EXPLORING THE LEGAL FRAMEWORK GOVERNING SHADOW DIRECTORS IN INDIA
Author: Pandit Aradhana Swanand, III year of B.A.,LL.B(Hons) from School of Law, CHRIST (Deemed to be University).
A Director of a company is appointed to the Board of Directors of the company and undertakes the responsibilities and functions of a Director as provided under the Companies Act, 2013. The Board of Directors are responsible for the management of the company’s affairs, and they have a fiduciary duty towards the company and its stakeholders.
Directorship may be of three types—de jure, de facto and shadow directorship. A de jure director is one who is formally appointed to the post of a director and a de facto director is one who though not appointed as a director, holds himself out as one to a third party such that they would reasonably perceive him to be a director. A shadow director is not appointed to the Board but exercises a clandestine but substantial control over the affairs of the company, as the Board is accustomed to act in accordance with his instructions and advice.
Directors are bound by the provisions of the Companies Act, 2013 as well as the Memorandum and Articles of Association of the Company. To escape these legal constraints, shadow directors operate from behind the scenes, without being formally appointed as directors.
The Companies Act, 1956 did not contain specific provisions for the definition or liability of a shadow director. The J.J. Irani Committee in 2005 had recommended that there be a legal framework to discourage shadow directors who operate the company in an underhanded manner.
They recommended that directorship should be attributed to such persons so that they may be held accountable for their actions. The Companies Act, 2013, however, failed to provide a legal status to such directors but made some provisions to hold them liable for their acts.
Additionally, there are numerous common law judgements that are relied upon to determine the duties, responsibilities and liabilities of shadow directors. This essay delves into the legal framework governing shadow directors and makes recommendations regarding the same.
The Companies Act, 2013, along with various judicial pronouncements provide for the definition, role, duties, responsibilities and liabilities of shadow directors.
Definition of shadow director
In India, there is no statutory definition of a shadow director. However, Section 2(59) of the Companies Act, 2013 defines an “officer” as any person in accordance with whose advice or instructions the directors are accustomed to act. In the case of Re Hydrodan (Corby) Ltd., the conditions necessary to determine whether a person is a shadow director were laid down. It must be proved that the person is not a director of the company, that he has provided instructions and directions to the directors in matters of management of the company, that instructions have been continually provided and that such directions have been intentionally adhered to on a regular basis.
The shadow director does not necessarily always exert control over the company in a clandestine manner and may even do so candidly. It was also clarified in the case of Buzzle Operations Pty. Ltd. v. Apple Computer Australia Pty. Ltd. that exercise of control in the manner of exerting commercial influence does not constitute shadow directorship.
The Companies Act, 1956 provided additional provisions for a shadow director that deemed him as a director, rather than an officer—Section 303(1) mandated companies to register the name of such an officer as a director in the Register of Directors and Section 307(10)(a) provided that shareholding by such directors had to be recorded with that of the regular directors. However, these provisions are lacking in the Companies Act, 2013.
Roles and Duties of a Shadow Director in the Company
Since the Companies Act, 2013 does not attribute the status of a director to a shadow director and instead defines him as an ‘officer’, he is not subject to the same duties and responsibilities as a director. As per the decision in Ultraframe (UK) Ltd. v. Fielding & Ors., a shadow director is not an actual statutory concept but rather a limited one.
It is much narrower than the statutory definition of a director and a shadow director is different from a de facto or de jure director. Therefore, a shadow director does not incur the same obligations as a director, nor does he wield the same powers. He has no fiduciary liability towards the company nor can he deal with its capital or assets. He is subjected to certain limitations—he must disclose his holdings of shares and debentures of the company, he cannot engage in any transfer of property or assets with the company and he is required to disclose his interests in transactions that he has advised the company to enter into, and he must incur liability for wrongful trading or insolvency. Similarly, a shadow director also does not exercise any legal powers in the company, like a veto over Board resolutions.
Provisions for Liability of a Shadow Director
Since the Companies Act, 2013 does not attribute the status of a director to a shadow director and instead defines him as an ‘officer’, he will not incur the same liabilities as a director. However, Section 2(60)(v) provides for the penal or pecuniary liability of an ‘officer in default’, who is someone in accordance with whose “advice, directions or instructions the Board of Directors of the Company is accustomed to act”, and doesn’t include persons who advice the Board in a professional capacity, like a Chartered Accountant or Legal Counsel. Such officers in default will incur liability in terms of imprisonment, fines or otherwise, regardless of their lack of an official position in the company.
Furthermore, Section 219(c) of the Companies Act, 2013 provides that an inspector appointed under the provisions of the Act for investigating the affairs of the company is also empowered to investigate any body corporate whose Board of Directors is accustomed to act in accordance with the instructions of the company or its directors.
Conclusion and Recommendations
The Companies Act, while providing for liability to be attached to persons who act like shadow directors, does not enumerate their duties, responsibilities and the consequences of breaching the same. By designating them the title of ‘officer’ rather than ‘director’, the Act makes them distinct from directors, resultantly exempting them from the duties and legal liabilities that directors are subjected to.
These lacunae in the regulatory framework is detrimental to the company, and most importantly, the shareholders of the company. Directors owe a fiduciary duty to shareholders and shadow directors are able to escape this duty and advise the Board in bad faith. There has however been a gradual move towards judicial recognition of shadow directors’ fiduciary liability.
Often, in private companies, it so happens that a shareholder having a majority shareholding will influence the decisions of the Board of Directors without actually having an official position in the company or being accountable to shareholders or the law. Shadow directors have to be reined in by making separate provisions to have them registered as Directors with the Registrar of Companies, and to include them as directors in the Articles of Association so that they are subject to the same liabilities as regular directors. The Companies Act has to enumerate the liabilities, duties and powers of such directors so that they don’t abuse their position to the detriment of others.