Boards frequently take advice from a range of internal executives and external advisors. But when does that advice cross the line into influence?
The AICD asks John Price, Commissioner, Australian Securities and Investments Commission (ASIC) about what it means to be a shadow director and the risks involved for the individual, the board and the company.
The issue of shadow or de facto directors highlights the importance of transparency in corporate governance and accountability for decision-making in the company. Boards must be alive to the potential risks and those involved in management must be careful not to unwittingly be labelled as a shadow or de facto director.
This has gained prominence in light of the appointment of administrators to Queensland Nickel Pty Ltd (QN). The administrators have said that Clive Palmer may have been a shadow or de factor director of QN. If a court finds that he was a de facto or shadow director, Mr Palmer may face the same prosecution and penalties as though he may have been duly appointed director.
What is a shadow or de facto director?
According to John Price, whether a person is shadow or de facto director will depend on the specific business and circumstances of the company in question.
“One exception to being a shadow director is for people who are advising the board in their professional capacity, e.g. accountants and solicitors,” he said.
Shadow or de facto directors can include someone who:
- exercises top-level management functions;
- undertakes tasks that would typically be expected of a director; or
- regularly attends and/or has a vote at board meetings.
Duties of shadow and de facto directors
Both de facto and shadow directors have the same statutory duties and liabilities under the Act as the appointed directors of the company, and can be held liable for breaches of directors’ duties.
Principally, a shadow director must act in the best interests of the company and must not prefer his or her own interests to those of the company.
Liabilities of shadow and de facto directors
If a shadow or de facto director fails to fulfil their statutory duties as a director, ASIC may take regulatory action, or the de facto director may be sued by the company, its shareholders or a third party.
This was seen in Chameleon Mining’s case against Phillip Grimaldi (Grimaldi v Chameleon Mining NL  FCAFC 6), where Mr Grimaldi had negotiated the acquisition of a large asset, found investors for the company, among other things without being an appointed director. He was liable to compensate Chameleon for losses incurred as a result of his actions as a de factor director.
In addition, a director may face criminal prosecution by ASIC, the imposition of civil penalties (fines), being personally liable for the debts of the company if it trades while insolvent, and being disqualified from managing a company.
It is important to note that your directors’ and officers’ insurance policy may not provide coverage for the actions of de factor or shadow directors. This is usually confined to duly appointed directors.
Risks for directors, the company and its stakeholders
While legal, the actions of shadow or de facto directors carry with it some serious risks for boards. A shadow director may compromise the ability of appointed directors to discharge their duties.
“The lack of internal or formal accountability of shadow and de facto directors may also carry with it increased risk of rogue decision-making or illegal phoenix activity by shadow or de facto directors,” Price says.
“The extension of statutory duties and liabilities to shadow and de facto directors reinforces the importance of transparency and accountability in corporate governance. Shareholders, creditors, employees and other stakeholders are entitled to know who makes, or participates in making decisions that affect the business, so that they can make fully informed decisions about their investment or relationship with the company.“
Under the Corporations Act 2001 (the Act) a person may be considered a director if:
- they act in the position of a director – referred to as a “de-facto director”; or
- the directors of the company are accustomed to act in accordance with the person’s instructions or wishes – referred to as a “shadow director”.