Disqualified directors and their shadows


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A lecture summarising the law of De facto/Shadow Directorship and interface with legislation on Disqualification of Directors. The lecture covers the position of law in the United Kingdom and Nigeria.

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Disqualified directors and their shadows

  1. 1. Shadow, De Facto and Disqualified Directors Edward C. KeazorA Director (and indeed the Board of Directors) is appointed and empowered by the Shareholders ofa Company to run the company as an agent for the said shareholders(hence the agency principle).The power however is accompanied with a heavy responsibility to run the affairs of the company toa statutory and ethical standard.In many instances when the Director(s) fail to carry out this duty in accordance with the saidstandards and the company suffers loss, either by way of Insolvency or otherwise, the Directors areusually held to account or indeed responsible for the losses. Note the distinction between theresponsibility and accountability of Directors. A brief word on the distinction between the two-Responsibility is the functional duty to carry out an act, which may be delegated or shared, whilstaccountability refers to the ultimate and singular burden of seeing that the act is carried out, this canneither be shared nor delegated- to put it in laymans terms- accountability is where the buck stops,as is well known, you cant pass the buck. In the event of Directors of a company carrying out an actthat exposes the company to loss and/or Insolvency, there are a number of sanctions that they mayface, examples being:a. Criminal Sanctions: If the act amounts to Criminal conduct e.g Fraud, Manslaughter etc TheDirectors as well as the company may face charges.b. Civil Sanctions: If the conduct of the directors directly results in financial loss to the Shareholders,the directors may face civil action to recoup the losses so suffered.In the UK however, where the Company is deemed to have committed a criminal act for which itfaces sanction of a fine as tends to be the case, civil action has never been brought based on the
  2. 2. contractual principle "Ex turpi causa non oritur actio" which means in plain English that a claimantcannot bring civil action based on his own illegal act. This principle was due to be tested in the UKCourts in the case of William Morrisons v Webster and Others. Where this supermarket chainbrought action for damages against the Former Chairman on Safeway (which Morrisons bought in2004) following criminal sanction against Morrisons based on cartel price-fixing of dairy products bythe defendants, before the purchase by Morrisons, the case against Mr Webster, was later howeverwithdrawn by Morrisons, as such this principle remains a moot point.c. Disqualification: Where a Director has carried out an act which is deemed to be of such a seriousnature as to merit the person being barred for a specified period from acting as a Director of aCompany - in the public interest, a disqualification order can be made preventing the said personfrom so acting as a Director.The mechanism for this is provided in the UK under the Company Directors Disqualification Act 1986,which provides for a procedure whereby an Order of Court is made on application for the person tobe disqualified from:i. Acting as a director of a company taking part, directly or indirectly, in the promotion, formation ormanagement of a company;ii. Being a liquidator or an administrator of a company;iii. Being a receiver or manager of a companys property.The five main circumstances, in which a Director may be disqualified being:i. Upon conviction of an Indictable offence (An indictable offence is a serious criminal offence suchas a Felony) Section 2;ii. For persistent breaches of Companies Legislation- This refers to failure to file returns anddocumentation relating to the company on at least three occasions in the five years preceding theOrder, also for conviction for an indictable offence related to failure to so file such documentation.Section 3iii. If in the winding up of a company the person has been guilty of either fraudulent trading(whether convicted or not) or for fraud committed whilst an Officer, Receiver, Liquidator oradministrative receiver of the company or in breach of such duties while so acting. Section 4iv. On Summary Conviction for an offence (whether indictable or otherwise) related to the failure tofile company documentation or otherwise comply with requirements of Companies legislationrelating to the filing of such documents. This order may be made by the court trying the said offence.Section 5Disqualification is an instrument used to regulate the actions of Directors who would otherwise beprovided the protection of limited liability of a company. Limited Liability refers to the principle inCompany Law limiting the liability of the Shareholder to the value of the shares. Also it acts to lift thecorporate veil. The sense behind this being that a registered company can act in its own name and
