The Liabilities of a De Facto Director
The director of a company is responsible for carrying out the interest of the organization. However, in some cases, a person who has not been officially appointed as director may step into this role.
Someone who has assumed governance powers within a company and appears to carry out the role of a full director could be identified by the courts as a ‘de facto director.’
The role of ‘de facto’ director can make a person liable for certain actions in the court of law, especially in commercial disputes. In general, being able to avoid, or at least identify, de facto directorship can be critical for yourself and your company in order to prevent unwanted liability.
Sometimes a person falls into the role of ‘de facto’ director. They can then be held liable for certain action unknowingly. This can be damaging for both them and the company as a whole.
Below we have outlined two case studies involving claims of de facto directorship. In both of these cases, the accused individuals were able to avoid the liabilities associated with the role.
1: Court Gives Guidance on the Liability of ‘De Facto’ Directors
Limited companies can seek court guidance on determining whether they have a ‘de facto’ director. A de facto director is someone who has not been officially appointed as the director of a company, but that the court views as having fiduciary duties on the groundsthat they have acted like an appointed director. In a complex case disputing patent ownership, a company argued that three individuals should have registered the patent in the company’s name rather than the name of another company. It said that the individuals’ failures to do so was a violation of their fiduciary duties which they were entitled to as the directors of the company. These individuals argued that they have never been officially appointed as full (de jure) directors and, therefore, could not be held liable. The company, however, argued that they should be considered ‘de facto’ directors. In this case, the court maintained that in order to determine whether someone should be treated as a de facto director, all relevant information must be considered. While there is no single test to determine whether someone qualifies as a de facto director, the following criteria are significant:
- Does the defendant work directly with the true director(s) of the company, and do so on equal footing when directing the company’s affairs? Evidence must be presented if so.
- Do they use the title of director?
- Is the individual part of the company’s chain of command or corporate governing structure?
- Can the individual’s actions be explained by some other role they hold (such as a consultant)? If so, they are entitled to the benefit of the doubt—meaning there is no inference that they are in fact a de facto director.
In this particular case study, the court concluded that based on the evidence, the individuals in this case were not de facto directors.
Recommendations to Avoid De Facto Directorship
- Non-directors should be kept out of the company’s corporate governance structure. This means they should be kept out of the decision-making process and implementation of corporate policy.
- If a non-director becomes involved in corporate governance, make it clear that their role holds less importance and that they cannot exercise true influence over the directors’ decisions.
- Non-directors should always act under the instruction of full directors. They should also be monitored and reviewed like a typical employee. This can be enforced by the job descriptions, performance appraisals, spending powers, monitoring, reporting, and allocation of company assets and representation powers.
- Avoid job titles that could imply someone is a de jure (full) director if they are not.
- Implement a formal appointment process to distinguish someone as a full director. Avoid excessive informality.
- Avoid giving non-directors classified and confidential board information.
- Maintain a high level of scrutiny in situations involving a full director.
- Consult a legal specialist to ensure you do not create opportunities for de factor directorship.
These recommendations can help you avoid de facto directorship in the eyes of the court. Next, we will talk about guidance from the Court of Appeal in another case study.
2: Court of Appeal Gives Guidance on the Liabilities of a ‘De Facto’ Director
A subsidiary company alleged that the director of their former holding company was acting as a de facto or shadow director, and, therefore, they were involved in a breach of their duties as the director of the subsidiary. The alleged breach occurred when the subsidiary entered into a business contract that the subsidiary argued was a conflict of interest for the de facto director. If the holding company’s director was also a de facto directory of the subsidy, then the business contract would have been a conflict of interest as it personally benefited the individual rather than serving the best interests of the subsidiary. This would qualify as a breach of duties. In this case, both the high court and the Court of Appeal concluded that the individual in question was not acting as a de facto director, and therefore was not liable for a breach of duties. Similar to the guidance given in the case study above, the Court of Appeal gave some guidance on how to determine whether a person is a de facto director. There is no single test to make this determination, but rather each case should be considered on its own. Nevertheless, there are some factors that are especially important when making this distinction.
Guidance from the Court of Appeal: Items That Qualify as Being ‘Of General Practical Importance’ When Determining De Facto Directorship
Shadow directors and de facto directors are not the same things, although they are very similar.
- A de facto director is someone who has assumed the responsibilities of an acting director. The court will need to determine the degree to which the individual in question assumed this role.
- The court will also have to consider the corporate governance structure of the company in order to determine whether the individual in question was acting naturally, or if they were exerting higher level governance powers than their appointed role.
- The court must consider whether the individual’s actions could fall under another job title that they possess within the company.
- It is important to understand that whether or not the individual realized they were acting as a de facto director is irrelevant. The court must look at the actions and the facts of the case alone. The defendant’s motivation or beliefs do not change whether or not they were acting as a de facto director.
- The court must look at the situation holistically and in context. Relevant factors include:
– Did the company view the individual as a director- Did third parties view the individual as a director
- Does the individual seem to have directorial decision-making powers? Simply being consulted about executive decisions does not in itself make one a de facto director. They must have superior governance power within the company.
Prevent Unexpected De Facto Director Liabilities by Consulting a Legal Expert
De facto directorship can create unwanted liabilities for both individuals and companies. In order to avoid legal complications, it is highly recommended that businesses seek legal guidance. At Helix Law, our experts can review your corporate governance structure to identify any individuals that could be viewed as de facto directors by the courts and guide you on what you should do to limit liability. Whether you’re already facing a commercial dispute, or you want to prevent one from happening, our experts are on your side to fight for your rights. Contact us today to schedule your consultation.