The law imposes duties on those who exercise power or control which affects third parties. Shadow directors however, have proved something of an anomaly. Until relatively recently a shadow director could exercise power and control over the affairs of a company, without having the same duties and responsibilities as de jure or de facto directors i . In the recent English case of Vivendi SA v Richards and Bloch ii , Newey J questioned the established view and concluded that shadow directors do in fact owe fiduciary duties to the company, at least to some degree. This article looks at that decision and considers its implications.
Vivendi – the facts
Mr Stephen Bloch was the sole director of Centenary Holdings III Limited (“the Company”) before its liquidation. Mr Murray Richards had entered into a consultancy agreement with the Company whereby he agreed to faithfully serve the Company and to use his best endeavours to promote its interest (“the Consultancy Agreement”).
Between March 2004 and February 2005 the Company made nine payments to third parties, which totalled more than £10 million (“the Payments”). This included £600,000 to Mr Richards under the Consultancy Agreement and £5.3 million by way of dividend. Vivendi alleged that Mr Bloch breached his duties as a director of the Company in causing the Company to make the Payments. Vivendi also alleged that Mr Richards was responsible; both as a “shadow director” and for dishonestly assisting Mr Bloch’s alleged breach of duty.
The Company went into liquidation in 2005. Vivendi brought the claim pursuant to an assignment from the Company’s liquidators. The proceedings were issued in May 2011. This was more than six years after the last payments were made. Vivendi accepted that the claim was statute barred except to the extent that they could establish dishonesty, pursuant to section 21 (1) of the Limitation Act 1980.
Two of the principal issues were (1) whether Mr Richards was a “shadow director”, and if so (2) whether he owed any duties to the Company.
Was Mr Richards a shadow director?
Newey J approached this question by reminding himself of the legal principles. A shadow director is the creation of statute. Sections 251 of the Companies Act 2006 (Section 132 of the Companies (Guernsey Law, 2008 contains the identical definition) provides that a shadow director is “a person in accordance with whose directions or instructions the directors of the company are accustomed to act”: However, a person is not to be considered a shadow director “by reason only that the directors act on the advice given by him in a professional capacity”.
The Court of Appeal considered the statutory definition in the leading case of Secretary of State for Trade and Industry v. Deveralliii. Morritt LJ said that the purpose of the legislation is to identify those with real influence in the corporate affairs of the company. Whether any particular communication from the alleged shadow director whether by words or conduct, is to be classified as a direction or instruction must be objectively ascertained by the court in light of all the evidence. He went on to say that the use of epithets may be misleading:
“Thus to describe the board as the cat’s paw, puppet or dancer to the tune of the shadow director implies a degree of control both of quality and extent over the corporate field in excess of what the statutory definition requires. What is needed is that the board is accustomed to act on the directions or instructions of the shadow director….Further in my view it is not necessary to the recognition of a shadow director that he should lurk in the shadows, though frequently he may, for example, in the case of a person resident abroad who owns all the shares in a company but chooses to operate it through a local board of directors….Lurking in the shadows may occur but is not an essential ingredient to the recognition of a shadow director”.
Newey J applied these principles and concluded that despite Mr Richards’ denial, he was a shadow director for a number of reasons:
- Mr Richards had prepared the business plan on behalf of the Company.
- Mr Richards was intimately involved in the running of the Company.
- Mr Richards was the one engaging in meaningful dialogue with advisers and the same could not be said of Mr Bloch.
- Mr Richards found the projects in which the Company invested.
- Mr Bloch lacked property experience, in contrast to Mr Richards.
- Mr Bloch said in his witness statement that “I would be his legman” for the Company. The Judge concluded that “legman” accurately encapsulated Mr Bloch’s role…..he was not his own man: he acted on instructions from Mr Richards. He gave effect to Mr Richards’ decisions. There are two aspects of this reasoning which are of note. First, the Judge makes no mention of the Consultancy Agreement. The Consultancy
Agreement provided that Mr Richards was, in effect, to act as a professional advisor in matters of corporate and property investment and development to the Company. On one view, it could be said that Mr Richard’s role was that of a professional advisor and it was hardly surprising that he prepared a business plan and be engaged in dialogue with advisors or indeed found the projects for the Company. Secondly, there is very little direct evidence of actual instruction or direction to Mr Bloch. The Judge’s approach was clearly to imply such instruction or direction from the course of conduct between the parties and by reference to Mr Bloch’s description that he was the “legman” for Mr Richards.
As a shadow director did Mr Richards owe fiduciary duties iv to the Company?
The question whether a shadow director owes fiduciary duties has troubled academics and the courts for some time. However, the accepted view prior to Vivendi (although it was not without criticism v ) was that a shadow director did not owe fiduciary duties unless he/she dealt directly with a company’s assets. In the English case of Ultraframe UK Ltd v. Fielding vi , Lewison J concluded that:
“1289 The indirect influence exerted by a paradigm shadow director who does not deal directly with or claim the right to deal directly with the company’s assets will not usually, in my judgment, be enough to impose fiduciary duties upon him; although he will of course be subject to those statutory duties and disabilities that the Companies Act creates. The case is the stronger where the shadow director has been acting throughout in furtherance of his own, rather than the company’s, interests. However, on the facts of a particular case, the activities of a shadow director may go beyond the mere exertion of indirect influence.”