  3. 3. indeed be sued or charged for an offence in its own name, however in circumstances as have beendetailed here, the Corporate "veil" can be lifted for direct action against the directing hands that didthe act.Who makes the Order?The Order is made by a Court- on application, under the auspices of the Secretary of State forBusiness Innovation and Skills (formerly the Secretary for Trade and Industry).The Procedure:In the event of the failure or liquidation/administration of a company, the Official Receiver (orInsolvency Professional in a voluntary liquidation, administrative receivership or administration)after reviewing the conduct of the Directors for the 3 years preceding liquidation, if any misconductis found such as- allowing the company to continue to trade when it was unable to pay its debts;afailure to keep proper accounting records, failure to prepare and file accounts or make returns toCompanies House, failure to submit tax returns or pay over to the Crown tax or other moneydue,failure to co-operate with the OR/IP, the information is passed to the Office of Secretary of Statefor Business, Innovation and Skills, where a decision is made as to whether it shall be in the publicinterest to seek a disqualification order, where the same is decided, the application is then made tothe Court on the auspices of the Secretary of State.An application has to be made within 2 years of the winding up of the company or voluntaryliquidation/administration etc. The court may of course extend time for the application to be madebeyond the 2-year time-limit.Upon a decision to apply for disqualification being made, the Director is given notice of the same.Furthermore, the Official Receiver or Insolvency Professional prepares a report which is submitted tothe Court.. The director is then given the opportunity to respond to any allegations raised againsthim, by way of filing an affidavit in Court, rebutting any issues of misconduct raised in the report.Accountants and other officers of the company may also give evidence of fact either in support or inopposition facts contained in the report. The court then hears the application and makes a decisionafter considering evidence from both sides. If a disqualification is decided upon, the court will thendecide how long it should last for i.e. between 2- 15 years.A new procedure was introduced in April 2001, whereby a Director could give an undertaking tocomply with the restrictions ordinarily imposed by a disqualification order and is the same in effect;only that it avoids the need for Court proceedings. The undertaking would be made to the Secretaryof State and would be enforced by an application to court for breach of undertaking.The Effects of Disqualification:The disqualification order is an almost total ban on any form of Executive activity by the banneddirector and for the avoidance of doubt, the person is absolutely barred from acting as: a. A directorof a company; b. Receiver of a companys property;c. Directly or indirectly being concerned or takingpart in the promotion, formation or management of a company; or Being a member of or being
  4. 4. concerned or taking part in the promotion, formation or management of a limited liabilitypartnership and; d. From acting as an insolvency practitioner.The consequence of breach of a disqualification order is a fine, imprisonment or both. This isdetailed in Section 13 of the act as thus- ” If a person acts in contravention of a disqualification orderor of section 12(2), or is guilty of an offence under section 11, he is liable-(a) on conviction onindictment, to imprisonment for not more than 2 years or a fine, or both ; and; (b) on summaryconviction, to imprisonment for not more than 6 months or a fine not exceeding the statutorymaximum, or both.”.The next part of this study is the nature of Shadow DirectorshipShadow Directors:A Shadow Director is defined by in section section 251, Companies Act 2006 (formerly Section 741(2)of the Companies Act 1985) ; section 251, Insolvency Act 1986; section 22(5), Company DirectorsDisqualification Act 1986) (CDDA) as “a person in accordance with whose directions or instructionsthe directors of the company are accustomed to act (although a person is not deemed a shadowdirector by reason only that the directors act on advice given by him in a professional capacity).”Guidance on the mechanics of the definition in the former Section 741(2) was provided by the HighCourt and reinforced by the Court of Appeal in Secretary of State for Trade and Industry v Deverelland another as thus:a) Majority of the board must be accustomed to act in accordance with the directions or instructionsof the alleged shadow director. The purpose of the legislation is to catch a person who effectivelycontrols the running of the company by controlling the board. Therefore, a person is unlikely to bewithin the definition of a shadow director if only one or two directors on a board of several directorsfollow his instructions;b) The directors must “do something in conformity with” such instructions. It is not sufficient for thealleged shadow director simply to give instructions to the directors; his instructions “must betranslated into action by the board”;c) The directors must act on the alleged shadow director’s directions as a regular course of conductof the directors over a period of time.Of great significance is the dictum in the lead judgement of Lord Justice Morritt: “(1) The definition of a shadow director is to be construed in the normal way to give effect to theparliamentary intention ascertainable from the mischief to be dealt with and the words used. Inparticular, as the purpose of the Act is the protection of the public and as the definition is used inother legislative contexts, it should not be strictly construed because it also has quasi-penalconsequences in the context of the Company Directors Disqualification Act 1986. I agree with thestatement to that effect of Sir Nicolas Browne-Wilkinson V-C in In re Lo-Line Electric Motors Ltd[1988] Ch 477, 489. (2) The purpose of the legislation is to identify those, other than professional
