Shadow and De Facto Directors: An Update.
UNSW Continuing Legal Education
Corporate Insolvency – 25 October 2017
Some people seemed to get all sunshine, and some all shadow
Louisa May Alcott, Little Women
1. Little Women may seem a bit out of place at a corporate insolvency seminar, but Miss Allcott neatly summarises my aim for today; which is to explore why some directors get all the sunshine, but others we have to look for in the shadows. We will look at the most recent legal authorities where these issues have been contested in order to discern the indicia of a de facto director as distinct from shadow directors, and directly appointed directors.
2. The most important point I want you take from today is that correctly identifying a de facto or shadow director depends on the factual confines of each case. While the overarching theory and principles are important, the ultimate determination that some one is a “director” will depend on close attention to the particular corporate structure.
Legislative Framework
3. Our starting point, of course, is prescribed by the Corporations Act 2001 (Cth). It defines ‘director’ in section 9 as:
(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.
4. It is clear by the terms of sub-section (b)(i) that the law contemplates the extension of director’s liability to a person not validly appointed as director, but who nonetheless acts in the position of a director. This extends the liability for breach of directors’ duties to such ‘deemed directors’.
5. It is also important to note the statutory distinction drawn between officers and directors. Under section 9, an officer includes a person who makes or participates in decisions that affect the whole or a substantial part of the business of a corporation, or who has the capacity to affect significantly the corporation’s financial standing.
6. This is hardly a bright-line test, but most commonly operates to impose certain obligations on senior managers in a company. Intuitively though, it is clear that a person with the capacity to ‘significantly affect a corporation’s financial standing’ may easily cross into the boundary of ‘acting in the position of a director’. I won’t focus on officers today, but it’s important to remember the porous boundaries between the classifications of various senior positions in corporate governance,[1] that arise from the exercise of particular roles and duties and expose that person to an escalating degree of liability and obligations.
Legal Principles on De Facto Directorship
7. In order to be considered 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 functions which are the “sole responsibility” of a director or board.[2]
8. The full Federal Court provided us with an authoritative statement on the legal principles on determining whether the facts permit a finding that a person is a de facto director in Grimaldi v Chameleon Mining NL [No 2]. The judges in that case noted that the shorthand description of a de jure director that I described above may be apt to mislead, in that it suggests that such duties can only properly be performed by such directors who are capable of ‘a priori enumeration’. They note that such enumeration is possible in relation to functions required by the Act or prescribed by a corporation’s constitution, but when it comes to the ‘most fundamental functions’: that of managing the business of a company, this simplistic a priori classification has no general utility.[3]
9. Rather, they emphasised that any comparison between the actions of an alleged de facto director and those of a duly appointed director must move beyond prima facie classification and be located squarely within the particular circumstances of each individual company and director.[4]
10. There are two final observations in Grimaldi I wish to draw your attention to. First, the fact a company has an active director and a properly constituted board apart from the alleged de facto director does not preclude a finding that the person is a de facto director.[5] Secondly, and more importantly for the purpose of this discussion, whether the company holds the person out to be a director or what third parties believe that person’s role to be are only relevant to the extent that they are contextual considerations. They are certainly not decisive in their legal characterisation.[6]
11. While noting that corporations legislation in the UK is different from ours, Australian judges have nonetheless drawn helpful guidance (no doubt a colonial hangover) from English judgments on this matter.[7] The reason is probably because lawyers love nothing more than a list, and in the English case of Smithton Ltd v Naggar, Arden LJ enumerated a list of factors that may tend toward a finding of the existence of a de facto directorship:
(a) whether the person has assumed responsibility to act as a director;
(b) the nature of the corporate governance structure and the position the person occupies within it;
(c) what the person actually did, as distinct from any job title;
(d) the cumulative effect of the activities relied on, with the whole of the circumstances being looked at “in the round”;
(e) whether the company regarded the person as a director and held him or her out as such;
(f) whether third parties considered that the person was a director; and
(g) whether the person was consulted about or participated in directorial decisions. [8]
12. The focus, therefore, is on a holistic assessment of the way the person operates within the particular corporate structure, the degree of autonomy they exercise in their functions and the appearance (and reality) of authoritative operation as a primary decision-maker for that company.
13. Though I must emphasise that while these factors provide a helpful guide, a fact-based assessment is critically important in the context of contested litigation. Quoting English Lords is one thing – but what wins cases is a focus on the facts of that case and the presentation of those facts to the court.
Recent Case Law on De Facto Directorship
14. I’d now like to apply these principles to recent cases that considered whether a relevant person could be considered a de facto director in the context of a litigated dispute.
A. In the matter of Swan Services Pty Limited (in liquidation) (‘Swan’)[9]
15. The case of Swan Services affirmed that the threshold for proving a de facto directorship is very high. However, it also demonstrates that this high threshold has not served to deter liquidators from initiating proceedings to recover claims for insolvent trading or for breaches of director’s duties on the basis of a de facto or shadow directorship.
