In a recent decision, the Court of Appeal upheld a finding that a director of a holding company had not become a de facto or shadow director of its subsidiary: Smithton Ltd v Naggar and others [2014] EWCA Civ 939.

A person may take on the duties of a company director, and therefore be liable for their breach, without ever having been formally appointed to the role. This may be because he has acted as a director, so as to become a de facto director (or director “in fact”), or because he has persuaded the directors to act in a particular way, so as to become a “shadow” director.

As the Court of Appeal noted in Smithton, the question of whether a director of a holding company has become a director of its subsidiary is one which often arises in practice. It is therefore important for group companies and their directors to understand when liability as a de facto or shadow director may arise. Although the assessment is a question of fact and degree in every case, the Smithton decision provides some insights as to the factors the court will take into account. 

Background

Under section 250 of the Companies Act 2006, a director “includes any person occupying the position of director, by whatever name called”; a person occupying such a position without expressly being named as a director is referred to as a de facto director. Under section 251, a shadow director is “a person in accordance with whose directions or instructions the directors of the company are accustomed to act”.

In the present case Hobart, a joint venture brokerage company, brought a claim against Mr Naggar, a director of its former majority shareholder (DDI). Hobart alleged (among other things) that Mr Naggar was either a de facto or a shadow director of Hobart and that he had infringed his duties as a director. It was alleged, in particular, that certain transactions entered into by Hobart involved a conflict of interest as they were with companies connected to Mr Naggar, and that those transactions were not entered into for the benefit of Hobart but to further Mr Naggar’s own interests.

At first instance, Rose J found that Mr Naggar was not a de facto or shadow director of Hobart, essentially because he was acting at all times in a different capacity, or wearing a different “hat”, and was not acting as a director of Hobart. Further, Hobart was governed in accordance with a structure set out in the joint venture agreement (JVA) which expressly stated that Mr Naggar should not be appointed a director of Hobart. It was also important that Hobart was authorised by the FSA and had never reported to it that Mr Naggar was one of its directors.

Decision

The Court of Appeal unanimously dismissed Hobart’s appeal, finding that there was no basis for interfering with Rose J’s decision.

The court referred to the leading case in this area, HMRC v Holland [2010] 1 WLR 2793. In that case, the Supreme Court (by a majority) decided that a director of a corporate director, which was the sole director of some 43 trading companies, was not a de facto director of those other companies, as he had acted only in his capacity as a director of the corporate director.

The Court of Appeal cited the statement of Lord Collins in Holland that there is no one definitive test for whether someone is a de facto director. The question is whether that person was part of the corporate governance system of the company and whether he assumed the status and function of a director so as to make himself responsible as if he were a director. The court went on to note a number of points that arise out of Holland and the previous cases which, it said, are of general practical importance in determining who is a de facto director.

  • The concepts of shadow and de facto director are different but there is some overlap.
  • In determining whether a person is a de facto director, the question is whether he has assumed responsibility to act as a director.
  • The questions must be determined objectively. It does not matter whether the individual thought he was acting as a director.
  • Whether the company considered the individual to be a director and held him out as such, and whether third parties considered that he was a director, are however relevant.
  • The court must look at the acts in their context and determine their cumulative effect.
  • The fact that a person is consulted about directorial decisions, or asked for approval, does not in general make him a director because he is not making the decision.

The Court of Appeal said that, ordinarily, it will be important for the court to determine a company’s corporate governance system to decide whether an individual has assumed the responsibility of a director. In the present case, Hobart challenged the judge’s failure to make findings on this issue. The Court of Appeal agreed with Hobart’s submission that the judge focused on “hat identification” rather than on ascertaining the corporate governance system of Hobart. However, Mr Naggar had not disputed that he performed directorial acts within Hobart’s corporate governance system; instead he ran his defence on the basis that he held multiple roles and had acted in a different capacity at all times from that of a Hobart director (namely, as director of Hobart’s holding company). In those circumstances, the court said, the judge was not in error for failing to address a defence which was not run.

As to whether the judge had gone wrong in determining which “hat” Mr Naggar was wearing, the Court of Appeal said that the court would not make an artificial attribution of a director’s act to some particular role. Determination of capacity boiled down to a question of assessing the evidence. The judge was entitled as a matter of common sense to take the view that, where there had been an agreement as to who would be on the board of Hobart, Mr Naggar would not act as a director having been expressly excluded from such a role under that agreement. The JVA was not necessarily a complete answer; Mr Naggar could have acted as director despite the JVA but, in the absence of other factors, this was unlikely.

Overall, the Court of Appeal concluded, Hobart’s challenge was merely a disagreement with the judge’s findings of fact, findings which she was entitled to make.

Emily Russell