  5. 5. advisers, with real influence in the corporate affairs of the company. But it is not necessary thatsuch influence should be exercised over the whole field of its corporate activities.I agree with the statements to that effect of Finn J in Australian Securities Commission v ASNominees Ltd, 133 ALR 1, 52-53 and Robert Walker LJ in In re Kaytech International plc [1999] BCC390, 402. (3) Whether any particular communication from the alleged shadow director, whether bywords or conduct, is to be classified as a direction or instruction must be objectively ascertained bythe court in the light of all the evidence. In that connection I do not accept that it is necessary toprove the understanding or expectation of either giver or receiver. In many, if not most, cases it willsuffice to prove the communication and its consequence. Evidence of such understanding orexpectation may be relevant but it cannot be conclusive. Certainly the label attached by either orboth parties then or thereafter cannot be more than a factor in considering whether thecommunication came within the statutory description of direction or instruction. (4) Non-professional advice may come within that statutory description. The proviso excepting advice givenin a professional capacity appears to assume that advice generally is or may be included. Moreoverthe concepts of "direction" and "instruction" do not exclude the concept of "advice" for all threeshare the common feature of "guidance ". (5) It will, no doubt, be sufficient to show that in the faceof "directions or instructions" from the alleged shadow director the properly appointed directors orsome of them cast themselves in a subservient role or surrendered their respective discretions. But Ido not consider that it is necessary to do so in all cases. Such a requirement would be to put a glosson the statutory requirement that the board are "accustomed to act" "in accordance with" suchdirections or instructions. It appears to me that Judge Cooke, in looking for the additional ingredientof a subservient role or the surrender of discretion by the board imposed a qualification beyond thatjustified by the statutory language.”The implications of this- in summary being:a. The definition of a Shadow Director should not be construed strictly or literally, but should haveregard to the facts of each individual case, because of the consequence of criminal sanction in theevent of breach.;b. The definition of Shadow Director is very likely to apply to any person who gives directions orinstructions to the Directors of a company unless the same is by way of professional advice.c. The purpose of the directions or instructions are less important than the fact that they were given(except where given for professional purposes);d. The Directors who acted in compliance with the direction or direction of the Shadow Director,need not be shown to act in a subservient position but more importantly to have acted or beaccustomed to act (i.e. there should be a course of conduct).The co-relation between Shadow Directorship and Disqualification of Directors is statutorilyexpressed in Section 22(5) of the Company Directors Disqualification Act 1986) (CDDA), whichrepeats the definition above i.e. " Shadow director, in relation to a company, means a person inaccordance with whose directions or instructions the directors of the company are accustomed to
  6. 6. act (but so that person is not deemed a shadow director by reason only that the directors act onadvice given by him in a professional capacity)”This definition being important -as per Morritt LJ, based on the penal sanction attendant on breachof the disqualification order, in that if a person were to act as the Shadow Director of a companywhilst disqualified, the consequences are serious and are detailed as stated above in Section 13 ofthe CDDA as thus- If a person acts in contravention of a disqualification order or of section 12(2), oris guilty of an offence under section 11, he is liable-(a) on conviction on indictment, to imprisonmentfor not more than 2 years or a fine, or both ; and; (b) on summary conviction, to imprisonment fornot more than 6 months or a fine not exceeding the statutory maximum, or both.The simple fact being that it is extremely risky for a disqualified Director to seek to continue to runor manage a company in the Shadows (literally and figuratively), since the Court will examine indetail, the nature of communication with the Directors and if any instructions are given and actedupon by a majority of the Board, then a Shadow Directorship will be assumed, unless theinstructions were given in professional capacity.The professional advice route does not provide a trouble-free escape route however, becauseSection 1 very clearly disqualifies the person from being involved with the promotion, formation andmanagement of a company. Thus, if the advice is given in the course of management of a companyoffering professional services, it would arguably be in clear breach of section 1(d) of the act.The two elements being : i. Management and ii. Of a company.We shall examine these hypothetically:i. Management:Chambers Dictionary defines management as “management noun 1 - the skill or practice ofcontrolling, directing or planning something, especially a commercial enterprise or activity. 