non-profit-fact-sheets
What Is a Shadow Director?
Published: May 21, 2024
Read Time: 14 minutes
Board directors often ask others for advice on a range of issues related to finance, law, risk, and governance. On occasion, these relationships can cross a line and create the complicated dynamic of having a shadow director. A shadow or de factor director is a person who exercises a high degree of influence on the organisation and/or leads management-related work that would typically be assigned to a Board director.
Having a shadow director can give the impression to a company’s stakeholders, creditors, and employees that the people making decisions are not being transparent. Board decisions can affect the company’s reputation and ability to operate, and having a shadow or de factor director creates risks for the company and its stakeholders.
“The lack of accountability, both internally and externally, can lead to rogue decisions or illegal activities,” says John Price, Commissioner for the Australian Securities and Investments Commission. However, company directors can mitigate the risks associated with having a shadow director by ensuring that accountability and transparency remain top priorities.
What Is a Shadow Director?
According to the law firm Chamberlains, a shadow director is a person who regularly performs the responsibilities of a Board director but is not officially recognised in the role. All company directors oversee and manage various business areas for their organisation. Sometimes, they seek out advice from internal or external people.
Advisors who offer directions or instructions to Board members despite not being in an official director role may be shadow directors, according to Australian law. In Australia, a such a person must be willing and able to exercise control over the company’s business activities and management.
A shadow director is an unappointed Board director who instructs others on how to perform their duties and influences the actions Boards take. He or she may also communicate their wishes or preferences to the directors of the company on how to perform their duties. The Corporations Act 2001 keeps all directors accountable, even if they are not officially appointed.
Shadow Directors Risks
Lawyers Daniel Atkin and Daniel Cheilyk describe a shadow director as an individual for whom the Board may be used to following direction or their wishes, despite not being in official role. The Act states that individuals such as lawyers, CEOs, CFOs, lenders, or major shareholders can all become shadow directors if they involve themselves in or participate in decision-making process. Shadow directors may be in a position of influence over the company and its internal governance policies, creating the risk of a conflict of interest.
A shadow director may say that they are not a director and continue to have influence on the company’s management and governance processes. However, in the event of a breach of law, they may still be personally liable or face criminal or civil consequences and can be disqualified from a directorship. In Australia, shadow directors and de factor directors are indeed responsible for complying with directors’ duties.
It is not always easy to know which people are the directors of a company. In some cases, individuals operating in an unofficial capacity may be taking on the role of director without having the title. For example, a lawyer acting on behalf of the company or an accountant providing advice to the Board for a period may be considered by the courts as a shadow director if certain conditions are met.
Identifying A Shadow Director
When a shadow director takes responsibility for certain work, they are expected to fulfill their duties the same way other directors do. They can be liable if they fail to do so. A court may find an individual to be a shadow director or de facto director under the following circumstances:
- The individual makes or participates in making decision that affect the entire or part of the company’s business.
- The individual has the capacity to significantly affect the corporation’s financial standing.
- The individual whose instructions or wishes prompt the official directors of the company to become accustomed to acting.
Lawyers, accountants, and consultants may offer advice to a Board without being shadow directors. The common factor in identifying a shadow director is the person’s influence. Some professionals have the power to influence decisions at the Board level through their advisory or de facto role, while others do not. A shadow director is likely to take on the responsibility for and participate in decisions, transactions, and management activities that affect operations, finances, and other business areas.
Court Case Examples
and who is not. Judge Connock who presided over the Oliana Foods v Culinary Co case in 2020 defined shadow director as follows: “What I have for convenience termed a ‘shadow’ director is a person who is not validly appointed as a director put a person to whose instructions or wishes the directors of the relevant company are accustomed to acting in accordance with.”
In the Re Akron Roads liquidation case, Judge Robertson summarised his four-question process for determining if a person is a shadow director.
- Who were the directors of the company, whether de facto or official?
- Did the defendant give instructions or express his or her wishes to the Board directors on how to act in relation to the company?
- Did the directors act in accordance with these wishes or directions?
- Were they accustomed to do so?
In both cases, a direct connection between the shadow director who gave direction or instruction to members of the Board, and the actions these directors took was present. Answering these questions in the affirmative proves that a person is a shadow director and is therefore liable under the Act.
Shadow Director Vs De Facto Director
The terms shadow director and de facto director are sometimes confused since they appear to exist under similar circumstances. The difference between a de facto director and a shadow director is that de facto director can more easily be identified due to transparency, while shadow directors are often operating behind the scenes, creating a sense of secrecy or lack of clarity.
