The recent High Court decision in Re UKLI Limited1 provides a useful summary of the factors the court will take into account when determining if an individual is a shadow director or a “de facto” director, and the differences between the two concepts. The case in question concerned the disqualification of a director but the principles have wider application.
UKLI Limited operated a land banking business. In essence, land banking involves a company purchasing land – usually arable land on the edge of urban areas – which it divides into numerous smaller plots and sells to investors. The supposed attraction to investors is that the land may in the future benefit from the grant of planning permission, thus leading to a significant increase in value.
Land banking has been the subject of major regulatory scrutiny, as many investors have been persuaded to pay significant amounts of money for land which has little or no chance of ever being developed. UKLI’s business was subject to an FSA investigation which concluded that the way its investment schemes were being operated and marketed was unlawful.
In November 2008, UKLI went into liquidation with an estimated deficiency of over £70m. The Secretary of State for Business, Innovation and Skills brought disqualification proceedings under section 6 of the Company Directors Disqualification Act 1986 (CDDA) against six individuals with regard to their conduct in UKLI. Five of these individuals gave disqualification undertakings prior to trial such that further proceedings against them were unnecessary. The trial therefore proceeded only against one, Mr Balinder Chohan.
To satisfy the requirements of section 6 of the CDDA, the Secretary of State must persuade the court that the defendant was:
- a director,
- of a company which became insolvent, and that
- his conduct as a director of that company (either taken alone or taken together with his conduct as a director of any other companies) makes him unfit to be concerned in the management of a company
There was no dispute as to UKLI’s insolvency, and after hearing the evidence the court was satisfied that Mr Chohan’s conduct made him unfit to be concerned in the management of a company. However, the issue as to whether Mr Chohan was a director was not straightforward.
Mr Chohan was not a formally appointed director in the relevant period. The Secretary of State argued that he was a de facto director or a shadow director at this time. It is well-established in case law that section 6 of the CDDA applies to de facto directors2. A shadow director is expressly included within the definition of “director” under section 6 of the CDDA.
In determining whether an individual was a de facto director, the court held that the following characteristics are all relevant, though not every one is required to be established and there is inevitably some overlap between them:
- A de facto director must presume to act as if he were a director.
- He must be part of the corporate governing structure and participate in directing the affairs of the company in relation to the acts or conduct complained of.
- He must be either the sole person directing the affairs of the company or a substantial or predominant influence and force in so doing as regards the matters of which complaint is made. Influence is not otherwise likely to be sufficient.
- He must undertake acts or functions such as to suggest that his remit to act in relation to the management of the company is the same as if he were a formally appointed director.
- The functions he performs and the acts of which complaint is made must be such as could only be undertaken by a director, not ones which could properly be performed by a manager or other employee below board level.
- It is relevant whether the person is held out as a director or claims or purports to act as such, but this factor and/or use of the title is not a necessary requirement, and even that may not always be sufficient.
- His role may relate to part of the affairs of the company only, so long as that part is the part of which complaint is made.
- Lack of accountability to others may be an indicator; so also may the fact of involvement in major decisions.
- The power to intervene to prevent some act on behalf of the company may suffice.
- The person concerned must be someone who is more than a mere agent, employee or advisor.
The court noted that the concept of a shadow director is entirely a creature of statute. The definition in section 22(5) of the CDDA provides that:
“’Shadow director’, in relation to a company, means a person in accordance with whose directions or instructions the directors of the company are accustomed to act (but so that a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity).” The court further held that the concepts of shadow directorship and de facto directorship were not mutually exclusive. After reviewing the authorities, the court concluded:
“It is now … clear that (a) the same sort of evidential indicia are likely to be relevant to establishing both shadow and de facto directorship and (b) a person may act as both, the one in fact shading into the other.”
The court concluded that on the evidence, Mr Chohan had indeed acted as a de facto or shadow director (although the judgment does not state explicitly that he acted as both). Consequently Mr Chohan was disqualified for a period of 12 years.
This case is helpful in summarising the tests for de facto and shadow directorship. Whilst shadow directorship is a relatively well-known concept, the concept of de facto directorship is less well-known; certainly it is less well-defined. It is therefore important for individuals who are not formally appointed directors, but whose activities are consistent with some of the ten criteria set out above, to be aware that they may fall within this definition.
It is easy to understand the temptation to define shadow directorship and de facto directorship as mutually exclusive concepts. In essence, one director lurks in the shadows, whilst the other actively holds himself out as a director. However, as this decision shows, the definitions of each type of director are not capable of being reduced to anything as simple as this. Whilst the areas of overlap are likely to be minimal in practice, as a matter of logic the court must be correct in its finding that the two concepts are not mutually exclusive.