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7-01-2020

Do Shadow Directors Assume All of The Duties of De Jure Directors?

simon-duncan

In restructuring and turnaround situations, banks are generally very careful not to find themselves in a situation where they could be pursued as shadow directors. This risk typically arises where the bank gives instructions to the directors of a debtor company and those directors breach their duties to the company carrying out those instructions.

In Standish & Others v The Royal Bank of Scotland Plc & Another [2019] EWHC 3116 (Ch) the High Court held that a bank that has been a shadow director of its customer will not be liable for breach of fiduciary duty unless the breach is linked to a specific instruction or direction given by the bank.

The facts

The claimants were shareholders in a company named Bowlplex Ltd (the “Company”), which owned and operated sixteen bowling sites across the UK. The Royal Bank of Scotland plc (the “Bank”) provided the Company with banking facilities.

The Company was referred in June 2010 to the Bank’s Global Restructuring Group, following the Company’s breach of its banking covenants.  As a result, the Company was introduced to West Register Number 2 Ltd (“West Register”), an indirect wholly owned subsidiary of the Bank, and West Register’s employee, Mr Sondhi. Mr Sondhi indicated that West Register wished to obtain an 80% stake in the Company in exchange for the continued support of the Bank.

The Company was subsequently restructured on two occasions. Under the first restructuring, West Register acquired 35% of the Company and the Bank agreed to a restructuring the Company’s indebtedness.  It was a condition of the first restructuring that West Register would be permitted to appoint an observer to attend the Company’s board meeting and a non-executive chairman.

West Register subsequently appointed a chairman with a background as a turnaround consultant. The Company then entered into a company voluntary arrangement under which the Bank wrote off £4.5 million of indebtedness and West Register increased its equity holding to 60%. Shortly thereafter, the chairman sacked the Company’s Managing Director and former majority shareholder.

Ultimately, the Company was sold and West Register was paid £13.6 million in respect of its shares.

The claim

The claimants alleged that the Bank and West Register conspired to obtain the claimants’ equity in the Company using unlawful means.  The unlawful means said to be at the root of this claim were put in various ways.   In particular, that West Register and/or Mr Sondhi breached the fiduciary duties to the Company that they had assumed as shadow directors.  In effect that they were acting in their own best interests, not those of the Company, contrary to Sections 172(1) and 175(1) Companies Act 2006.

It was not suggested that the Bank or Mr Sondhi were de facto directors.  A de facto director is a person who assumes to act as a director and is held out as such by the Company and claims and purports to be a director.

These claims had failed before Chief Master Marsh at first instance.  He held that the claim had no prospect of success and the proceedings were struck out. The main difficulty for the claimants was that the decisions taken by the directors were taken of their own free will.  The directors were not instructed to take specific steps as claimed, by West Register or Mr Sondhi.

The appeal

The claimants sought to further amend their particulars of claim to argue that as shadow directors, West Register and Mr Sondhi assumed all of the duties of a de jure director.  The basis of this claim was Section 170(5) of the Companies Act 2006.

The general duties apply to shadow directors where, and to the extent that, the corresponding common law rules or equitable principles so apply.

That would include the duty to act in the best interests of the Company.  For the purposes of the appeal, the Court was prepared to assume that West Register and Mr Sondhi were shadow directors.

Mr Justice Trower referred to the decision of David Richards J in McKillen v Misland (Cyprus) Investments Limited [2012] EWHC 521.  That decision noted that the duties owed by shadow directors are limited in extent. This was further illustrated by the fact that the status of shadow directorship can be acquired or imposed where the relevant instructions do not extend over all (or even most) of the company’s activities or affairs.

This approach was well established in the insolvency context before the enactment of the 2006 Act.  Reference was made to Morritt LJ’s judgment in Secretary of State for Trade and Industry v Deverell [2001] Ch 340 where it was said that it is not necessary for the shadow director’s influence to be exercised over the whole field of its corporate activities.

That being so, Section 170 CA 2006 cannot be read as imposing the full range of fiduciary duties owed by a de jure director on somebody simply because that person has acquired the status of shadow director.  Put another way, because the status of shadow directorship can be acquired through the giving of instructions that are limited to only some part of a company’s activities or affairs, there can be commensurable limitations on the nature and extent of the duties that they will thereby owe.

As a result the appeal was dismissed.

Significance

The alleged breach of duty must be linked to the instruction given by the shadow director.  Even if the bank has acted as a shadow director, and given instructions to the directors of the company, the Bank will not owe the same duties to the company as the de jure directors.  The bank can prefer its own interests.  Furthermore, the breach complained of must have resulted from a specific instruction. It is not enough to infer general commercial pressure or a broader interest in the progress of a board meeting or that the appointment of a turnaround consultant will suffice.

Note that the duties owed by de jure directors at common law and imposed by Section 170(1) of the Companies Act 2006 apply to de facto directors too who are therefore subject to the same duties.

There are few cases in which shadow directors fiduciary duties are considered. This follows from the previous decision of Lord Millet in Ultraframe that shadow directors owed no fiduciary duties to the company but likewise they could not avail themselves of the Section 1157 defence, now the relevant section.  Since the reversal of that by the Companies Act 2006, this case gives some clarification of the effect and ambit of that reversal.  Note that despite this judgment giving shadow directors some comfort, those assisting companies in distressed situations should still ensure that their actions to not expose them to liability. 

However, for those pursuing actions against shadow directors, the case emphasises the need to satisfy the evidential burden of proof to establish that a duty is owed to the company by the individual, it has been breached and a claim arises only if losses arise from that breach.

 

About the author:

Simon Duncan is a senior associate at Moon Beever LLP specialising in a wide range of litigation including commercial and insolvency litigation.

If you have any questions regarding the article or would like some advice, please contact Simon on sduncan@moonbeever.com.  

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