A shadow director or de factor director has influence over the way the Board runs its company. The de facto director operates in the same capacity of an official director. They may have previously been in the regular role and stayed on to advise the Board in an unofficial capacity. Meanwhile, the shadow director, while not officially appointed to the Board, is likely to act on the behalf of the organisation on a regular basis and over a longer period of time.
Yet, in both cases, individuals are still responsible for their actions and may be liable for mismanaging the company or incurring debts and insolvency. Both roles have a significant responsibility to the company’s activities and are bound to the same legal obligations as officially appointed Board directors.
How Do Shadow Directors Influence Companies?
The Corporate Governance Institute lists several types of influence a shadow director may have on a company. They include approving spending, influencing budgeting decisions, and securing loans on behalf of the company. A shadow director may influence high level discussions and decision-making simply by participating in board meetings and planning sessions.
They may also regularly negotiate on behalf of the company and take on the responsibilities of an entire area of business. Other examples are filing taxes and submitting charitable status forms for the company. Entering into a legal agreement with an insurance carrier or singing a lease are also examples of the kinds of actions shadow directors may take. One way to identify such individuals is to review the Board meeting minutes of a company and checking to see if a person is marked as present or recorded as voting despite not being a Board member.
What does it mean to shadow a director?
Shadowing a director typically means observing and learning from a director’s activities and decision-making processes without being directly involved in the decision-making. This could involve attending meetings, reviewing reports, and understanding the strategic direction and operations of the company. The purpose is often educational, helping potential future directors to gain insights into governance, compliance, and the practical aspects of directing a company. However, this is different from the legal concept of a 'shadow director,' who exerts significant influence over the board's decisions.
What is a shadow director in Australia?
In Australia, a shadow director is an individual who is not officially appointed as a director but whose instructions or wishes the officially appointed directors of the company are accustomed to act upon. According to the Corporations Act 2001, such a person can be considered a director and held liable as such.
This means they have the same duties and responsibilities as formally appointed directors, despite not holding a formal title. The law aims to ensure that individuals who influence the board's decisions are held accountable for their actions, especially in cases of misconduct or mismanagement.
What is an example of a shadow director?
An example of a shadow director in Australia could be a major shareholder or a senior executive who does not have a formal director title but regularly advises or directs the board on significant decisions. For instance, if a company’s major investor consistently tells the board how to vote on certain matters and the board follows these instructions, the investor could be deemed a shadow director. Another example might be a former director who continues to exert influence over the company’s current directors, guiding their decisions from behind the scenes.
What are the risks of being a shadow director?
Being a shadow director in Australia carries significant risks, primarily because such individuals can be held liable for the same legal and fiduciary duties as formally appointed directors. This includes obligations under the Corporations Act 2001, such as acting in good faith, avoiding conflicts of interest, and ensuring the company does not trade while insolvent.
If a company fails to comply with its legal obligations, shadow directors can face substantial penalties, including fines and personal liability for company debts. They may also be subject to disqualification from managing corporations and other legal actions if found to have breached their duties.
Are shadow directors illegal?
Shadow directors themselves are not illegal in Australia; however, the position comes with significant legal responsibilities and potential liabilities. The law recognises shadow directors to ensure that those who exert control over a company’s operations are held accountable for their actions. While it is not illegal to be a shadow director, failing to comply with the legal duties and obligations imposed on directors can result in serious legal consequences. This framework is designed to promote good corporate governance and protect the interests of shareholders, creditors, and other stakeholders.
What is the power of a shadow director?
A shadow director in Australia wields significant power due to their ability to influence the decisions of the formally appointed board of directors. This power stems from the board's habitual compliance with the shadow director’s instructions or wishes. Although a shadow director does not hold a formal title, their influence can shape strategic decisions, financial management, and corporate policies. However, with this power comes the responsibility to adhere to the same legal and fiduciary duties as official directors, ensuring that their influence is exercised in the best interests of the company and its stakeholders.
How to avoid becoming a shadow director?
To avoid becoming a shadow director in Australia, individuals should refrain from exerting undue influence or control over the board’s decisions unless they are formally appointed as a director. This includes avoiding giving instructions or directives that the board is likely to follow. It is also important to maintain clear boundaries between advisory roles and direct decision-making authority. Regularly consulting with legal advisors to understand the implications of your actions and ensuring that any advice provided to the board is non-binding and framed within appropriate professional boundaries can help mitigate the risk of being deemed a shadow director.
