Shadow Directors in Corporate Governance


She called her son Jacob and told him what his father had said to his brother.

Rebekah: “Now do exactly as I tell you. Go out to the flocks and bring me two young goats, and I’ll prepare your father’s favourite dish from them. Then take it to your father, and after he has enjoyed it he will bless you before his death, instead of Esau!”

Genesis 27: 6-10 (LB)

But at his birthday party for Herod, Herodias’ daughter performed a dance that greatly pleased him.

So he vowed to give her anything she wanted.

Consequently, at her mother’s urging, the girl asked for John the Baptist’s head on a tray.

The king was grieved, but because of his oath, and because he didn’t want to back down in front of his guests, he issued the necessary orders.

So John was beheaded in the prison.

Matthew 14: 6-10 (LB)

In the above extract from two notorious Bible stories, we see “shadow directors” at work in the actions and expressions of the lead characters of the drama. Their identifying criterion was that they exerted far-reaching results silently from backstage. There are other stories in the Bible where hidden but powerful personalities manipulated or controlled events from the sidelines, just as with Rebekah and Herod’s purported wife.

Who is a shadow director? A layman not conversant with the terminologies of corporate governance may probably imagine that a shadow director is someone within the company who lurks irrelevantly in the shadows of an all-powerful board/management. Well, this common perception of a shadow director is converse to the reality on the ground for even though the shadow director is never part of the boardroom; he is actually the monkey’s hand in the pot of soup that may soon turn to a human hand. Although a shadow director may never be heard of at all where all goes well with the company governance/administration, he or she will surely be unveiled should things go wrong with the governance of the company.

Nigerian company law, modeled after the English company law, acknowledges that there are persons, who may not necessarily have been appointed by the company to act as directors, but who nevertheless exert a certain degree of influence and control over the management of the company. A shadow director in relation to a company is a person in accordance with whose directions or instructions the directors of the company are accustomed to act (See Section 245(1) of the Company and Allied Matters Act [CAMA], Laws of the Federation of Nigeria, 2004). However, a person not duly appointed as a director and acts as such on behalf of the company which refuses to be bound by his directives and orders cannot be regarded as a shadow director (Section 250 of CAMA). It is also noteworthy that a person who in his professional capacity gives advice (not orders or instruction) to the board or director, shall not be deemed to be a shadow director, even where the company acted on such advice (Section 245(3) of CAMA).

How is the Existence of a Shadow Director Determined?

Shadow directors are often unknown until a problem shows up in the managerial decisions of the company and it becomes necessary to identify individuals who exercised dominant control over the affairs of the company. Section 245 of CAMA requires that the disclosures made by the directors under Section 275 of the same CAMA include those of shadow directors (ICSAN Notes, Corporate Secretaryship, page 11).

In Nigeria, we have not really had any elaborate judicial pronouncements on the issue of shadow directors. However, in the English case of Re Hydrodam (Corby) Limited, four test were listed for determining whether a person qualifies to be regarded as a shadow director, to wit:

  • The identity of the appointed and acting directors must be established.
  • It must be established that the alleged shadow director did direct the appointed directors in their actions or decisions in the running of the company.
  • It must be established that the appointed directors followed those directions or instructions of the alleged shadow director.
  • It must be established that it is the usual practice of the directors to follow the directions or instructions of the alleged shadow director.

Consistent with the above tests, in Re Unisoft (Corby) Limited (No. 2) (1994), it was held that the compliance by one of the directors of the company with the instructions of an outsider was not enough to make the outsider a shadow director. The outsider could be regarded as a shadow director if the majority of the board was accustomed to act on his instructions.

Another recent case has given guidance on the definition based on the English Company Directors Disqualification Act (1986), which enumerated as follows:

  • The definition of shadow director should not be strictly construed.
  • The purpose of the legislation is to identify those, other than professional advisers, with real influence over an element of the company’s business affairs.
  • Evidence is needed to show that a communication was either a “direction or instruction.”
  • Non-professional advice could fall within the definition.
  • A person can still be a shadow director even though the board has not adopted a subservient role to him or has not surrendered its discretion.
  • It is not necessary that a shadow director is someone who “lurks in the shadows”: a person can be a shadow director even if he is involved in the internal management of the company.

Other judicial consideration has concluded that:

  • In determining whether someone has become a shadow director, it is necessary to look at all the various matters as a whole.
  • If only a minority of the company’s board of directors are accustomed to act on someone’s direction that is not enough to make the person a shadow director.
  • The mere giving of instructions does not make someone a shadow director. It is only when they are translated into action by the board that the question can arise.

Who could be at risk of becoming a shadow director?