2 themanagers of a company, etc, as a group. 3 manner of directing, controlling or using something.”Using this as a general guide, the key elements would be control, direction of the organisation,enterprise or activity, the next element being:ii. CompanyGuidance is provided in S. 22. (2) of the CDDA- “ The expression “company”— in section 11, includesan unregistered company and a company incorporated outside Great Britain which has anestablished place of business in Great Britain, and (b) elsewhere, includes any company which maybe wound up under Part V of the Insolvency Act.”Part V of the Insolvency Act and specifically S.220 defines an unregistered company as thus“Meaning of "unregistered company" (1) For the purposes of this Part, the expression "unregisteredcompany" includes any trustee savings bank certified under the enactments relating to such banks,any association and any company, with the following exceptions –(a) a railway company incorporated by Act of Parliament,
  7. 7. (b) a company registered in any part of the United Kingdom under the Joint Stock Companies Acts orunder the legislation (past or present) relating to companies in Great Britain.(2) On such day as the Treasury appoints by order under section 4(3) of the Trustee Savings BanksAct 1985, the words in subsection (1) from "any trustee" to "banks" cease to have effect and arehereby repealed.”There is no mention of Partnerships or Sole Traderships, however for greater clarity, reference mustbe made to the Companies Act 2006 which defines a company in Section 1 as thus:“(1) In the Companies Acts, unless the context otherwise requires— “company” means a companyformed and registered under this Act, that is—(a) a company so formed and registered after the commencement of this Part, or(b) a company that immediately before the commencement of this Part—(i) was formed and registered under the Companies Act 1985 (c. 6) or the Companies (NorthernIreland) Order 1986 (S.I. 1986/1032 (N.I. 6)), or (ii) was an existing company for the purposes of thatAct or that Order, (which is to be treated on commencement as if formed and registered under thisAct).(2) Certain provisions of the Companies Acts apply to—(a) companies registered, but not formed, under this Act (see Chapter 1 of Part 33), and;(b) bodies incorporated in the United Kingdom but not registered under this Act (see Chapter 2 ofthat Part).(3) For provisions applying to companies incorporated outside the United Kingdom, see Part 34(overseas companies)”As seen above the contrary position is found in the provisions of Part V of the Insolvent PartnershipsOrder 1994, which provides for the winding up of Insolvent Partnerships as an UnregisteredCompany either on presentation of a petition against all members, where no petition is presentedagainst any member, or indeed Insolvency proceedings not involving winding up. The operative factbeing that there is provision for a Partnership to be deemed an unregistered company.Once again, this definition does not clearly extend to a Partnership or indeed a Sole Trader and issubject to inference rather than clear prescription in the CDDA, thus it is arguable that to comeunder the definition of company under Section 22(5), the company would have to be one registeredunder the Companies Acts, this is purely a subjective argument and it is important to note that thisprinciple has not been tested judicially.In conclusion and for the sake of good order it is important to distinguish between a ShadowDirector and a De facto Director:
  8. 8. De Facto Directors:In Secretary of State for Trade and Industry v. Deverell and Another, reference was had to thejudgement in In re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 applying the definition of Millett J: "A defacto director ... is one who claims to act and purports to act as a director, although not validlyappointed as such”The judgement also affirmed the definition given by Judge Cook in Deverell (at the High Court) inwhich he set out two categories of de facto directors (in addition to two categories i.e shadow andproper directors so called) i.e “De facto directors type 1, being those who assume to act, claim to beand are held out by the company as being directors”; (b)” De facto directors type 2, being those whodirectly assume the functions of the directors and act on a equal footing with those who are butwithout having any sort of label”The essential characteristics of De facto Directors being that they either openly assume the dutiesand profile of Directors or they directly hold themselves out as Directors, even if they are notproperly appointed as such.It will thus be seen that the main distinction between a de facto Director and a Shadow Director isthat the latter does not hold himself out, rather preferring to give directions from the background.The implications of this are considerable and have tested and will continue to test the courts andLawyers. This summarises the position under UK Law.I will now consider the:The situation under Nigerian LawThe Companies and Allied Matters Act at Section 244. (1) states:“ Directors of a company registered under this Decree are persons duly appointed by the companyor direct and manage the business of the company. (2) In favour of any person dealing with the company there shall be a rebuttable presumptionthat all persons who are described by the company as directors, whether as executive or otherwise,have been duly appointed.
