The law imposes a wide range of duties and responsibilities on directors and other officers. However, the law on “who can be considered a director” is far from settled.
The definition of “director” within section 9 of the Corporations Act 2001 (Cth) ("the Act") has a wide ambit. Included within the definition are people:- who act in the position of a director, by whatever name called and whether or not validly appointed (de facto director ); and
- whose instructions or wishes the directors of the corporation are accustomed to act in accordance with (shadow director ).
Persons acting in a professional capacity or business relationship are exempted from the operation of these provisions provided they are merely giving advice to the directors.
De Facto Directors
Section 9 includes de facto directors within the definition of a “director”. A person may be a de facto director even if they are generally engaged in the affairs of the company, rather than performing specific functions.5 De facto directors are subject to the same duties and liabilities as directors properly appointed, including the duty to prevent insolvent trading.
In the case of Deputy Commissioner of Taxation v Austin (1998) 16 ACLC 1555 the Court considered the concept of de facto directorships. Mr Austin and his wife were friends with another couple. The two wives ran a restaurant business. The company in question was a $2 company incorporated to incur debts for the supply of goods and services for the restaurant and the wages of the employees.
Mr Austin was appointed as a director of the company for 3 months to assist at a time when the families were experiencing personal problems. Mr Austin then sought to resign his directorship and his accountant prepared documents to this effect. These documents were never lodged with ASIC.
Following his purported resignation, Mr Austin undertook numerous negotiations with the Deputy Commissioner of Taxation (DCT) for the payment of outstanding group tax and penalties, countersigned company cheques in favour of the DCT, issued stop notices to the company’s bank and negotiated with other creditors.
The Court decided that Mr Austin was a de facto director of the company. In such a small company it was likely that Mr Austin was exercising top management functions. Despite his purported resignation, Mr Austin had practical direction and effective control of the company.
Shadow Directors
Section 9 includes shadow directors within the definition of “director”.
This seeks to situate the true source of decision-making within the corporation and to hold persons responsible for the consequences of their decisions (see Australian Securities Commission v AS Nominees Ltd (1995) 13 ACLC 1822). Shadow directors are also subject to the same duties and liabilities as directors properly appointed, including the duty to prevent insolvent trading.
Each element of the definition of a “shadow director” must be examined in order to determine the extent of those included within the definition.
(a)Person
Under section 221(3) only an individual can be a validly appointed as a director. Despite this, the extended definition of "director" in section 9 means that a corporation can be a “director” for the purposes of section 9 even though they cannot be “appointed” as such. This is supported by the line of cases which have found a holding company to be a director of its subsidiary.
(b) Instructions or Wishes
“Instructions and wishes” can be distinguished from “advice”. Whereas “advice” is merely an opinion and is not ordered as a course of action a party is required or compelled to follow “directions or instructions”.
In this sense, “instructions and wishes” involve no element of choice on the part of those being instructed and suggests the absence of available alternatives. A single instruction or wish is unlikely to satisfy section 9 as its requirements suggests “instructions or wishes”, the plural suggesting a number of acts. In addition, a single act is unlikely to result in the directors becoming “accustomed to act” upon it, although it is arguable that a single instruction or wish of fundamental importance that results in an action repeatedly being taken by the corporation may fulfil this requirement.
It is unclear whether the instructions or wishes must be given to the board of directors as a whole or merely to a particular board member. This may be a crucial issue in determining whether the directors are accustomed to act in accordance with the instructions or wishes. Arguably, section 9 implicitly requires the instructions or wishes to be given to the board as a whole. However, it is arguable that if a person gives instructions or wishes to a dominant managing director or nominee director, and the board is accustomed to act in accordance with their instructions, then from a policy perspective the person is effectively contributing a vital element of decision-making in the corporation’s affairs. In this way they
should arguably be subject to the same duties and liabilities as directors.
(c) Directors of the body
Whether or not all of the board members, or merely a majority of board members, must be accustomed to act in accordance with a person’s instructions or wishes is far from clear.
Although there has been some commentary supporting the need for all directors to be accustomed the case of Re Lo-Line Electric Motors Ltd [1988] BCLC 698 suggested that “the board” must act in accordance with the instructions. This implies the requirement of a simply majority of directors to be so accustomed.
The decision in Kuwait Asia Bank v National Mutual [1990] 3 All ER 404 indicated that a minority of directors accustomed to act in accordance with a person’s instructions or wishes will be insufficient to form a shadow directorship. Since decisions made by the board are made by a majority of directors, the preferable position would be to simply require a majority of directors to be accustomed to act in accordance with the person’s instructions or wishes. To require all board members to be so accustomed may provide a considerable loophole in the law.
