Emerging From The Shadows

When is a director of a holding company a shadow or de facto director of a subsidiary?
 

The question of who is a director is important because of the substantial duties which a director has. Where a director has been duly appointed, this is fairly straightforward to determine. The difficulty arises when someone has not been appointed as a director but has acted as one (a de facto director) or persuaded the directors to act in a particular way (a shadow director). A question which often arises in practice is whether a director of a holding company of a group of companies has become a director of its subsidiary.

What makes a person a de facto or shadow director?

In the recent case of Smithton Limited v Naggar [2014] EWCA Civ 939 the Court of Appeal reaffirmed the Supreme Court’s decision in the leading case of HMRC v Holland [2010] 1WLR 2793 that there is no definitive test but the court should ask whether the person formed part of the corporate governance structure of the company and whether their acts demonstrated the assumption of acts as a director.

The Court of Appeal set out a number of practical points to be considered when answering those questions including:

• whether the person had assumed a responsibility to act as a director, to be determined objectively and irrespective of the defendant’s motivation or belief;
• whether the company considered the person to be a director and held him out as such;
• whether third parties considered that the person was a director; and
• that circumstances should be considered “in the round” including the cumulative effect of activities but it was also important to look at the acts in their context. A single act might lead to liability in an exceptional case.

The facts of the case

Proceedings were brought against Mr Naggar, a director of holding company (Dawnay Day International Limited “Dawnay”) by its subsidiary (Hobart now called Smithton Limited, “Hobart”) to recoup losses of around £4 million which Hobart claimed it had incurred as a result of transactions with clients introduced to it through Mr Naggar on the basis that Mr Naggar was a de facto or a shadow director of Hobart.

Hobart was a joint venture company and subject to strong shareholder control. Dawnay held just over 50% of the voting rights and the rest were held by the management of Hobart, principally Mr Townsley. Mr Townsley was also one of the directors of Hobart. Mr Naggar was not a director of Hobart.

It appears however that nothing much of significance was discussed or decided at board meetings and important decisions were taken by Mr Naggar and Mr Townsley acting effectively as partners in the business. Mr Naggar did not attend any board meetings or meetings of its principal board committee, he did not hold himself out to be a director of Hobart and no-one held him out as such.

As Mr Naggar held many directorships, the judge at first instance approached the question of de facto and shadow directorships by identifying which “hat” he wore at any particular point of time. The meant looking at what he actually did. The judge concluded that the evidence presented fell short of showing that Mr Naggar was involved in the management of Hobart to any significant extent or that the board were accustomed to act in accordance with his instructions. Hobart appealed. The Court of Appeal upheld the first instance decision and dismissed the appeal.