What is a Shadow Director & De Facto Director?

A de facto director and a shadow director of a company are people who are not officially appointed in the position of a director of that company.

A de factor director is a person who is not validly appointed as a director but a person who does the work of a director and/or acts in the position of director of that company.

A shadow director is a person who is not validly appointed as a director but a person to whose instructions or wishes the actual directors of the relevant company are accustomed to acting in accordance with (including de facto directors).

If a person is found to be a de facto director or a shadow director of a company, then they will be bound by the same obligations and duties as if they were a validly appointed director and be liable as if they were a validly appointed de jure director.

In this article, our corporations disputes lawyers explain the difference between a de facto director and a shadow director, and explain the risks of a breach of those duties.

What is a Director of a Company?

Section 9 of the Corporations Act 2001 (Cth) (“the Corporations Act”) defines the term director to mean:

“director” of a company or other body means:

(a)  a person who:

(i)  is appointed to the position of a director; or

(ii)  is appointed to the position of an alternate director and is acting in that capacity;

regardless of the name that is given to their position; and

(b)  unless the contrary intention appears, a person who is not validly appointed as a director if:

(i)  they act in the position of a director; or

(ii)  the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.

The Corporations Act clearly intended a person who is not officially appointed to the position of director to be defined as a director.  This is commonly referred to as a de facto director or a shadow director.

Section 9 of the Corporations Act 2001 defines the term officer to mean (inter alia):

“officer” of a corporation … means:

(a)  a director or secretary of the corporation; or

(b)  a person:

(i)  who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; or

(ii)  who has the capacity to affect significantly the corporation’s financial standing; or

(iii)  in accordance with whose instructions or wishes the directors of the corporation are accustomed to act (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 corporation).

In In the matter of Idylic Solutions Pty Ltd – Australian Securities and Investments Commission v Hobbs [2012] NSWSC 1276, Ward J said at [1337]:

The term “director”, as defined in s 9 of the Corporations Act, includes a person who, though not validly appointed as a director, acts in the position of a director (a de facto director) or whose instructions or wishes are ones in accordance with which the directors of the company or body are accustomed to act (a shadow director). The term “officer” is defined in s 9 of the Corporations Act as including a person who is a director (which, by reference to the earlier definition of director, includes a de facto or shadow director); who makes or participates in making decisions that affect the whole or a substantial part of the corporation’s business; who has the capacity significantly to affect the corporation’s financial standing; or in accordance with whose instructions or wishes the directors of the corporation are accustomed to act. There is room for overlap between persons occupying a de facto role (as director and officer) and those occupying a shadow role of that kind.

This essentially states that the characteristics of a director, shadow director, or defacto director include:

1. A person who makes or participates in making decisions that affect the whole or a substantial part of the corporation’s business; and/or
2. A person who has the capacity significantly to affect the corporation’s financial standing; and/or
3. A person who in accordance with whose instructions or wishes the directors of the corporation are accustomed to act.

A director of a company can be a director of that company even without any purported appointment of that person to that position at any time. These are de facto directors and shadow directors.

What is a De Facto Director?

A de facto director is an individual who has not been officially appointed as a director but acts in the position of a director, and has the power over decision making for the company.

For someone to be classed as a de facto director they must do the work of a director of the company or act in the position of director.  But what is “the work of a director” and what does “act in the position of director” mean?  For law geeks like me there is a lot of great case law on this issue.