“1290 For example, in the present case it is common ground that Mr Fielding became the sole signatory on Seaquest's bank account. It is, in my judgment, indisputable that as sole signatory on that account he was not entitled to draw on the account for his personal benefit. By voluntarily becoming the sole signatory on that account, he took it upon himself to assume control of an asset belonging to another. That voluntary assumption must, in my judgment, carry with it a duty to use the asset for the benefit of the person to whom it belongs. That duty is properly called a fiduciary duty. However, it is important to recognise that this fact alone does not mean that wider fiduciary duties are imposed upon him. In the case of Northstar, for example, Ms Patey was a signatory on the bank account. She was only a book-keeper. It is plain that she could not have applied Northstar’s money for her own benefit, and hence had fiduciary duties as regards the money under her control; but that does not mean that she owed the full range of directors' fiduciary duties to Northstar.”
In Vivendi Newey J concluded that Ultraframe understates the extent to which shadow directors owe fiduciary duties. In particular, he considered that a shadow director will normally owe the duty of good faith when giving directions or instructions and that a shadow director can reasonably be expected to act in the company’s interests rather than his own when giving directions and instructions. On this basis Mr Richards was subject to the duty of good faith in relation to the directions and instructions he gave Mr Bloch.
The decision in Vivendi has been welcomed by various commentators vii as imposing liability on all those with real influence in the corporate governance of a company and fitting with the gradual merging of de facto and shadow director concepts.
However, the judgment does raise a number of questions. First, why should a shadow director who simply exerts influence be subject to the same duties as a shadow director who actually controls the board and is effectively able to exercise power? This is the distinction made by Lewison J in Ultraframe.
Take for example a case where A agrees with B’s director C, to lend B some money. A becomes interested in the performance of B to ensure the safe return of his money. A develops a close relationship with C. A gives directions and instructions to C regarding B. C is anxious not to upset A and therefore C acts upon the directions of A over a period of time. A’s motivation throughout is to see the return of his money. C’s motivation is to keep an investor on side. On one view A may be a “shadow director” and owes B fiduciary duties. Is this really right? Why should A put B’s interests above his own when he has entered a commercial relationship at arm’s length? Has A really assumed responsibility for the conduct (or at least in part) of B?
The problem partly lies in the broad statutory definition of shadow director as explained by Morritt LJ in Deverall. It will be recalled that the case of Deverall concerned disqualification of director proceedings and there is clearly a good public policy argument for the broad definition in that context viii . Should that same wide definition apply in a different context when quasi penal consequences are not in play? The answer may be that a shadow director owes fiduciary duties only where he has power and control of the affairs of the company. This perhaps represents a middle ground between Ultraframe and Vivendi.
Secondly, it is not clear from the judgment the extent of a shadow director’s duties. In other words does a shadow director owe duties beyond that of a fiduciary? So for example, if a shadow director knows that a de jure director intends to make a payment to a third party at a time when the company is insolvent does he have a duty to act to prevent what might be a preference even though he neither gave an instruction or direction to the de jure director in respect of the payment? It is suggested that a shadow director will owe ordinary duties of care at the very least. As Professor Birks observed, a fiduciary duty cannot exist at all without the lower level duties of care ix . The reason for this is that the purpose of a fiduciary duty is to ensure that the fiduciary takes care in carrying out his duties x
Thirdly, how does the decision in Vivendi sit with the rule that “a person occupying a fiduciary position will be absolved from liability for what would otherwise be a breach of duty by obtaining fully informed consent” either of the company or the person creating the fiduciary position: Australian Securities and Investments Commission v Citigroup Global Markets Australia Property Ltd xi . Typically the person who creates the fiduciary position will not be the company but rather the de jure director(s). On the face of it a shadow director will have a defence to a claim that he/she is in breach of fiduciary duty if he can establish that he had the informed consent of the de jure directors. In Vivendi this point was not advanced by Mr Richards, who represented himself at trial.
Fourthly, can a shadow director be subject to the misfeasance procedure in section 212 of the Insolvency Act 1986 (Section 422 of the Companies (Guernsey) Law 2008). That section provides a summary procedure in relation to breach of duty against delinquent “officers”. In Re Paycheck Services 3 Limited xii Lord Hope and Lord Collins stated that shadow directors were not “officers” and were not expressly included. Yet this appears at odds with Vivendi, the thrust of which is to align the liabilities of de jure, de factor and shadow directors.
The decision in Vivendi is undoubtedly welcome. It clarifies that those who exercise power and control (and indeed influence) over a company and its affairs owe fiduciary duties to a company. However, the extent of those duties and when they arise are still questions that remain to be answered. Vivendi is unlikely to be the last word on the subject.