This article identifies the vulnerabilities for ICAEW members who act as a shadow or de-facto director. The web pages on Financial and accounting duties and responsibilities of directors should be read in conjunction with this article.

What classifies a director?

The Companies Act 2006 (CA2006) simply defines a director as including any person occupying the position of director, by whatever name called. However, general principles have been established in case law, including the recent Court of Appeal case of Smithton v Naggar ([2014] EWCA Ci 939).

What classifies a de-facto director?

A de-facto director (or director ‘in fact’) is someone who acts as a director but who has not been formally appointed (a person who has been formally appointed being a ‘de jure’ director or ‘director in law’). The matter is determined on an objective basis and irrespective of the person’s motivation or belief.

The issue may be particularly relevant to a member employed by a company in a senior financial position where the company relies upon the member’s qualification and skills. There is no definitive test to determine the issue and all relevant facts need to be taken into account in determining whether or not an individual will be deemed to be a de-facto director.

Relevant factors include:

• whether there were other persons acting as directors
• whether the individual has been held out as acting as a director, including using the title ‘director’ in communications, or has been considered to be a director by the company or third parties
• whether the individual was part of the corporate governing structure
• in what capacity the individual was acting.

A de-facto director is subject to the same duties and liabilities as a de jure director under the Companies Act 2006 (CA2006) and certain other legislation, including the Company Directors Disqualification Act (CDDA).

Acts of a de-facto director can include:

• accepting responsibility for the company’s financial affairs
• acting as sole signatory for the company bank account
• negotiating with third parties on behalf of the board
• recruiting and appointing senior management positions.

A person (including a member employed by a company) may be a shadow director or a de facto director, depending upon the circumstances surrounding the role and there is some overlap between the two concepts. 

What classifies a shadow director?

A shadow director is someone who is not appointed as a director but who gives directions or instructions that the directors of the company are accustomed to act upon.

A person however is not regarded as a shadow director solely because the company directors act on the advice given by that person in a professional capacity. There are various exceptions in relation to directors of a subsidiary acting on direction or instruction of its parent. Whether or not a person is a shadow director is a question of fact and dependent upon all of the relevant circumstances.

The question of whether or not a person is a shadow director may arise in a wide variety of contexts, for instance for management consultants (subject to the exception for professional advice), lenders and creditors of a company or a joint venture shareholder.

Many of the CA2006 provisions applicable to de-jure directors apply also to shadow directors. The small business, enterprise and employment bill 2014 provides for the CA2006 to be amended so that the general duties of directors will apply as far as possible. The Bill also contains provisions to restrict the use of corporate directors by companies.

A shadow director is also subject to a number of other legislative provisions that apply to de jure directors; in particular, a shadow director may be liable for wrongful or fraudulent trading under the Insolvency Act 1986 and to disqualification provisions of the CDDA.

Who is at risk of being a de-facto or shadow director?

A member connected to a company in a senior financial position may, by virtue of their qualification, skills and standing in the organisation, be at risk of being a de-facto or shadow director. This may be especially true if there are no other qualified accountants within the organisation and the member has influence over the board.

A member who is a director of a company (including as a shadow or de-facto director) must carry out his or her duties in line with ICAEW’s fundamental ethical principles. This means acting responsibility and with integrity having regard not just to the interests of the company but to those of other stakeholders such as employees, creditors and the public authorities.

General risks arising

Both de-facto and shadow directors may be liable for offences under other legislation, including the Insolvency Act 1986 and criminal sanction where applicable.

There may also be reputational risks for members, for instance, if there is a perception that they are acting as de facto or shadow directors in order to avoid the formalities of appointment as de jure directors and being disclosed on the company’s register of directors.

Risk of disqualification

Anyone who was a director or shadow director of a company at any time in the three years before the start of an insolvency may be disqualified under CDDA if found to be unfit to be concerned in the management of a company.

Matters which may result in a finding of unfitness include serious offences such as conviction for an indictable offence concerning the promotion, management or liquidation of a company or fraud in the winding up of a company, including fraudulent trading. However administrative failings, including failure to keep proper accounting records or to prepare and file accounts or submit annual returns to Companies House can also result in a finding of unfitness.

Following a report from an insolvency practitioner the Insolvency Service decides whether to take disqualification proceedings. If found unfit to be a director, the Court will disqualify the individual for a period of between two and 15 years. In addition the individual may be ordered to pay the Insolvency Service’s costs, as well as their own.

The Insolvency Service may accept an undertaking from the person concerned that they will not act as a director for a specified period of between two and 15 years in lieu of Court proceedings.

A disqualification order against an individual will mean that the individual cannot:

• be involved, either directly or indirectly, in the promotion, formation or management  of a company
• act as a member of an LLP
• sit on the board of a charity, school or police authority
• be a pension trustee
• become a registered social landlord
• sit on a health board or social care body
• act as an insolvency practitioner

A register of individuals disqualified by court order or undertaking is maintained by Companies House and can be accessed through its website, free of charge.

Impact on membership of ICAEW

Disqualification as a director following either a disqualification order or an undertaking would be considered by ICAEW as conclusive evidence of an “…act or default likely to bring discredit on himself, the Institute or the profession of accountancy" (Disciplinary bye-law 4.1a).

The Sentencing Guidelines of ICAEW give a starting point for punishment as exclusion from membership (exclusion or severe reprimand for disqualification for “only” five years or less), plus a fine of up to £5,000, and costs. Members finding themselves disqualified as a director should consider putting forward any mitigating factors to seek to avoid exclusion. Members may also want to seek advice from a specialist solicitor who could, in addition, represent them before ICAEW’s disciplinary committee.

Managing the risks

For all of these reasons members need to recognise when they are at risk of becoming a de facto or shadow director and, if they do assume these roles, to ensure they comply with all relevant duties and obligations. Given the implications of insolvency law and CDDA it might be advisable for relevant members to obtain professional advice.

A member who is aware that he or she is, or might be, a de facto or shadow director should consider becoming formally appointed (as a de jure director) so that there is no doubt as to their position.

Alternatively, the member could reduce or eliminate the risk of being found to be a de facto or shadow director by ceasing to act in the ways outlined above or by changing the surrounding circumstances, for instance making sure that they only act on the instructions of the board.

Members can further help the company by ensuring that it is properly run, that annual returns and accounts are filed on time, PAYE and VAT are paid promptly and professional advice is sought if the company’s finances are strained.

Your gateway to resources for business

• Access a range of business-focused support, advice and information from a range of sources in our business resources area.
• Members in doubt as to their position in relation to matters of professional conduct should contact ICAEW’s ethics helpline or seek legal advice. Telephone: +44(0)1908 248250, skype at icaew_uk or email ethics@icaew.com.
• If you’d like any further information on this topic or to give any suggestions or feedback on how we can improve your membership, please get in touch: business.members@icaew.com