Casting a light on shadow directors

      By Lee Kim Shin

      The Business Times, 10 July 2017

      In general, a person formally becomes a company director by a resolution of the board or shareholders. However, a person may have the same legal duties and liabilities of a director despite not being formally appointed as one. Singapore corporate law recognises the concept of a shadow director, otherwise described as the “puppet master” or “cat’s paw” who acts as the directing mind of a company.

      In a case decided earlier this year, Sakae Holdings succeeded in persuading the court that although one of the defendants in a joint venture company (of which Sakae was a minority shareholder) had formally resigned as a director, he was, in fact, a shadow director, and had breached his fiduciary duties to the company.

      The Sakae case illustrates how the concept of a shadow director is a cornerstone of corporate transparency. Those who regularly direct, or even advise, directors on company matters should be conscious of the risk that they may be regarded, as a matter of law, as shadow directors, and thus held accountable for any wrongdoing, including any wrongdoing by the company.

      Who is a shadow director?

      Under the Companies Act, a person is regarded as a shadow director if he is found to be “a person in accordance with whose directions or instructions the directors or the majority of the directors are accustomed to act”.

      In deciding if the company’s directors are “accustomed to act” in such a way, the courts ask if there exists a consistent pattern of compliance with that person’s directions or instructions. The occasional departure from the pattern will not affect the court’s finding of shadow directorship. Neither is there a requirement that the shadow director’s directions or instructions must extend over all or most of the company’s corporate activities.

      For example, a person may be a shadow director if the board consults him on all significant issues in the running of the company, and he expects his views to be respected by the board.

      Attending and providing advice at board meetings on a regular basis are also relevant factors. That said, the Companies Act clarifies that a person who advises the board in a professional capacity – for example, a lawyer or an accountant – is not regarded as a shadow director.

      A person is also not a shadow director if only one or a minority of the directors is accustomed to act in accordance with his directions or instructions.

      A more interesting question is whether a corporate parent could be a shadow director of a subsidiary if all its nominee directors control the subsidiary board, and these directors only act in accordance with the instructions of the corporate parent. In its report issued in April 2011, the Steering Committee for Review of the Companies Act considered the question, but concluded that it should be left for the courts to answer.

      What are the duties and liabilities of a shadow director?

      Like any director, a shadow director owes fiduciary duties to the company, and must act in the collective interests of all its shareholders. He must not prefer his own interests to those of the company. A breach of these fiduciary duties – for example, by allowing the company to incur obligations when it is insolvent – may render the director liable to the company or to third parties for losses incurred. In addition, if he breaches his statutory duties as a director under the Companies Act, he may be liable for criminal offences.

      The issue of shadow directorship therefore often arises when the company is wound up on insolvency. In another case this year, the Singapore court agreed with the liquidator that a former director of an insolvent shipping company, Parakou Shipping, was, in fact, a shadow director who had taken part in a conspiracy to evade its creditors by causing the company to dispose of its assets when liquidation was imminent. The shadow director was in breach of his fiduciary duties and, thus, liable to Parakou for losses caused to the company.

      It should be noted that a typical directors and officers liability (D&O) insurance may not cover the liabilities of a shadow director.

      Nominator of nominee director

      Recent changes to the Companies Act have augmented the concept of shadow directorships. In particular, a nominee director – defined as someone who is “accustomed or under an obligation whether formal or informal to act in accordance with the directions, instructions or wishes of any other person” – is now required to disclose his nominee status and information about his nominator to the companies. (Certain companies, such as those listed on the Singapore Stock Exchange, and Singaporean financial institutions are exempted.)

      Persons who are registered as nominators in this register should be careful not to exercise too much control over their nominee directors on the board; otherwise, they risk being deemed to be shadow directors.

      A final point: Since a significant number of registered nominators are also corporate shareholders, the issue – skirted by the 2011 Steering Committee– of whether corporate shareholders could be considered shadow directors may well be considered by the courts sooner rather than later.

      Lee Kim Shin is a member of the Governing Council of the Singapore Institute of Directors.