16. The liquidator of Swan Group claimed that the company had been trading while insolvent and sought to recover the debt of about $11 million incurred during that period. The liquidator sued Mr Swan, the appointed director of the company as well as Mrs Swan, his then wife, on the basis that she was a ‘de facto’ director. She had never been formally appointed a director. Throughout the relevant period, she had been the Group’s general counsel, human resources manager and CEO and had lent the Group significant amounts of money.
17. Mrs Swan’s high-level interest in the Group was inextricable from the fact that she was married to its sole director. However, Black J held that he would not treat a family member differently to any other person who becomes closely involved in a company’s management in determining whether they should be characterised as a de facto director.[10] Despite this, I think there were clearly some underlying biases at play about the presumed devotion of a wife to her husband’s company.
18. In any case, this characterisation was not material, given that her interest could also be attributed to the fact she considered herself to be a secured creditor of the Group. While acknowledging that the threshold was not met in this case, Black J noted that a secured creditor acting on a company’s behalf in significant matters may more readily be characterised as a de facto creditor.[11]
19. In applying various aspects of the Grimaldi test discussed above, Black J held that Mrs Swan could not be characterised a de facto director, in spite of her close involvement in the company. Mr Swan was identified by employees as holding a position in the company superior to Mrs Swan and he was the sole signatory on the bank accounts. Although Mrs Swan sought to attain more authority from her husband, she did not succeed in ever challenging his position and held a limited position of influence. Further, in her financial dealings with the ATO, it was always clear that Mrs Swan was only a secured creditor.
20. Consequently, Mrs Swan was relieved from liability for trading while insolvent. We can see that a person can have significant involvement in a company and believe themselves to have a high level of control without exerting the requisite authority to be considered de-facto director. Swan serves to emphasise the evidential threshold for establishing a de facto directorship.
B. Cases applying Swan
21. A case that I appeared in earlier this year was one of the first to be able to rely on Swan as authority in the determination of de facto directors: In the matter of ACN 092 745 330 (‘ACN 330).[12]
22. The liquidator of the company sued Mr Battaglia and his wife and their family company to recover payments made from the liquidated company to Mr Battaglia (either directly to him or to his wife or his company). Although he was not at the material times appointed as a director, the liquidator alleged that Mr Battaglia was either a director or an officer of the company and was in breach of relevant duties by causing the payments to be made.
23. In the trial, the liquidator adduced several pieces of evidence on which he relied to prove that Mr Battaglia had performed tasks that would typically be performed by a director. For example, the liquidator pointed to Mr Battaglia’s LinkedIn profile, which described him as “founder and Director” of the company,[13] his email signature which described him as “Managing Director”[14]. In addition, Mr Battaglia had signed, under the heading “Director” a number of contracts binding the company.[15]
24. Superficially, the effect of this evidence was to raise a seemingly incontrovertible assumption that Mr Battaglia was in fact acting in the position of director. However, as I’ve been emphasising today, how Mr Battaglia actually operated within the particular corporate structure beyond the name which he assigned himself on contracts is what is truly determinative.
25. We conducted a rigorous fact based defence. We were able to show that the LinkedIn material related only to recent times and could not be extended backwards to the times at which the liquidator was alleging Mr Battaglia was a director. The emails on examination were not as forceful as initially thought as the designation “Managing Director” could and did relate to positions Mr Battaglia held in other companies within the Group. The signatures on contracts and similar document was slightly more problematic. There were 5 documents identified. In most cases, the document was an agreement entered into by the company. However, the agreements were multi-party agreements, and included as parties other companies in the Group. Mr Battaglia was involved with these other companies. We also looked at the agreements within the context of the operations of the company over the relevant time. From that point of view, where there were dozens of agreements involving many millions of dollars of contracts, most of which were properly executed by the appointed directors, it seemed to us that an argument of mistake could be mounted. It helped that one agreement had Mr Battaglia’s signature, but that had been crossed out and the appointed directors had signed in his place, correcting the error.
26. Barrett AJA found that while it was clear Mr Battaglia occupied a responsible position in the company and was a ‘key operative’, his activities and responsibilities could not be elevated beyond that of a senior manager.[16] His Honour found that the occasions on which he purported to sign contracts as director or managing director of the company could be consigned to acts of carelessness or as acting under a misapprehension as to which company was involved, given that he was a director of other companies in the Group. The more important factor was that he always operated under the superior authority of the two appointed directors; and his access and involvement in any financial matters was always through the intermediation of another senior officer.[17] He did not operate the bank accounts and relied on a director to approve payments.
