What is a shadow director, I hear you ask! Like all other directors, shadow directors play a critical role in the management of a company. Their advice can have a significant impact on the company’s operations. However, shadow directors are not often mentioned or widely understood.
In this article, Farrah Motley, Director of Prosper Law, explains what a Shadow Director is and to familiarise you with the legal consequences of being a shadow director.
Author: Farrah Motley, Director of Prosper Law and an experienced Australian business lawyer.
What is a Shadow Director?
A shadow director is someone who holds the power of a director without being officially recognised. They are the same as any other “ordinary director” but are not registered. Consequently, they are not recognised by ASIC as a director of a company.
A person interacting with directors of the company can assist in identifying a shadow director. Shadow directors exercise control and authority over other directors. This allows them to gain power on par with other directors without officially being one.
Suppose a company’s director follows the advice of a person (whether he accepts or rejects it). Such a person may be a shadow director (taking other factors into account).
A shadow director can be anyone aged over 18 like any other director.
Besides that, there are no pre-existing requirements to become a shadow director. But, a company’s internal regulations may influence how this may apply.
For example, the company constitution may state, “A shadow director must be a past employee who has worked at least three years with the company.”
The case of Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd determined that a shadow director is identified by the authority they have managed to establish within the company.
Several actions determine to identify a shadow director, including:
- negotiating on behalf of the company;
- securing loans or borrowings on behalf of the business; and
- managing an entire company division of the company.
Everyone who advises a company is not a shadow director. Lawyers, consultants, and accountants are not shadow directors. The mere receipt of advice from advisors and the fact that directors rely on it does not make those advisors shadow directors. But, an advisor who can control the directors’ decisions may be a shadow director.
A third party insisting on certain terms is not a Shadow Director considering directors still use their judgement to decide whether to accept the terms. The same is true for a lender.
A shadow director is the same as any other “ordinary director” – the duties of a shadow director are like those of a director. The director’s duties are determined by specific regulations and guidelines for each “source.” In general, directors’ duties are divided into the following “source categories”:
- Duties arising under the Corporations Act 2001 (Cth) (the Act);
- Fiduciary duties;
- Common law duties;
- Duties arising from the corporate constitution; and other statutory duties (duties arising from health and safety legislation, environmental legislation, tax legislation).
The most important duties of directors include to:
- act in good faith, in the best interests of the company, and for a proper purpose;
- exercise care and diligence in the exercise of their authority;
- not to use their position for personal gain, to benefit themselves or someone else, or to harm the company;
- not to misuse the information to which they have access to benefit anyone or harm the company;
- avoid conflicts of interest;
- prevent insolvent trading;
- keep written financial records reflecting the company’s financial transactions and general financial position, and performance; and
- prepare financial statements reflecting the true and fair financial position of the company.
Shadow directors (like other directors) act for the benefit of the company as a whole. Simply put, shadow directors act in the interest of all members or shareholders of the company.
But, they may sometimes consider other interests as well, for example, the interest of:
- wholly owned subsidiaries;
- corporate groups;
- the general public.
Sometimes the interests of many other members collide with each other. Under these conditions, a shadow director must make the decision that is in the best interest of the company as a whole.
Just like the duties, the consequences a shadow director faces are the same as those for a breach of a director’s duties.
The penalties are primarily civil. But, there are criminal penalties as well. Criminal penalties result in imprisonment. Civil penalties, on the other hand, are pecuniary and may disqualify a person from acting as a director of an Australian company for a specified time.
Possible penalties include:
- fines of up to $200,000, imprisonment for up to five years, or both;
- personal liability for any loss or damage incurred by the company or related individuals; and
- a prohibition from managing a company for some time or even permanently.
A shadow director should always be aware of his potential liability.
For example, in the case of a company that becomes insolvent, the liquidator may examine the actions of the shadow director.
The director may also suffer reputational damage if he fails to fulfil duties and appears to be trying to avoid legal responsibility for his actions.
A company is a separate legal entity. Thus, it is different by law from its directors (whether shadow directors or not). All debts, legal proceedings and assets belong to the company.
A director can be personally liable in a company only if he uses his personal assets as a director. In that event, the director has chosen to use his assets when the company is in debt. As a result, the director is liable if something goes wrong.
The same applies to shadow directors. A shadow director can only become liable if he signs a document allowing such liability.
The Corporations Act 2001 does not require shadow directors to be shareholders. The Act simply states that every director must be over 18 and live in Australia (for a company with one director).
Therefore, it is up to the company’s constitution to state such a rule.
A company may restrict shareholders from being directors, while another company may want a director to be a shareholder.
Prosper Law is Australia’s online law firm. We provide legal services to businesses and individuals across Australia. Our areas of practice include contracts, eCommerce, publishing, legal counsel, and employment law.
If you would like to speak to an Australian business lawyer, get in touch today.
Contact the team at Prosper Law today to discuss how we can provide you with your legal needs at a fixed fee or affordable hourly rates.
Farrah Motley | Director
PROSPER LAW– Australia’s Online Law Firm
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