To become a shadow director, a person must exercise a real influence over the company’s affairs and direct the acts of the directors, such that the majority of the board acts on those instructions, as a matter of practice, over a period of time. It is not a requirement that that person needs to have controlled all of the activities of the board.

Those at risk of being shadow directors are:

  • A parent company that gives instructions to the directors of its subsidiaries, although in certain circumstances there is a specific exception under CAMA.
  • A shareholder in a joint venture company that gives instructions to the board of the joint venture company, or gives instructions to its nominated directors to direct the actions of the board of the joint venture company.
  • An institutional or private equity investor who has a right under the investment agreement to appoint an observer or representative to a board. If the board acts on that observer’s or representative’s instructions on a regular basis, there is a risk of him, or the investor, becoming a shadow director.

What Actions Are Deemed Risky?

Some examples of actions that could risk imposing shadow directorship include:

  • Imposing financial reporting requirements on the company, or taking control of the financial affairs of the company.
  • Making or substantially influencing, major strategic decisions of the company, or exercising any power of veto over the company’s decisions.
  • Negotiating with third parties on behalf of the rest of the board.
  • Controlling the appointment of senior management of the company.

Ultimately, whether such actions can make a person liable as a shadow director will depend on the facts of each case.

Exceptions to Risky Actions

There are certain exceptions to the definition of a shadow director, where circumstances may allow the person in question to fall outside of the scope of a shadow directorship.

  • Professional advisers, although this protection is lost if a professional adviser crosses the line so that he becomes the dominant influence on the directors – See S. 245(3) of CAMA.
  • A parent company will not be considered to be a shadow director of any of its subsidiaries if it imposes a common policy that applies to all group companies without being in breach of its duties to the subsidiary.

Consequences That May Arise on the Finding of a Shadow Director

Where a person is found to be a shadow director, there are various consequences that may arise under different statutes, which include the following:

  • Certain transactions involving the directors of a company that must be approved by the company’s members also apply to a shadow director.
  • A shadow director is required to declare the nature and extent of his interest in any transaction or arrangement that has been entered into by the company, in writing or generally – See Section 275(11) of CAMA.
  • The general duties owed by directors in the CAMA apply to shadow directors.
  • A member of the company can bring a derivative claim against a shadow director for any act or omission involving negligence, default, breach of duty or breach of trust.
  • A court can make a disqualification order against a shadow director.
  • A liquidator can seek to bring an action against a shadow director of a company for fraud in anticipation of winding up, misconduct in the course of winding up, material omissions from statements relating to company’s affairs and false representation to creditors. In addition, any director (including a shadow director) found liable of fraudulent or wrongful trading can be ordered to make such contribution to the company’s assets as the court thinks proper.
  • A shadow director is “connected” with the company. Certain transactions entered into by a company before the onset of insolvency proceedings can be challenged by a liquidator or administrator; for example, as a preference or a transaction at undervalue. Where the transaction is with a connected party, the period within which such a challenge can be brought may be lengthened, or the burden of proof may be reversed, depending on the nature of the challenge brought.

As a Lender to Companies, How Should I Minimise the Risks of Being Labeled a Shadow Director?

To minimise the risk of a lender inadvertently becoming a shadow director and incurring the liabilities and duties associated with being a shadow director, the lender should:

  • Generally avoid giving directions or instructions to the board or any other action that could be construed as limiting the discretion of the board (for example, requiring the right to approve or veto the appointment of a new board or principal officers of the company).
  • Present any conditions of continued support as contractual terms of credit that the company can then consider whether or not to accept.
  • Make it clear to the board that any conditions on which the lender will agree to continue to support the company are conditions of that continued support and are relevant to the lender’s position as lender only (and not as another stakeholder to the company). It is then the prerogative of the board to consider whether it wishes to accept those conditions.
  • Suggest that the board should consider the lender’s conditions and requirements with professional advisers and then respond formally to the lender.
  • If the lender is attending board meetings, ensure that it is present as an observer. Ensure the lender is not drawn into any discussions with the board during the meeting, and the lender leaves before any decisions are taken.
  • Never sign a document on behalf of the company or become a signatory to its bank account. Likewise, a lender should not negotiate on behalf of the company or hold itself out as acting for the company.
  • In cases where it is likely to be heavily involved (for example, as agent, sole lender or co-coordinator) with the company’s affairs, consider at the beginning of the process writing to the company, stating that the lender will be acting in its own interests, will not direct and should not be viewed as directing the company, and that all decisions and day-to-day management of the business remain with the board.

 

Previous In Pursuit of an “Egunje” Free Police Force
Next Employing more Staff for your Business

No Comment

Leave a reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.