A director, if not by name…
The High Court has held that a director of a holding company became a de facto director of its subsidiary, with all the liability of a director, when he became significantly involved in the subsidiary’s affairs.
- A person may be considered a director of a company even if they have not been formally appointed as such.
- How likely this is to happen depends on the extent to which the person has become involved in the company’s day-to-day affairs and assumed the responsibilities of a director.
- This kind of so-called de facto director bears the same responsibilities – and is subject to the same liabilities – as a formal director of the company.
What happened?
Aston Risk Management Ltd v Jones and others [2023] EWHC 603 (Ch) concerned a company (the subsidiary) whose business was providing audiology services.
The subsidiary was originally incorporated by an individual (CJ), who was the subsidiary’s first director. In due course, CJ brought a second individual (ML) into the business. ML was also appointed as a director of the subsidiary.
In 2014, the subsidiary and its owners brought in two new investors. The investment structure that was implemented involved the following arrangements.
- A new holding company was incorporated, which acquired all the shares in the subsidiary.
- The directors of the new holding company were CJ and one of the two new investors (LJ).
- The directors of the subsidiary remained (at all relevant times) CJ and ML.
- The shareholders of the holding company entered into a shareholders’ agreement regulating how the holding company and the subsidiary would conduct their business. Broadly speaking, the agreement required all decisions to be taken by a majority vote of the holding company’s board, giving each of CJ and LJ an effective veto right over operational matters.
In practice, LJ took a very active role in the subsidiary’s operations, often leading negotiations for it and issuing instructions on its behalf.
In due course, the subsidiary entered into administration. Questions arose over whether the subsidiary’s directors had been in breach of their duties to the subsidiary.
As part of this, it was alleged that, even though LJ had not been formally appointed as a director of the subsidiary, because of his close involvement in its affairs, he had become a de facto director of the subsidiary and therefore liable for any breach of duty.
LJ argued that he was not a de facto director of the subsidiary. He claimed that, to the extent he had become involved in the subsidiary’s affairs, he was acting on behalf of the subsidiary’s holding company, not as an individual director.
English law recognises three different types of company director.
A de jure director (“director in law”) is someone who has been formally and validly appointed or re-appointed (normally by the company’s board or shareholders) to perform the office of director of a company. Most company directors are de jure directors and their details appear at Companies House.
A de facto director (“director in fact”) is someone who has not been formally appointed as a director, often (but not always) because of some defect in the appointment process, but nonetheless carries out the functions and responsibilities of a director (even if they do not describe themselves as such). There is no single test for identifying a de facto director, but a person will not be a de facto director merely because they carry out senior or executive functions. Rather, they must be part of the company’s “corporate governance structure” and carry out functions that only a director can perform.
A shadow director is someone who neither has been formally appointed as a director nor carries out the roles or functions of a director, but in accordance with whose directions or instructions the company’s board is accustomed to act. Effectively, a shadow director is someone who controls the board from behind the scenes.
In theory, a person can be both a de facto director and a shadow director at the same time, although this is very unusual. The statutory duties that come with serving as a director apply to all three categories (although they do not apply at all times to shadow directors).
(Other variations of directorship exist in practice, including executive directors, non-executive directors, professional or nominee directors, and alternate directors, but, in each case, a director of these kinds will fall into one of the categories above.)
What did the court say?
The court found that LJ was a de facto director of the subsidiary.
In reaching its decision, the court set out certain principles (largely lifted from the most recent authoritative case on de facto directors, Smithton Ltd v Naggar [2014] EWCA Civ 939) that are relevant when deciding whether someone is a de facto director of a company.
- To be a de facto director, a person must be part of the corporate governance system of the company. This requires the court to determine what the corporate governance system is.
- The person must also assume the status of a director so as to become responsible as if a director. The court will examine what the person actually did and not the job title (if any) that has been given to them.
- A person who has ultimate control of the management of a company’s business (whether alone or with others) is likely to be a de facto director.
- However, a “purely negative role” of giving permission for business activities will not, by itself, make someone a de facto The fact that a person is consulted about directorial decisions or needs to give approval does not mean they are taking directorial decisions.
- The court will apply an objective test. It does not matter whether the person believed that they were acting as a director or not. However, the court is more likely to find that someone is a de facto director if the person holds themselves out, or the company holds them out, as a director and if third parties consider the person a director.
The judge said that the role LJ had played in directing the subsidiary’s affairs was consistent only with him being part of the subsidiary’s corporate governance structure, if not the key and principal element of it. He had assumed functions of the company that could only properly be discharged by a director. The judge gave examples of behaviour that demonstrated LJ’s involvement.
- He had held meetings to discuss the management of the subsidiary, either without the subsidiary’s directors being present or with only CJ present and not with ML (the subsidiary’s only director who was not also on the holding company’s board).
- In other respects, he had taken the lead at management meetings and produced “action point minutes” for those meetings.
- He had previously referred to himself as a “partner” in the subsidiary alongside ML.
- In reality, LJ was the “dominant personality who effectively drove the required decisions and ensured that he got what he wanted”. The judge found that CJ was prepared to go along with whatever LJ wanted, and ML in reality had little (if any) role to play in the subsidiary’s decision-making or day-to-day affairs.
- He had also taken the lead in discussions between the subsidiary and its counterparties, including a substantial customer of the subsidiary.
- He had formally instructed legal advisers on behalf of the subsidiary in connection with its potential entry into administration.
The judge also considered a case in which the court had found that, where a company had a corporate director, a person acting on behalf of the corporate director was unlikely to become a de facto director of the company itself. This is because to reach that conclusion would ignore the separate legal personality of the corporate director.
However, in this case, although LJ was a director of the holding company, the holding company itself was not a corporate director of the subsidiary. It was a different set of circumstances and one in which LJ was not able to claim that he was acting on behalf of another corporate entity.
What does this mean for me?
The court went on to consider whether LJ, as a de facto director of the subsidiary, had breached his duties. However, these are particular to the case and of less general interest.
The judgment is, however, a useful reminder of the risks for individuals – particularly directors of holding companies – of becoming heavily involved in the affairs of subsidiaries. This can, as in this case, end up bringing with it personal responsibilities and liability for the individual.
It is never desirable for a company to have de facto directors, as this increases uncertainty over the entity’s corporate structure and muddies reporting lines and authorities. It is worth remembering some useful practical tips for avoiding the risk of a company having a de facto director.
- Create and follow a clear corporate governance structure. Ensure the company has directors who have been formally appointed and registered at Companies House. Make sure that decisions are taken at board meetings by these directors and the decisions are minuted. If decisions are to involve persons at holding company level or above, ensure that this is limited to giving those persons a right to approve or veto. Operational decisions should be taken by the company’s own de jure directors.
- Delineate clearly any delegated authorities. Generally, significant contracts and documentation should be signed by a company’s directors. If anyone other than a director is to be given authority to sign documents or negotiate transactions, set this authority out specifically in writing.
- Consider retaining someone under a formal contract of employment. It is common for a person acting as a director to be employed in parallel under a contract of employment. However, it is less likely that a person who has not been formally appointed will be considered a de facto director if they are an employee and carrying out functions that an employee could carry out.
- Choose job titles carefully. Clearly assigning a job title that does not include the word “director” will reduce the risk that a person will be found to be a de facto director (although it will not eliminate it). If individuals are to be styled “director” despite not being statutory directors, take care to ensure, when necessary, that third parties understand that the person is not a statutory director.
