Corporate Advisory and Governance Alert: Are you a shadow director? Determining your liability as an advisor to a company - 28 Nov 2011

A recent decision of the NSW Court of Appeal has clarified when a person will be considered a shadow director of a company.

A shadow director attracts all of the legal obligations, duties and liabilities that attach to any other director of a company. This court decision provides some clarity for those who are unsure how involved in a company's decision making they have to be in order to be considered a shadow director.

Here, partners Brian Moller and Michael Hansel and solicitor Katherine Hammond outline the case in Buzzle Operations v Apple Computer Australia and what company advisors and creditors can learn from it.

Key points

  • If the directors of a company act on a creditor or advisor's instructions because they consider those instructions a sufficient reason to act, the advisor may be considered a shadow director. Because of this, those who have not been formally appointed as a director may still be liable for insolvent trading and other directors' liabilities if the company regularly relies on their advice without first assessing whether the advice should be acted on.
  • However, if the directors of a company make their own decisions in which the instructions given by an advisor or creditor are just one factor taken into account, the advisor will not be considered a shadow director. This provides a level of comfort to those who become actively involved in a company, or who impose conditions which the directors must or feel compelled to follow if they wish to pursue a particular course of action.

What is a shadow director?

According to the Corporations Act 2001 (Cth), the broad definition of 'director' extends beyond those who have been validly appointed as a director to include those not validly appointed, if the appointed "directors are accustomed to acting in accordance with the person's instructions or wishes", rather than just acting on advice given by the person in their usual business relationship with the directors.

The confusion arises in determining "when the directors of the company are accustomed to acting in accordance with a person's instructions or wishes". For example, a creditor who takes a keen interest in and exerts a marked degree of commercial pressure on a debtor company, which the company complies with, may be concerned that they will be considered a shadow director if the company feels that it has no other option but to act in accordance with the creditor's instructions.

Buzzle Operations v Apple Computer Australia

Buzzle Operations Pty Ltd (in liq) and Another v Apple Computer Australia Pty Ltd and Others (2011) came about after Buzzle Operations acquired six Apple product reseller businesses.

The assets of the business - the resellers' Apple products - were transferred to Buzzle. In exchange, Buzzle issued the resellers with shares and was obliged to make cash payments once it had listed on the ASX, or at a time when the directors formed the view, on reasonable grounds, that Buzzle had adequate funds to make a cash payment.

Apple had a charge over the assets, which was granted when Apple had initially transferred the assets to the resellers. As a result, Apple's consent was required for the acquisition to go ahead.

Buzzle made cash payments in November and December 2000, but went into receivership in March 2001. When an order was made for Buzzle to be wound up in February 2002, the liquidator initiated proceedings against Apple on the basis that the cash payments constituted uncommercial transactions and unfair preferences to a related party, and that Apple was liable for insolvent trading.

The liquidator maintained that Apple was liable because it was a shadow director of Buzzle. It argued that the directors of Buzzle had become accustomed to acting in accordance with Apple's instructions or wishes, rather than merely acting on the advice Apple gave them in properly performing functions attached to its business relationship with them.

The basis for this argument was that:

  • Apple participated significantly in the discussions leading up to and after the acquisition, and threatened to withhold its consent to the acquisition unless Buzzle complied with certain conditions, took certain action, and agreed not to incur debts outside the ordinary course of business; and
  • Buzzle's directors felt that they had "absolutely no choice but to agree to Apple's terms" and did in fact comply with many, if not all, of Apple's demands.

The deciding factors

The Court found that Apple was not a shadow director of Buzzle, and its decision clarifies the following points:

  • In order to establish that a person or entity is a shadow director, it must be shown that there is a causal connection between the alleged shadow director giving an instruction or expressing a wish, and the other directors acting on it. However, it is not necessary to show that the other directors exercised no discretion of their own. The ultimate question to be determined is who is making the board's decisions, and where the locus of control sits.
  • The question for consideration is whether the directors are acting in accordance with the alleged shadow director's wishes because the directors have decided that to do so is in the interests of the company or because they wish to pursue a certain course of action, rather than because they have simply deferred to the alleged shadow director's decision making.
    In Buzzle's case, although the directors felt they had no choice but to follow Apple's instructions, this was not because they were unquestioningly deferential and accustomed to acting in accordance with Apple's instructions, but rather because they knew they needed to follow Apple's instructions in that instance if they wanted to proceed with the acquisition.
  • Being "accustomed to act" requires a pattern of behaviour and habitual compliance over a period of time.
  • Not every person whose advice or instructions are followed by a board is a shadow director. If someone has a genuine interest in giving advice to the board (for example, a bank or mortgagee), the fact that the board will tend to take that advice will not make that person a shadow director. The important factor is the potential for the alleged shadow director to control decisions, viewed in light of the circumstances as a whole. For instance, a lender who is entitled to demand repayment of a loan and appoint a receiver can say, for example, that it will stay its hand only if the borrowing company sells certain assets.