27. His Honour also dismissed arguments that relied on the views of a few outsiders who interacted and contracted with the company. There was email evidence tendered to prove that a few creditors perceived him to be a director. Barratt AJA made the cogent observation that is impossible to test what these people had in mind when they formed such an assumption; but it was likely they were not closely considering the terms of section 9(b)(ii) of the Corporations Act 2001 (Cth) when doing so. Divorced from the context of company law, the term ‘director’ is used in common parlance to indicate a senior position: we see it used to refer to the chief executive of a gallery, museum or government department, but this does not mean ‘director’ in the technical legal sense.[18]
28. This case emphasises the importance of fact review. It was won with a combination of a fact-driven defence and a failure of the plaintiff to prove all the necessary facts. (And a bit of advocacy … .) It shows it is not sufficient to merely to show the outward semblance of the indicia of a director; it is essential to rigorously unpack the role that a person actually fulfils within the context of the operations of the company.
Shadow Directorship
29. Recalling the terminology of section 9,[19] a director includes a person who is not validly appointed as a director, but where the directors of the company are accustomed to act in accordance with that person’s instructions or wishes. This is referred to as shadow directorship.
30. Although they are commonly confused, there is a distinction between de facto directors and shadow directors. Primarily, shadow directors tend to give instructions, which are then accepted or implemented by officially appointed directors. Shadow directors are considered as working more ‘behind the scenes’ than the front-of-shop role of a director.[20]
31. The key authority for shadow directorship is the Court of Appeal decision in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (‘Buzzle’).[21] In that case, six retailers of Apple products formed Buzzle Operations. Buzzle acquired stock on credit from Apple and, in return, Apple took a charge over Buzzle’s assets. In November 2000, the company became insolvent, but continued to trade on this business model, incurring a further $18 million in debts to Apple and other creditors. Ultimately they were only able to repay $12 million. When Buzzle went into liquidation, its liquidators commenced proceedings against Apple, arguing that Apple and its finance director incurred liability as shadow directors of Buzzle when the debt was incurred.[22]
32. Hodgson, Young and Whealy JJA endorsed the opinion of White J at first instance, agreeing that a shadow director requires proof that the other directors were collectively accustomed to act on that accused persons’ instructions or wishes. In adopting this position, they reasoned that while Apple and its finance director exercised commercial pressure on the directors of Buzzle, those directors were still at liberty to decide what was in the best interests of the company. The fact that the interests of both parties often aligned (ie, keeping the company out of administration) did not mean that Buzzle followed Apple’s instructions as a pattern of passive compliance.[23]
33. This case illustrates that the standard for shadow directorship is similarly stringent as that imposed for de facto directorship. This is understandable, as it a bold claim to make that appointed directors followed the instructions of others simply as a matter of course. Such would likely be a breach of the director’s duty.
Conclusion
34. The cases we have looked at today affirm that the Courts do not take too lightly attempts by liquidators to recoup debts from unsuspecting directors. Nonetheless, the legal recognition and enforcement of liability on de facto and shadow directorship clearly encourages transparency in corporate governance and a willingness to hold those accountable for their decisions, of the titles a company gives them or what they hold themselves out to be.
35. I re-iterate finally that your best guide to either imposing or resisting liability for a de facto Director is not a bare list; but a thorough approach to fact review and a clear understanding of the corporate structure you are dealing with.
References
[1] See Hodgson v Amcor (2012) 264 FLR 1.
[2] In the matter of ACN 092 745 330 [2017] NSWSC 241, [110] (Barrett AJA).
[3] (2012) 200 FCR 296, 323 [70] (Finn, Stone and Perram JJ).
[4] Ibid 322 [65].
[5] Ibid 325 [74].
[6] Ibid 325 [75].
[7] In the matter of ACN 092 745 330 [2017] NSWSC 241, [112] (Barrett AJA).
[8] [2015] 1 WLR 1893, [33].
[9] [2016] NSWSC 1724.
[10] Swan [2016] NSWSC 1724, [31].
Black J distinguished the alternative finding in Deputy Cmr of Taxation v Austin (1998) 28 CSR 565, 570.
[11] In the matter of Swan Services Pty Limited (in liquidation) [2016] NSWSC 1724, [32].
[12] [2017] NSWSC 241.
[13] Ibid [66] (Barrett AJA).
[14] Ibid [67].
[15] Ibid [68], [73].
[16] Ibid [114].
[17] Ibid.
[18] Ibid [115].
[19] Corporations Act 2001 (Cth).
[20] Standard Chartered Bank of Australia Ltd v Antico & Ors (1995) 13 ACLC 1381; In Re Akron Roads Pty Ltd (in liquidation) (No 3) [2016] VSC 657.
[21] (2011) 81 NSWLR 47.
[22] Katrina Morgan, ‘Shadow Directorships – Creditors Take Heart’, Australian Banking and Finance, August 2011 22, 22.
[23] (2011) 81 NSWLR 47, 72–3 [196]–[197] (Young JA).