances where the person is a shadow director.

Although the definition is broad, section 9AC(1)(b)(ii) provides a carve out for advisors acting in their professional capacity to instruct the company and states that a person is not considered to be a shadow director if the person providing advice to the directors is doing so in the “proper functions attaching to the person’s professional capacity or their business relationship with the directors or the corporation.”[2]  

De facto Directors 

A de facto director is a person who performs the roles and responsibilities of a director without being formally appointed as a director of the company.  It is important that the person performs the same functions that would reasonably be expected to be performed by a director.

Whether the functions would be performed by a director is a question of degree which will depend on the commercial context of the company, its operations and governance structure.

This term can also refer to a person who has previously been a director, but in practice uses a different job title or description or plays an advisory role.  

The Federal Court provided extensive guidance on the meaning of “de facto” director, with the principles identified summarised as follows[3]:

    a)   to be a de facto director, a person must be shown to have assumed or performed functions      
           which only a de jure director or board can properly perform, or which are the sole
           responsibility  of a director or board;

    b)  any comparison of what an alleged de facto director does, however, will vary from company to 
           company, according to the particular company’s circumstances;

    c)   the existence of active directors or a properly constituted and apparently functioning board
          does not preclude a finding that an alleged de facto director was a director;

    d)  whether the company has held the alleged de facto director out as a director will be a
          relevant, but not decisive, consideration;

    e)  the focus of the consideration is on the way the alleged de facto director operates within the
         particular corporate governance context, the degree of autonomy exercised, and the 
         appearance (and reality) of authoritative operation as a primary level decision maker for the
         company;

    f)  it may be useful to direct attention to the following considerations:

         i)  whether the person has assumed responsibility to act as a director;

        ii)  the nature of the corporate governance structure and the position the person occupies
             within it;

        iii) what the person actually did, as distinct from any job title;

        iv) the cumulative effect of the activities relied on, with the whole of the circumstances being
             looked at “in the round”;

         v) whether the company regarded the person as a director and held them out as such;

        vi) whether third parties considered that the person was a director; and

       vii) whether the person was consulted about or participated in directorial decisions.

Shadow Directors 

Separately, a shadow director is a person that is not validly appointed as a director but who exerts significant control over the management and control of the company so that the directors of the company act accordingly.

To establish if a person is a shadow director, the general position is that the directors of the company must perform positive acts in accordance with the alleged shadow director’s directions on a regular and consistent basis and over a period of time. A causal connection between the instructions given, and the action taken by the directors must also exist.

The Court will also take into consideration factors established in case law in determining whether an individual is a shadow director. This commonly, but not exhaustively, includes:

    a)  the size of the company[4];

    b)  the person’s discretion or powers of delegation[5];

    c)  who represents the company before external third parties[6];

    d)  the nature of the person’s conduct and whether it is of a kind expected of a director to
          perform[7];

    e)  whether the person’s decisions affect the whole or substantial part of the business of the                      company;[8] and

    f)  whether there is a causal connection between the instruction or wish of a potential shadow                director and the actions taken by the directors.[9]

Generally speaking, a de facto director acts as if they are a director of a company whereas a shadow director makes decisions and provides instructions to the already appointed directors. 

Duties of Shadow Directors and De Facto Directors

Generally, if a person is considered to be a shadow director or de facto director then that person will have a high level of influence and power over the board and the company in general.

As such, shadow directors and de facto directors are subject to the same duties as validly appointed directors pursuant to section 180 of the Corporations Act.

These include:

    a)  duty of care and diligence;

    b)  duty of good faith and the interest of the company;

    c)  duty to disclose all material personal interests to the company;

    d)  duty to maintain proper books and records;

    e)  duty to not improperly use information;

     f)  duty to not improperly use position;

    g)  duty to prevent insolvent trading; and

    h)  general director duties at common law and in equity.[10]

Implications for shadow directors and de facto directors if there is a breach  

Shadow directors and de facto directors, despite their lack of formal appointment, are subject to significant legal obligations and potential liabilities. If a shadow director or de facto director breaches their duties (as stated above), the penalties are the same as those of a validly appointed director, under both the Corporations Act and the Australian Securities and Investment Commission Act (ASIC).