The leading authority on these questions in Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6, where Finn, Stone and Perram JJ set out the leading principles from a number of relevant authorities from Australian case law from [64] to [69].  The citation is too long for this article, but in summary:

1. A person may be a director even without any purported appointment of that person to that position at any time. The definition applies as much to a person who is a true usurper of the functions of a director in a company … as to a person who takes “an active part in directing the affairs of [a] company” [64].
2. The formula, “acts in the position of a director” … contemplates that in some degree the person has been “doing the work of a director” in that company. Or the person has been acting in a role (or roles) within the company and performing functions one would reasonably expect to have been performed by a director [65].
3. The roles and functions so performed will vary with the commercial context, operations, and governance structure … of the company. Whether a person is a director is a question of degree having regard to “the nature of the functions or powers which are exercised and the extent of their exercise” [66].
4. There is no reason why the relationship of a person with a company may not evolve over time into that of de facto director. It also may be the case that the person only performs the role and functions that constitute him or her a director for a limited period of time [67].
5. Whether a person has acted in the position of a director is a question of substance and not simply of how that person has been denominated in, or by, the company … Whether or not he or she will be a director will turn on the nature and extent of the functions to be performed [68].
6. A rigid distinction between a de facto and a shadow director cannot be maintained [69].

Although the de facto director is not officially a director and/or has not been officially allowed a place on the board of the company, a de facto director will still have a high level of influence on the strategy, planning, and decision making of the company.

De facto directors are recognised by law to be directors, as the level of influence that they have over the company that they direct matches that of an official director and, therefore, has the same/similar responsibilities.

When determining if a person is a de facto director, a Court will likely consider factors such as:

1. The internal affairs of the company.
2. The duties perform for the company.
3. The size of the company and the responsibilities allocated.
4. The company structure.
5. If people outside the company or inside the company consider you to be a director.
6. If you consider yourself, or are considered by the company to be, a director.
7. If you perform the general duties expected of a director of a company.

As with any appointed director, a de facto director has duties and responsibilities that must be met. This is to ensure that they are not taking advantage of their position as someone with a high level of control and leadership over the company for personal gain.

If these duties are not met, harsh consequences can apply that have damaging effects on both the company and the director personally.

Just because the director has not been formally appointed, these consequences will still potentially apply.

Claiming to not have been aware that you were in the role of a de facto director will not be accepted as a legal defence if duties are breached, so a person must make sure they know their role and position in a company.

What is a Shadow Director?

A shadow director is a person who is not validly appointed as a director but a person to whose instructions or wishes the de jure directors of the relevant company are accustomed to acting in accordance with, or a person who has influence over other directors of the company, or the board of a directors.

In Oliana Foods Pty Ltd v Culinary Co Pty Ltd (in liq) [2020] VSC 693 Connock J defined shadow director at [236] to mean:

What I have for convenience termed a ‘shadow’ director is a person who is not validly appointed as a director but a person to whose instructions or wishes the directors of the relevant company are accustomed to acting in accordance with.

The appointed directors should be used to following the directions of this shadow director.

This is stated in section 9 of the Corporations Act (as outlined above), which states that a shadow director is a “a person in accordance with whose directions or instructions the directors of the company are accustomed to act”.

In Re Akron Roads Pty Ltd (in liquidation) (No 3) [2016] VSC 657, Robertson J summarised the relevant legal principles in relation to shadow directors at [271].

