Phillip Larkin, in "This Be The Verse", blamed his parents for being "fucked up" by them. To what extent may subsidiary companies look to their parent companies for this responsibility, and pass the buck up the tree?
For specific acts of a subsidiary there are certain remedies from the parent. For example, subsidiary companies (or their liquidators) may locate parental blame via a contract (e.g. by way of guarantee). Also, liquidators may find parents directly liable for their subsidiaries' transactions at an undervalue, fraudulent or wrongful trading, or unlawful distributions, but these are all discrete misfeasances through which a liquidator may seek an (indiscrete) remedy. Such events are slaps on the wrist compared to when a parent brings up their subsidiary poorly, encouraging hooligan behaviour and contempt for authority...
It is oft a far greater fear of a parent company to be found to be a shadow director or de facto director of its subsidary. Not only would the parent be personally liable for all the wrongs of the tear-away, but the longer-lasting effect may be the damage to the parent's reputation in the business community.
In sum, a "shadow director" is a legal entity/person who controls the company but is not officially appointed as a director (an officially appointed director is a de jure director); a de facto director is also not officially appointed but effectively sits on the board and is involved with decision-making. The exact distinction between shadow and de facto directors has caused much debate in case law, and the rest of this post follows the most recent rulings:
In Re Hydrodan (Corby ) Ltd [1994] 2 BCLC 180 the court decided that directors of parent companies are not automatically shadow directors of their subsidiaries. Limiting options available to prosecution, the judge held that the case for a shadow dierctor as opposed to a de facto director would be mutually exclusive. On de facto directors the judge said:
A de facto director is a person who assumes to act as a director. He is held out as a director of the company, and claims and purports to be a director, although never actually or validly appointed as such. To establish that a person was a de facto director of a company it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a director. It is not sufficient to show that he was concerned in the management of the company's affairs or undertook tasks in relation to its business which can properly be performed by a manager below board level.
The case of Secretary of State for Trade and Industry v Laing and others [1996] 2 BCLC 324 found that a company which is a shadow director does not automatically make the directors of that company shadow directors too.
In Secretary of State for Trade and Industry v Tjolle [1998] BCC 282 the judge highlighted the grey scale, stating that being a de facto director was "very much a question of degree". The court repeated some of the Hydrodan factors as "relevant" and added further factors to include: whether the individual used the title of director, whether the individual had proper information (e.g. management accounts) on which to base decisions, and whether the individual had to make major decisions. The judge distinguished his analysis from Hydrodan by stating that it was key to ask whether the indvidual was "part of the governing structure"? The reason for this is that there would be no justification for the law making a person liable for misfeasance or disqualification proceedings unless they were truly in a position to exercise the powers and discharge the functions of a director.
The Tjolle court's retention of its discretion was the last word to date on defining the de facto test.
Of shadow directors, the Court of Appeal agreed with the definition in section 22(5) of the Company Directors Disqualification Act 1986 (Secretary of State for Trade and Industry v Deverell & Another [2000] 2 All ER 365). In this case, the court held that:
- The purpose of the legislation was to identify those (other than professional advisers) with real influence in the company's corporate affairs, but this influence did not have to be over the whole field of its corporate activities.
- Whether a communication, by words or conduct, was to be classified as a "direction or instruction" had to be objectively ascertained by the court in light of all the evidence.
- It would not be necessary to show the subservient roles of the properly appointed directors.
- A person may be held to be a shadow director notwithstandiong that he took no steps to hide the part he played in the affairs of the company.
This last point is difficult to reconcile with the mutual exclusivity of de facto directors. It suggests that the person/company may impliedly hold itself out as being a director, by not hiding the fact that he is behaving in such a way. In this situation previous case law would find the legal entity to be de facto, yet Deverell suggests it could actually still be in the shadows.
In certain circumstances being a shadow director may be preferable to being a de facto director. Ultraframe v Fielding and Others [2005] EWHC 1638 (Ch) created a trade-off between shadow and de facto directors. Whereas shadow directors could be liable for controlling all its subsidiaries' misfeasances, the definition of a shadow director is not wide enough to impose the same fiduciary duties as owed by the company's de jure or de facto directors. However, the court held that a shadow director may be subject to specific fiduciary duties where his acts go beyond indirect influence.
Corporate Blawg UK expects that the courts will cling to their discretion, in order to lift the coroprate veil when it is justified and appropriate to do so. To reduce this risk, corporations can ensure they have clear and distinct management boards, and that all group companies can be seen to act independently of each other.
Despite the risks, large successful companies find parenthood hard to ignore. It is unlikely that grown-up corporate entities will follow Philip Larkin's tongue-in-cheek advice:
Man hands on misery to man.
It deepens like a coastal shelf.
Get out as early as you can,
And don't have any kids yourself.
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