Directors have numerous duties they must carry out in the interests of a company in England and Wales, and if they do not meet these obligations, the consequences could include them being removed from office, taken to court for damages, or even receive criminal fines.
However, it is not always appreciated that an individual can be considered a ‘director’ in the eyes of the law even if they were never formally appointed as such. If this is the case, they will still be subject to the same duties – and can face the same consequences if they fail to deliver on their responsibilities.
This article will explain the different types of formal and informal directors – and how to tell if you might be a director in the eyes of the law.
Formal and informal directors
The Companies Act 2006 (the “CA 2006”) sets out in clear language the expected duties of directors, as well as defining who can be considered a ‘director’. The CA 2006 defines the following types of directors:
- Executive directors;
- Non-executive directors;
- Formally appointed executive and non-executive directors (de jure directors);
- De facto directors; and
- Shadow directors.
An executive director is a director who carries out executive functions in the company and is usually a full or part-time employee of the company, whereas a non-executive director is not an employee of the company or holder of an executive office – but nevertheless would usually devote part of their time to the affairs of the company as an independent adviser or supervisor.
De jure refers to a right or existence stated by law – so a de jure company director is one who has been legally recognised as having an official appointment to the role.
By contrast, a de facto director is somebody who has not been properly appointed to their position, but otherwise acts as a director would, and holds themselves out to third parties as a director. We might say that this individual is ‘a director in all but name’.
Historically (pre-1980s) the term ‘de facto director’ was more narrowly defined, and referred specifically to an individual who had been made director through a defective application, or otherwise had at one time been a fully appointed de jure director before ceasing to be one (but continuing to act in the role).
These days, a de facto director can be any person who acts as if they were a director – regardless of whether they have ever had any kind of official appointment to the position.
The law also recognises ‘shadow directors’. A shadow director is an individual who does not personally act as a director, but who exerts control over the company by providing instructions to its directors.
However, not all persons who provide directions and advice to the company directors are necessarily considered ‘shadow directors’. For example, professional advisors and consultants are not generally seen as shadow directors, nor are big clients who might be able to influence the company’s decisions with the persuasive power of the business they conduct with the company.
Often, a shadow director might be a person who has been previously disqualified from acting as a formally appointed director, but who still aims to control the governing majority of the company by instructing the board to follow their wishes.
Thus, a shadow director is often somebody who (as the name would imply) conceals their influence over the board – but this secrecy is not essential to the definition. It is possible for an individual to operate openly in this way and still be classed as a shadow director.
For example, a person who owns all of a company’s shares and resides abroad may wish to control the company from afar by passing instructions to a local board of directors. Although this person would not be deemed a de jure director, they would likely be considered a shadow director and thus be subject to the usual fiduciary duties.
Regardless of the type of director an individual is, they are still required to uphold the duties expected of all company directors.
Section 172 of the CA 2006 provides that a director must “act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”.
This section of the legislation goes on to state that a director must consider:
- The likely long-term consequences of their decisions;
- The interests of their employees;
- Maintenance of good business relationships with suppliers, customers, and other professional contacts;
- The environmental and community impact of the business;
- The impact of their decisions on the company’s reputation for high standards of business conduct; and
- The need to act fairly between all members of the company.
Therefore, even a person who has never been formally appointed as a director can be found to be in breach of directors’ duties if they are acting unofficially as either a de facto director or a shadow director influencing company decision making from the sidelines.
A director is also expected to avoid conflicts of interest, exercise independent judgement, not take gifts from third parties and to disclose any personal interest in company business.
In general, directors have a duty to exercise reasonable care, skill and diligence. In some cases, this duty may be breached accidentally – especially if a de facto or shadow director fails to understand their position.
Breaching director’s duties
In the event of a breach of director duties, action is usually taken by the company itself against the director. Depending on the case, shareholders may make a claim if they have personally suffered a financial loss.
In some situations of comparatively minor transgressions, a breach may be ratified by the company. This means that the act is sanctioned retrospectively and requires no further action. However, this is only an option in certain cases (for example, if a director slightly oversteps their authority but causes no detriment to the business) and cannot be used for situations involving illegal or fraudulent acts.
Serious breaches can lead to significant consequences for all types of directors, whether formally appointed or not. Often, this can mean the instigation of court proceedings with the intent to recover costs and/or property, seek compensation, remove the director from their position, seek an injunction against them, or any of numerous other corrective outcomes.
It is very important that any individual who holds a position of influence over a company without having been officially appointed as a director, understands whether or not they may be considered an informal company director in the eyes of the law.
This post was contributed by Girlings Solicitors. For many decades Girlings has provided legal services in Kent from its three offices in Canterbury, Ashford, and Herne Bay for businesses and individuals alike.