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Court of Appeal gives guidance on ‘de facto’ directors’ liabilities

Limited companies will welcome guidance on how to spot whether they have ‘de facto’ directors following a Court of Appeal ruling. De facto directors are those not formally appointed as directors but who will be treated by a court as having fiduciary and other duties to the company as if they had, because they have acted like a full director.

A subsidiary company claimed that a director of its former holding company had been either a shadow or de facto director of it, and his conduct as such meant he was in breach of his duties as a director of the subsidiary.

The alleged breach arose because of certain transactions entered into by the subsidiary. If the holding company director was also a shadow or de facto director of the subsidiary then he had a conflict of interest and the transactions had been entered into for his personal benefit rather than in the best interests of the subsidiary, in breach of his duties.

Both the High Court and the Court of Appeal decided that he was neither a shadow nor a de facto director. The Court of Appeal gave useful guidance on how to determine whether a person is a de facto director: there was no one definitive test to determine whether someone is a de facto director; it was a matter of fact and degree. The question is whether they were part of the corporate governance system of the company and whether they assumed the status and function of a director so as to make themselves responsible as though they were a director.

The Court of Appeal referred to the following principles from previous authorities, as being ‘of general practical importance’:

• The concepts of shadow director and de facto are different but there is some overlap.
• The question of whether an individual is a de facto director is whether they have assumed responsibility to act as a director. To answer that question, the court may have to determine the capacity in which they were acting.
• The court will in general also have to determine the corporate governance structure of the company so as to decide in relation to the company’s business whether the defendant’s acts were directorial in nature.
• The court is required to look at what the director actually did, and not any job title actually given to him.
• A defendant cannot avoid liability simply by showing that he, in good faith, did not think he was acting as a director. The question whether or not he acted as a director is to be determined objectively and irrespective of the defendant’s motivation or belief.
• The court must look at the cumulative effect of the activities relied on. The court should look at all the circumstances ‘in the round’.
• It is also important to look at the acts in their context. A single act might lead to liability in an exceptional case.
• Relevant factors include:
o whether the company considered him to be a director and held him out as such;
o whether third parties considered that he was a director.
• The fact that a person is consulted about directorial decisions or his approval does not in general make him a director because he is not making the decision.
• Acts outside the period when he is said to have been a de facto director may throw light on whether he was a de facto director in the relevant period.

The alleged de facto director in this case had not denied in the High Court that he was part of the corporate governance system of the subsidiary. However, the Court of Appeal ruled that he could successfully argue that all the acts relied on to show he was a de facto director of the subsidiary were acts he could legitimately carry out in his other capacity as director of the holding company, and that he had acted in that other capacity at all times.

Recommendation

Each company in a group of companies should consider its corporate governance system and whether individuals – particularly directors of their holding company or companies – are part of that system. If so, they should check whether those individuals may be de facto directors of the company and as such owe duties to it as directors.

Case ref: Smithton Ltd v Naggar and others [2014] EWCA Civ 939.

29 August 2014

Jonathan Waters has over 12 years of experience advising businesses in relation to commercial disputes and how to avoid or resolve them. He has a particular interest in construction law and adjudication, and he is currently studying for an Msc in Construction Law & Dispute Resolution at King’s College. Before starting Helix Law, he was the partner in charge of Commercial Litigation, Employment Law and Property Litigation at Stephen Rimmer LLP. He has a degree in Business Administration and before qualifying as a solicitor he worked in industry and investment banking for over a decade.

This article is written to raise awareness of the issues it discusses and it may not be updated after it is first written, even if the law changes. It is not intended to be legal advice and cannot be relied on as such. Helix Law is not responsible or liable for any action taken or not taken as a result of  this article. If you think the matters set out affect you and you wish to apply them to your particular circumstances then we are happy to give you free initial telephone advice.