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Practices

What is a de facto director?

11 February 2011

The Supreme Court recently favoured a narrower definition of "de facto" director, but only by a bare majority after an interesting (and contentious) debate.

The case involved the following situation (simplifying greatly): C, a private company, had only one director, D, which was a corporate director. X, an individual, was the sole director of D.

C made unlawful dividend payments and when it became insolvent, HM Revenue & Customs (being C's only creditor) sought to recover sums from C's directors under insolvency legislation, claiming misfeasance and breach of duty. D had no assets either, so HMRC pursued X personally on the grounds that X was a de facto director of C.

Terminology for directors

The Companies Act 2006 states that a director "includes any person occupying the position of director, by whatever name called". This is unhelpfully circular, but the key point is that the law can treat a person as a director even if he is not formally appointed to the board. Such persons have become known as de facto directors.

Historically the term was confined to those who acted as if formally appointed, but whose appointment was either defective or had come to an end. However, in the last 20 years, the courts have instead concentrated upon a person’s conduct rather than any technical invalidity of appointment.

As a result, the distinction with "shadow directors" has been significantly eroded. A shadow director is "a person in accordance with whose directions or instructions the directors of a company are accustomed to act". It was previously thought that these were mutually exclusive categories since a de facto director would openly hold himself out as a director, whereas a shadow director would claim not to be a director. Now it is recognised that there can be an overlap, but in this case HMRC only sought to argue that X was a de facto director since the relevant insolvency legislation did not apply to shadow directors.

The decision

The majority of Supreme Court held that X was not a de facto director of C, but two judges strongly disagreed. The majority decision was based on the following points:

  • company law recognises that a company is a different person from its directors, and this distinction must be respected (provided that D was not a pure shell or façade, which was not alleged);
  • where relevant acts are done by an individual entirely within the ambit of the discharge of his duties as a director of a corporate director, it is to that capacity that his acts must be attributed. On the facts, X had not overstepped the boundaries;
  • fiduciary duties will only be imposed on a person who has assumed responsibility and become part of the "corporate governing structure" of a company, and this does not follow simply from being the sole director of a corporate director;
  • the 2006 Act subsequently introduced a requirement that each company have at least one natural person as a director. This was "hardly necessary if the natural person or persons who were the guiding minds behind the corporate director's decisions relating to the company were ipso facto to be treated as de facto directors of the company". Any further extension of the concept of de facto director would be a matter for the legislature.

The dissenting minority regarded the assertion that everything that X did was undertaken in his capacity as a director of D as "the most arid formalism". If what X actually did amounted to taking all important decisions affecting C, they thought it made no difference that he was also acting as the sole director of D since there was no reason in principle why a person could not be acting in more than one capacity.

Further, there was a significant difference between this case and situations where there were several directors of the corporate director and the relevant person was merely participating in a collective decision. It was essential to examine what X did on his own initiative. He was "the founder and guiding spirit" of the whole empire, which comprised 42 companies identical to C with D as sole director of each.

Practical implications

The minority judges feared that the decision would "make it easier for risk-averse individuals to use artificial corporate structures in order to insulate themselves against responsibility to an insolvent company's unsecured creditors".

Their dissent initially appears to have much to commend it, especially on the facts of the case where, for instance, a computer simply generated automatic board minutes for the 42 companies in order to approve the dividend payments.

However, the following factors should serve to limit the potential for abuse:

  • the majority did not say that a sole director of a company's corporate director could never be a de facto director of the company. X had succeeded in confining himself to acting solely as D's director, but others may be less careful;
  • the change under the Companies Act 2006 (see above) means that there must now always be an individual director to proceed against if required (admittedly he need not be situated in the UK and could be difficult to pursue in practice);
  • although the section of the insolvency legislation relied on here did not apply to shadow directors, other sections do (though may require the liquidator to take action rather than being available to individual creditors like HMRC). The case confirmed that shadow directors do not necessarily "lurk in the shadows", and with each company now having an individual director it may be easier for a shadow directorship to arise if that individual becomes accustomed to acting on the instructions of another.

Overall, while the issues could be debated at length, it is much better to concentrate on avoiding liabilities by discharging directorial duties promptly and diligently, rather than seeking to devise intricate corporate structures.

The case discussed is Holland v The Commissioners for Her Majesty's Revenue and Customers and another [2010] UKSC 51