The recent High Court decision in Re UKLI Limited(1) provides a useful summary of both the factors that the court will take into account when determining whether an individual is a shadow director or a de facto director and the differences between these two concepts. The case in question concerned the disqualification of a director, but the principles have a wider scope of 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 – that it divides into numerous smaller plots and sells to investors. The supposed attraction for 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 that has little or no chance of ever being developed. UKLI's business was subject to an investigation by the Financial Services Authority, which concluded that the way in which its investment schemes were being operated and marketed was unlawful.
In November 2008 UKLI went into liquidation with an estimated deficiency of over £70 million. Disqualification proceedings were brought under Section 6 of the Company Directors Disqualification Act 1986 against six individuals with regard to their conduct in UKLI. Five of these individuals gave disqualification undertakings before trial such that further proceedings against them were unnecessary. The trial therefore proceeded against only one individual, Balinder Chohan.
To satisfy the requirements of Section 6 of the Company Directors Disqualification Act, the court must be persuaded that:
- the defendant is a director of a company that became insolvent; and
- the defendant's conduct as a director of that company (taken either alone or together with his or her conduct as a director of any other companies) makes him or her 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 Chohan's conduct made him unfit to be concerned in the management of a company. However, the issue as to whether Chohan was a director was not straightforward.
Chohan was not a formally appointed director in the relevant period. The claimant 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 applies to de facto directors.(2) A shadow director is expressly included within the definition of 'director' under Section 6.
In determining whether an individual is a de facto director, the court held that the following characteristics are all relevant, although 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 or she were a director.
- The individual 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.
- The individual must be either the sole person directing the affairs of the company or a substantial or predominant influence and force in doing so regarding the matters for which the complaint is made. Influence is not otherwise likely to be sufficient.
- The individual must undertake acts or functions such as to suggest that his or her remit to act in relation to the management of the company is the same as if he or she were a formally appointed director.
- The functions that the individual performs and the acts for which the complaint is made must be such as could be undertaken only by a director, not functions or acts that could properly be performed by a manager or other employee below board level.
- It is relevant whether the individual 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 requirement and even that may not always be sufficient.
- The individual's role may relate only to part of the affairs of the company, so long as that part is the part for which the complaint is made.
- Lack of accountability to others may be an indicator, as may the fact of involvement in major decisions.
- The power to intervene to prevent some act on behalf of the company may suffice.
- The individual must be more than a mere agent, employee or adviser.
The court noted that the concept of a 'shadow director' is entirely a creature of statute. The definition in Section 22(5) of the Company Directors Disqualification Act 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' are 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, Chohan had indeed acted as a de facto or shadow director (although the judgment does not state explicitly that he acted as both). Consequently, Chohan was disqualified for a period of 12 years.
This case is helpful in summarising the tests for de facto and shadow directorship. While shadow directorship is a relatively familiar 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 10 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, while the other actively holds himself out as a director. However, as this decision shows, the definitions of both types of director cannot be reduced to anything as simple as this. While 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.
(1) Re UKLI Limited, Secretary of State for Business, Innovation and Skills v Balinder Chohan  EWHC 680 (Ch).
(2) Re Low Line Electric Motors Ltd  Ch 477.
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