What is a ‘shadow director’? Are they liable in an insolvency procedure?

Company directors take on specific fiduciary, common law and statutory duties and responsibilities when they are appointed, and their status is registered at Companies House. If you are not officially a director, but provide advice and guidance to the board which is regularly acted upon, you could be viewed as a ‘shadow director.’

You can be vulnerable to legal action if the company becomes insolvent in much the same way as a director in law, which is why it is so important to establish your exact status within the company.

What  is the definition of a 'shadow director'?

The Companies Act, 2006, defines a shadow director as a person,

“in accordance with whose directions or instructions the directors of a company are accustomed to act.”

A common example of where this situation might occur is within the finance function, but there are several other factors which also come into play when deciding whether you could be regarded as a shadow director:

• Whether or not the company portrayed you as a director – perhaps using the title in written communications.
• If third parties considered you to be a director – because you regularly negotiated on behalf of the company, for instance.
• Whether you assumed responsibility for an entire area of the business - you were the sole signatory on the company’s bank account, or took the lead when recruiting senior members of the management team, for example.

During insolvency procedures, these and other factors specific to your company will be taken into account by the Insolvency Service when determining your status.

The main message, however, is to be aware of the potential for liability as a shadow director when the company is financially stable, as well as when insolvency strikes.

Duties and responsibilities: your potential areas of risk

Directors in law accept fiduciary, statutory and common law duties and responsibilities when acting on behalf of the company, and it has been said that shadow directors should assume the same duties and responsibilities.

If you take this approach there is a natural tendency to err on the side of caution, which will help to reduce your risk of liability.

If the company enters insolvency, your actions will be scrutinised by the administrator or liquidator, to determine your role within the business and identify instances where personal liability might apply.

Scenarios where this might occur include:

• Trading wrongfully or unlawfully
• Failing to put creditor interests first
• Failing to complete and file company accounts and statutory returns

A risk to your professional reputation also exists if the company becomes insolvent. Apart from the stigma of being associated with a failed business, you could be viewed as trying to avoid legal repercussions by acting as a director in all but name.

How to mitigate risk

There are certain actions you can take to mitigate your risk of liability, one of which is allowing board members to take the decisions. This would suggest that you are not, in fact, a shadow director, but you also need to ensure the minutes of any board meetings you attend record that you are ‘in attendance’ rather than ‘present.’

Simple measures such as making sure the company is up-to-date with all its filing obligations, including statutory accounts and returns, will avoid needless pressure should the business begin to fail.

If you are a shadow director, taking out all the relevant director insurances will help to manage your risk of liability, as would seeking legal advice on how to proceed in general.

What are the possible ramifications for shadow directors during insolvency?

During an insolvency procedure the actions of all directors, including shadow directors, will be scrutinised for any instances of misconduct or unlawful trading. If the company is to be forcibly liquidated, the insolvency practitioner will send a report to the Secretary of State on director conduct.

The financial penalties for misconduct can be severe, ranging from fines to liability for the company’s debts. Lack of director insurance to cover some of this liability could have serious consequences, including personal bankruptcy.

Under the Company Directors’ Disqualification Act, you may be disqualified from being a director or shadow director for between two and 15 years. If significant losses have been incurred by creditors because the company continued to trade when insolvent, you could face additional sanctions.

Where fraud has been identified, criminal action could be brought, potentially resulting in a prison sentence.

Begbies Traynor is one of the UK’s largest Independent Professional Services Consultancies. If you are unsure of your status as a shadow director, we can clarify your position and help you mitigate the risks. Call one of the team to arrange a same-day consultation.