1. To establish that a defendant is a shadow director of a company it is necessary to prove:
   • who are the directors of the company, whether de facto or de jure;
   • that the defendant gave instructions or expressed wishes to those directors on how to act in relation to the company or that he was one of the persons who did so;
   • that those directors acted in accordance with such instructions of wishes; and
   • that there were accustomed so to act.
2. What is needed is first a board of directors claiming and purporting to act as such; and secondly a pattern of behaviour in which the board did not exercise any discretion or judgment of its own, but acted in accordance with the instructions or wishes of others.
3. It is not necessary that the instructions or wishes be given over the whole field of corporate activity for which the directors are responsible.
4. There is no inconsistency with a person being a shadow director and on the other hand and the board exercising some discretion or judgment in areas in respect of which the shadow director does not give instructions or express a wish. Rather, the test for a shadow director only requires that when the directors are given instructions or wishes, they are accustomed to act as s 9 requires.
5. The directors of the company must be accustomed to act as directors or the company in accordance with the person’s instructions or wishes as to how they should act. This requires habitual compliance over a period of time.
6. The directors who must be accustomed to act need not be all of the directors but should be a governing majority of the board.
7. Although it is not necessary to establish that a person is a shadow director that the directors of the company do not exercise any discretion of their own, there must be a causal connection between the instructions or wish of the shadow director and the act taken by the directors.
8. The fact that a person has a genuine interest of his or her or its own in giving advice to the board, such as a bank or mortgagee, the mere fact that the board will tend to take that advice to preserve it from the mortgagee’s wrath will not make the mortgagee, et cetera a shadow director.
9. Similarly, the fact that the governing majority of the board accepts the views and wishes of another director (who represents and acts for another company) does not by itself make the other company a shadow director. The views or wishes of that director may be sound advice that the governing majority may consider as directors should be adopted as it is in the best interests of the company.
10. Similarly, not every person whose advice is in fact heeded as a general rule by the board is to be classed as a de facto or shadow director.
11. On the other hand, if the instructions or wishes of the other director (who represented the putative director) were to carry out acts not in the best interests of the company, such as a decision to continue trading while insolvent, that might support the conclusion that the directors deferred to the decision making of the director who represents the putative director and were thus deferring to the decisions of the other company.
12. It is not necessary to go so far as to show that the de jure directors were subservient or had surrendered their roles.

A shadow director does not take on the role of a director or claim to be in a position to be a director. Instead, they take a more backseat role in the company, while still having an extremely large influence on the affairs and management of the company.

They are often referred to as a ‘puppet master’ of sorts, as they do not take actions themselves necessarily but are highly influential over the decisions and actions made by others.

It is important to understand that not everyone with a high level of influence over the affairs of the company will be considered to be a shadow director.

What are the Duties of a De Facto Director and/or a Shadow Director?

As we have discussed, a de facto director and/or a shadow director are considered by law to be in the same position as a regular director.

Therefore, the duties that they have line up almost exactly with those of a director. Shadow directors and de facto directors must both fulfill director duties.

A director of a company has a number of duties and obligations.  These include:

1. Duty of care and diligence.
2. Duty of good faith and the interest of the company.
3. Duty to disclose all material personal interests to the company.
4. Duty to maintain proper books and records.
5. Duty to not improperly use information.
6. Duty to not improperly use position.
7. Duty to prevent insolvent trading.
8. Duties at common law and in equity.

Duty of Care and Diligence

De facto directors and shadow directors have the responsibility to act with care and diligence regarding the company and the decisions made about it.

As directors have a lot of power of the future and wellbeing of the company that they direct, they must be sure to act with care and diligence in relation to the company.

This means that they are required to act with care and consideration and be aware and up to date on the internal and external affairs of the company and how it is running.

As a party with a lot of influence and power, it is important that they are aware of their actions and the consequences they will have on the company .

Duty of Good Faith

De facto directors and shadow directors also have the duty to act in good faith when acting for the company .

To act with good faith is to act honestly and in the best interests of the company.

The motivation behind any decision made by a director should be known and made for no other reason than to benefit the company.

This does not mean that you cannot gain from the position as a de facto director, but you should be acting properly.

Duty to Properly Use Position

De facto directors and shadow directors also have the duty to properly use their position and not take advantage of their power.

A de facto director and a shadow director will have a higher extent of influence and power over the board and the company in general.

A director should be sure to never use this power improperly, for reasons such as personal gain or gain for a limited selection of employees.

A director should only use your power for the good of the company, nothing else!

Duty to Prevent Insolvent Trading

De facto directors and shadow directors also have the duty to prevent the company from engaging in insolvent trading.

Insolvent trading occurs when the company continues to incur debt when already insolvent, or unable to pay existing debts.

This should be prevented entirely by directors, as it is damaging to both the company and any creditors of the company.