Civil Penalties

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 for contravention of a civil penalty and the person may be liable for a fine of up to $200,000.[11] The Court may also disqualify the person from being a director or from managing the company or any future companies.

In addition to the above, 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 or other relevant legislation. The Court can also, on the nomination of ASIC, order payment to the company of money, transfer of property or payment of the amount of its loss or damage to the company if the company has suffered or is likely to suffer loss and damage as a result of the breach by the shadow director or de facto director.

Compensation

Further, under section 1317H of the Corporations Act, 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.[12]

Criminal Penalties

Depending on the seriousness of the breach, criminal penalties may also apply under section 184 of the Corporations Act, 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.[13]

Case Example

The case of Container Freight Services Pty Ltd (in liq) v Sinadinos[14] (Sinadinos Case) provides a recent example of when courts may find that a person acting with authority in a company is a shadow director or de facto director of that company.

In the Sinadinos Case, Mr Sinadinos resigned as a director of the company on 3 February 2017 and his wife, Ms Kalantzis continued as a director of the company until the company was wound up by an order of the Court on 18 March 2020. The liquidator provided evidence that the company made payments to Mr Sinadinos, Ms Kalantzis or entities owned by Mr Sinadinos without any identifiable commercial justification or reason (Impugned Payments) during the company’s tenure and that Mr Sinados should be jointly responsible for these payments made by the company, although not holding an official officeholder position.

The plaintiffs (being the liquidators) submitted that the manner in which Mr Sinadinos operated within the corporate governance of the company, including the degree of autonomy that he exercised as well as him having an authority as a primary level decision maker for the company, leads to the conclusion that he remained a de facto director after he resigned as a de jure director. In accordance with those submissions, the Court held that Mr Sinadinos was in fact a de facto director and therefore equally as liable for any breach of director duties under the Corporations Act.

As Mr Sinadinos was held to be a de facto director, the Court held that Mr Sinadinos and Ms Kalantzis contravened the following director duties:

    a)  duty to act with care and diligence (section 180(1));

    b)  duty to act in good faith (section 181); and

    c)  duty to not improperly use their position (section 182).

The plaintiffs submitted that, given the difficulties the liquidator faced in obtaining books and records of the company and in the absence of any evidence from Mr Sinadinos and Ms Kalantzis providing some commercial justification or reason for the company making the Impugned Payments, that the Court can infer that each of the Impugned Payments was solely for the benefit of Mr Sinadinos or Ms Kalantzis, or entities controlled by them, and to the detriment of the company.

The Court held that, ppursuant to section 1317H of the Corporations Act, by reason of the defendants’ contraventions of section 180(1), section 181(1) and section 182 of the Corporations Act, Mr Sinadinos and Ms Kalantzis must pay to the company, compensation in the amount of $4,978,667.61.

This case shows that a person exerting influence over a company can be found by the Court to be a shadow director or de facto director and can therefore be in breach of director duties and liable to the penalties imposed by that breach.

What can directors and companies do now

We recommend that all companies and any key person who assists, manages or influences the management and decision making of the company, consider their level of involvement in the company and the risks involved if they are at risk of being a shadow director or de facto director.

Companies should monitor individuals who exert significant influence over the decision-making processes of the company and ensure that their actions align with their legal obligations. Companies should also establish and/or maintain clear reporting structures which can assist in separating and delegating roles and responsibilities.

Irrespective of the size of the company, all internal management policies should be considered and reviewed to ensure that there are processes in place to minimise the risk of persons being found to act as shadow directors or de facto directors.

At a foundational level, all companies and any key persons involved in the governance of the company should ensure that all key persons act in accordance with the director duties under the Corporations Act.

A review of insurance policies should be undertaken to determine whether the non-directors who are involved in the management of the business are provided with coverage should it be found that they are a de factor director or shadow direct