  9. 9. (3) Where a person not duly appointed acts or holds himself out as a director, he shall beguilty of an offence, and on conviction shall be liable to imprisonment for 2 years or to a fine of N100for each day he so acts or holds out himself as a director, or to both such imprisonment or fine andshall be restrained by the company. (4) If it is the company that holds him out as a director, it shall be liable to a fine of N1,000each day it holds him out, and he and the company may be restrained by any member from so actingunless or until he is duly appointed.”This seemingly makes it illegal to hold a De facto Directorship.Disqualification of Directors is provided for in 254. (1) which states “Where-(a) a person is convicted by a High Court of any offence in connection with the promotion,formation or management of a company; or(b) in the course of winding up a company it appears that a person-(i) has been guilty of any offence for which he is liable (whether he has been convicted or not) under section 513 of this Decree; or (ii) has otherwise been guilty, while an officer of the company, of any fraud in relation to the company or of any breach of his duty to the company;The Court shall make an order that that person shall not be a director of or in any way, whetherdirectly or indirectly, be concerned or take part in the management of a company for a specifiedperiod not exceeding 10 years.”This provision of CAMA mirrors the provisions of the UK CDDA 1986 in its effect.The Company may still be liable for the acts of such a Director, note the contents of Section 260which provides: “The acts of a director, manager, or secretary shall be valid notwithstanding anydefect that may afterwards be discovered in his appointment or qualification.”This is distilled by Section 250, which states: “Where a person not duly appointed as a director actsas such on behalf of the company, his act shall not bind the company and he shall be personallyliable for such action: Provided that where it is the company which holds him out as director, thecompany shall be bound by his acts.”This effectively deems de facto Directorships illegal where such a Director is deliberately held out orholds himself/herself out as a Director without proper appointment. However the company will bebound by the said person’s acts, where the company itself held out the person as a Director.In respect of Shadow Directorships: Section 245 (1) states “ Without prejudice to the provisions ofsections 244 and 250, and for the purposes of sections 253, 275 and 281 of this Decree, "director"shall include any person on whose instructions and directions the directors are accustomed to act.
  10. 10. (2) Subject to sections 275, 280 and 281 of this Decree, nothing contained in section 250 ofthis Decree shall be deemed to derogate from the duties or liabilities of the duly appointeddirectors. (3) For the avoidance of doubt, the fact that a person in his professional capacity gives adviceand a director acts on it shall not be constructed to make such a person under this Decree person inaccordance with whose directions or instructions the director of a company is accustomed to act.This provides effectively for Shadow Directorships, where the person gives instructions to the Board,which they are accustomed to complying with, otherwise than in professional capacity- this is nototherwise illegal.Further provision for Shadow Directors is made in CAMA as follows:Section 284 (in relation to arrangements for acquisition of non-cash assets of companies) and AlsoSection 291 which deals with Directors contracts of employment for more than 5 years, Subsection7 states specifically “In this section-(a) "employment" includes employment under a contract for services; and(b) "group" in relation to a director of a holding company, means the group which consists of thatcompany and it subsidiaries and for purposes of this section, a shadow director shall be treated as adirector.”Finally Section 340. (1) (Part XI -Financial Statement and Audit Chapter l -Financial Statements-Accounting records ) states: “ The group financial statements of a holding company for a year shallcomply with Part 1 of Schedule 4 to this Decree (so far as applicable) as regards the disclosure oftransactions, arrangements and agreements mentioned therein, including loans, quasi loans andother dealings in favour of directors. (2) In the case of a company other than a holding company, its individual accounts shallcomply with Part 1 of Schedule 4 to this Decree (so far as applicable) as regards disclosure matterscontained therein. (3) Particulars which are required to be contained in Part 1 of Schedule 4 to this Decree in anyfinancial statements shall be required in respect of shadow directors as well as a director given byway of notes.”In summary, the composite effect of these provisions in relation to Nigerian Law are thus: a. It is illegal for a person to hold himself/herself or to be held out as a Director of a Company where the person is not such- in essence a De facto Directorship may be illegal b. Where the Board acts under the directions of a person, that person shall be deemed to be a Director i.e a Shadow Director. Shadow Directorships are in themselves not illegal under Nigerian Law;
  11. 11. c. A disqualified Director (under S.254 CAMA) may not in anyway act in the direction of the affairs of a company and any such person who acquires Shadow Directorship status e.g by giving instructions to the Board of Directors which are complied with by the Board , is deemed to act in contravention of the law and liable to prosecution, hence this is the main instance in which Shadow Directorship may be illegal. The wrong which this law seeks to remedy being attempts to subvert the regime of disqualification provided for under S.254 to erring Directors.ConclusionThere seems to be a commonality of purpose in both UK and Nigerian law to ensuring the following: a. Protection to Shareholders and the public in instances where a person acts to effectively direct the affairs of a company whether they are stated to be Directors or otherwise and further where they improperly act as Directors – especially with the knowledge of the company; b. Protection of Shareholders and the Public where a person disqualified from acting as a Director may seek to subvert a disqualification order, by continuing to direct the affairs of the company from the “Shadows” as it were; c. Specification of guidelines for regulation and enforcement of the two instances listed above.A final note being that these principles are extremely important for a Company to bear in mind inthe conduct of its affairs, in that the intricacies of legislation in this regard places a heavyresponsibility of compliance, which sadly may companies have and continue to fall foul of even tilldate. The consequences of breach should neither be ignored nor underestimatedEdward C Keazor LLB BL ACISBarrister-at-Law Rose ChambersLagos, Nigeria