(d) Accustomed to Act
This element is intended to cover those persons with effective control of a
corporation, making decisions that the directors of the corporation simply follow without independent thought, analysis or discretion. It suggests some sort of ongoing control or interference in internal affairs. As stated by Millet J in Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 at 183:What is needed is . . . a pattern of behaviour in which the board did not exercise any discretion or judgment of its own, but acted in accordance with the direction of others. For a director to be “accustomed” to act in accordance with a person’s instructions or wishes, it is not necessary for the director to follow every direction or instruction received. The term “accustomed” suggests that the director must generally accept the instructions of the person. In others words it is arguable that the director must customarily accept and act upon the person’s instructions or wishes without independent analysis.
(e) Professional Capacity or Business Relationship Exemption
The definition of director is designed to encompass all those who have a decisionmaking role within the corporation. It is not intended to cover those who merely offer advice or suggestions on particular issues. For this reason, section 9 provides that a person will not fall within the definition of “director” merely because the directors or members of the board are accustomed to act on advice given by that person in their professional capacity or as a result of a business relationship with the directors, members of the board, or the body. Accordingly, an exemption is provided to advisers.
It is conceivable that advice given in a professional capacity or business relationship may in fact lead to instructions or wishes. The danger in this possible overlap between professional or business advice on the one hand and instructions and wishes on the other bears great relevance to financial institutions with insolvent corporate clients, holding companies with insolvent subsidiaries, and “company doctors” or accountants or lawyers with insolvency expertise.
Risks for Company Doctors, Banks and Other Financial Institutions Participating in Informal Work-Outs
There have been no cases where a financial institution has been held to be a shadow director to date. However, in times of economic difficulty, financial institutions will be keen to become actively involved in the internal affairs of its corporate clients facing insolvency.
If the degree of this involvement is to the extent that the financial institution is making decisions for the corporate client, the risk is run that the financial institution will be considered a shadow director. Banks and other financial institutions exercising management discretion in important strategic issues may be caught by the definition of “director”. Although no financial institutions have been held de facto or shadow directors within Australia to date, in the absence of an “arm’s length” relationship, it is possible that such a relationship will be found by the courts.
“Company doctors” or accountants or lawyers with insolvency expertise often undertake a review of a corporation’s financial affairs and operations to aid the recovery of failing businesses at the request of creditors. Company doctors also run the risk of becoming a shadow director if they assume effective decision-making power and control of the
corporation’s affairs when assisting the financial recovery.
An example of this overlap between advice on the one hand and directions and instructions on the other is provided by Re Tasbian (No.3) [1992] BCC 358. Briefly, in this case a chartered accountant was appointed to an ailing retail business (Tasbian) by a finance company (Castle). As Tasbian had never traded at a profit, the accountant was appointed to get the company “on track” and producing a profit, which he was ultimately unable to achieve.
However, during his appointment, the accountant had taken over effective control of Tasbian as he had required all Tasbian cheques to be countersigned by himself, had bargained with external entities on Tasbian’s behalf, negotiated an informal moratorium with Tasbian’s trade creditors and so on. In this way, he was not merely providing advice but was exercising decision-making powers and control on behalf of Tasbian and was thus a de facto director of Tasbian.
In addition, the accountant had acted beyond his professional expertise by engaging in nefarious conduct through a tax avoidance scheme designed for Tasbian. This unprofessional conduct indicated that he was not covered by the “professional” advice exemption. As a result, the accountant was held to be a “director” of Tasbian and subject to disqualification and other sanctions.
Clearly, the distinction between advice and instructions and wishes is important to maintain to receive protection under section 9. The wide definition of “director” may threaten those involved in “workouts” or other forms of financial management.
Holding Companies as Shadow Directors
In addition to the insolvent trading provisions imposing liability on holding companies for the debts of their insolvent subsidiaries, holding companies with subsidiaries face the possibility of being found to be a shadow director of their subsidiaries. This possibility will be of particular concern to holding companies with subsidiaries in financial difficulty. Once again, in times of economic difficulty a holding company is likely to exercise management discretion and general decision-making powers in relation to the affairs of its subsidiary. If the board of the subsidiary simply accepts these decisions without independent analysis, the holding company is likely to be a shadow director within the terms of section 9.
This article is an excerpt from an AAR Paper: Insolvent trading - risks and benefits for liquidators, creditors and ASIC . To read the rest of the paper, please visit www.aar.com.au/pubs/insol/cirfeb04.htm
March, 2004
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