Can you sue a shadow director?
Yes, in Australia, shadow directors can be sued just like formally appointed directors. They are subject to the same legal and fiduciary duties under the Corporations Act 2001. If a shadow director breaches these duties, they can be held liable for damages or face other legal consequences. This includes personal liability for the company’s debts if they allow the company to trade while insolvent, or if they engage in fraudulent or negligent conduct. Stakeholders such as shareholders, creditors, and regulatory bodies can initiate legal action against shadow directors for breaches of their responsibilities.
Do shadow directors owe directors duties?
Yes, shadow directors in Australia owe the same directors’ duties as formally appointed directors. These duties are outlined in the Corporations Act 2001 and include acting in good faith in the best interests of the company, exercising care and diligence, avoiding conflicts of interest, and not improperly using their position or information for personal gain. Shadow directors must ensure that their influence over the company’s affairs is exercised responsibly and in compliance with legal and fiduciary standards. Failure to adhere to these duties can result in significant legal and financial consequences.
What is a silent director?
A silent director in Australia is someone who is formally appointed to the board but does not actively participate in the management or decision-making processes of the company. They typically do not attend board meetings, contribute to discussions, or influence decisions. Despite their lack of active involvement, silent directors still hold the same legal responsibilities and liabilities as active directors under the Corporations Act 2001. This means they must ensure the company complies with its legal obligations and can be held accountable for any breaches of their duties.
What is a dummy director?
A dummy director in Australia is a person who is appointed to the board of directors in name only, without any real intention to fulfill the responsibilities or duties of the role. Often, dummy directors are used to conceal the true control of the company, which can raise serious legal and ethical concerns. Under the Corporations Act 2001, dummy directors are still legally liable for the actions of the company, and using dummy directors to evade legal responsibilities or mislead stakeholders can result in significant penalties, including fines and imprisonment for those involved.
Can you be an owner of a company and not a director?
Yes, in Australia, it is possible to be an owner (shareholder) of a company without being a director. Shareholders own shares in the company and have a financial interest in its success, but they do not necessarily have a role in managing the company’s day-to-day operations. Directors, on the other hand, are responsible for the governance and management of the company. While shareholders can influence significant decisions through voting at general meetings, the directors are the ones who implement these decisions and oversee the company’s operations.
Is a shadow director a non-executive director?
No, a shadow director is not the same as a non-executive director in Australia. A non-executive director is formally appointed to the board and participates in board meetings and decision-making processes without being involved in the day-to-day management of the company. They bring independent judgment and expertise to the board. In contrast, a shadow director is someone who is not formally appointed but whose instructions or wishes the board follows. Shadow directors operate behind the scenes and may exert significant influence over the company’s decisions without holding an official title.
Can advisory board members be shadow directors?
Advisory board members can potentially be considered shadow directors. A shadow director is someone who, while not officially appointed as a director, exerts significant influence over the board's decisions to the extent that the official directors typically follow their directions or instructions. This can happen if an advisory board member regularly influences the company's decision-making processes and the official directors act upon their guidance.
The classification as a shadow director depends on the extent of their involvement and influence, and the legal definitions and implications can vary by jurisdiction. Documentation showing that the advisory board member's instructions are generally followed by the official directors can serve as evidence of this classification. It is important to understand that being considered a shadow director carries legal responsibilities and potential liabilities.
Additional Resources
• To learn more about The Corporations Act 2001, visit the Federal Register of Legislation.
• To learn more about how to determine if a person is disqualified from being a responsible person.
References
Australian Securities & Investments Commission. (2022). Small business company directors.
Breen, G., & Martelli, B. (2002). Insolvency: Liability For Insolvent Trading – The Shadow Director and Other Issues. Australian Construction Law Newsletter 82.
Conmy, S. (2024). What is a shadow director? Corporate Governance Institute,
Hucke, A. (2023). Shadow Directors, De Factor Directors, and the Legal Implications of Both.
This fact sheet is intended as a simple overview. Non-profit law is incredibly complex and there are many components, allowances, restrictions, exceptions and important qualifications that are not described above. Dedicated legal advice should be sought from a legal practitioner before taking action.
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Better Boards connects the leaders of Australasian non-profit organisations to the knowledge and networks necessary to grow and develop their leadership skills and build a strong governance framework for their organisation.
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