Further Reading – https://stonegatelegal.com.au/breach-of-directors-duties-in-australia/

What’s the Difference Between De facto directors and shadow directors?

Both shadow directors and de facto directors fulfill similar roles. Neither are officially directors but have a high level of influence and both must fulfill director duties.

A de factor director is a person who is not validly appointed as a director but a person who does the work of a director and/or acts in the position of director of that company.

A shadow director is a person who is not validly appointed as a director but a person to whose instructions or wishes the actual directors of the relevant company are accustomed to acting in accordance with (including de facto directors).

This means that de facto directors are practically directors of the company that they work for and act as a director of the company, while shadow directors only advise and direct the directors that have been validly appointed to the role.

How does Liability Apply?

As both a shadow director and as a de facto director, personal liability applies.  But what does this mean?

Director duties apply to both types of alternative directors. This means that a director has the responsibility to uphold the duties of a director, such as care and diligence, good faith, preventing insolvent trading, and a couple of others.

There are very serious consequences associated with breaching directors’ duties, including (inter alia) the following:

1. Personal liability.
2. Commercial consequences.
3. Criminal consequences.
4. Disqualification from directorship.

We will explain these in more detail below.

Personal Liability

When a de facto director and/or a shadow director fails to fulfill their duties, they can be held personally liable for a range of penalties and obligations.

These may include civil penalties, compensation payments to affected third parties, repayment of company debts and financial losses, and fulfilling the company’s tax obligations.

Commercial Consequences

If de facto director and/or a shadow director breaches their duty it can negatively impact a company’s reputation, leading to increased scrutiny from the public, investors, and regulatory bodies such as ASIC.

This tarnished reputation can have significant commercial consequences for the company.

Criminal Consequences

In severe cases where a de facto director and/or a shadow director has substantially violated their duty to act in good faith or has breached their obligations regarding the improper use of information, they may face criminal charges.

Such charges can result in a maximum prison sentence of 15 years. Criminal convictions for these breaches typically involve dishonesty or recklessness, such as making false or misleading disclosures or engaging in deceitful behaviour as a de facto director and/or a shadow director.

Disqualification from Directorship

If a director breaches a civil penalty provision and the Court deems disqualification appropriate, the Court has the power to disqualify that person from managing corporations for a suitable period.

ASIC also has the authority to disqualify individuals from managing corporations for up to five years in specific circumstances.

De Facto Director and Shadow Director FAQ

In this frequently asked questions section, we provide answers to commonly asked questions about these roles and their implications in corporate governance.

What is a De Facto Director?

A De Facto Director is a person who acts and behaves like a director, assuming the responsibilities and making decisions typically reserved for directors, even though they have not been validly appointed to this role.

What are the legal implications of being a De Facto Director?

From a legal perspective, De Facto Directors have the same duties, obligations, and potential liabilities as formally appointed directors. They can be held accountable for any breaches of directors’ duties and may face personal liability for their actions.

Who can be considered a Shadow Director?

A Shadow Director is a person who has not been formally appointed as a director but exercises significant influence or control over the company and its directors. The instructions, guidance, or directions of shadow directors are typically followed by the de jure directors, making them effectively equivalent to directors.

Are Shadow Directors subject to the same legal responsibilities as appointed directors?

Yes, Shadow Directors have the same legal responsibilities and duties as formally appointed directors. They are expected to act in the best interests of the company, exercise due care and diligence, and avoid conflicts of interest. Failure to fulfill these obligations may result in legal consequences and liabilities.

Can De Facto Directors and Shadow Directors be held liable for their actions?

Yes, both De Facto Directors and Shadow Directors can be held personally liable for their actions, just like formally appointed directors. If they breach their duties or engage in wrongful conduct, they may face legal action, civil penalties, compensatory payments, and even disqualification from managing corporations.

What is a de jure director?

A de jure director is a person who has been legally appointed as a director. Sometimes a de jure director is known as a “director in law” or a “true director”.