In-House Lawyers as Shadow Directors- Managing Risk and Protecting Your Legal Role

In-House Lawyers as Shadow Directors- Managing Risk and Protecting Your Legal Role

In-House Lawyers as Shadow Directors: Managing and Protecting Your Legal Role

Paper presented by Hunt & Humphry at a seminar hosted by The Law Society of Western Australia, Perth, 2 March 2016

 

  1. Directors as organs of the company

Companies are of course inanimate entities and can only act through natural persons. Some functions are carried out by the shareholders and some by the company’s directors. The power of directors is usually derived from the company’s constitution.

As long ago as 1915 Viscount Haldane stated[1]:

A corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation.

Then later Lord Denning held[2]:

A company may in many ways be likened to a human body. They have a brain and a nerve centre which controls what they do. They also have hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind and will of the company, and control what they do.

The importance of the role of directors in the management led to the law imposing certain fiduciary obligations on those so acting. And so when a company runs into financial difficulties stakeholders such as shareholders, creditors and regulatory authorities start looking around for those responsible so as to extract a return or impose punishment. Obviously validly appointed directors are in the firing line. But who else may be liable?

  1. Definition of the word “directors”

A review of the historical definitions illuminates how the current definition is to be interpreted.[3] However cases on differently worded definitions must be approached with care.[4]

The Companies Act 1893 (WA) had no definition of the word “directors”. The definition of “director” first appeared in Western Australia in the Companies Act 1943 (WA):

“Director” includes any person occupying the position of director of whatever name called.

 The Companies Act 1961 (WA) defined the word “director” in this way:

“director” includes any person occupying the position of director of whatever name called and includes a person in accordance with whose directions or instructions the directors of a corporation are accustomed to act.

The Companies Act 1981 (WA), commonly known as the Companies (Western Australia) Code, defined director this way:

“director”, in relation to a corporation, includes –

  • any person occupying or acting in the position of director of the corporation, by whatever name called and whether or not validly appointed to occupy or duly authorized to act in the position;
  • any person in accordance with whose directions or instructions the directors of a corporation are accustomed to act; and
  • in the case of a foreign company …

The Corporations Law (Cth) provided a definition in section 60 (hence the reference in the cases to CL s60):

  • Subject to subsection (2), a reference to a director, in relation to a body corporate, includes a reference to:
    • a person occupying or acting in the position of the body, by whatever named called and whether or not validly appointed to occupy, or duly authorised to act in, the position;
    • a person in accordance with whose directions or instructions the directors of the body are accustomed to act;
    • in the case of a body incorporated or formed outside Australia:
      • a member of the body’s board;
      • a person occupying or acting in the position of a member of the body’s board, by whatever named called and whether or not validly appointed to occupy, or duly authorised to act in, the position; and
      • a person in accordance with whose directions or instructions the members of the body’s board are accustomed to act.
    • In the case of a close corporation – a member of the close corporation.
  • A person shall not be regarded as a person in accordance with whose directions or instructions:
    • a body corporate’s directors; or
    • the members of the board of a body incorporated or formed outside Australia;

are accustomed to act merely because the directors or members act on advice given by the person in the proper performance of the functions attaching to the person’s professional capacity or to the person’s business relationship with the directors or the members of the board, or with the body.

  • For the purposes of subsection (1), if there are no positions of director (by whatever name called) in relation to a body, the reference in paragraph (1)(a) to a position of director of the body is a reference to a position the holder of which has control, or shares control, over the general conduct of the affairs of the body.

The Corporations Act 2001 (Cth) now provides a definition in section 9:

director of a company or other body means:

  • a person who:
  • is appointed to the position of a director; or
  • is appointed to the position of an alternate director and is acting in that capacity;

regardless of the name that is given to their position; and

  • unless the contrary intention appears, a person who is not validly appointed as a director if:
  • they act in the position of a director; or
  • the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.

 

Subparagraph (b)(ii) does not apply merely because the directors act on advice given by the person in the proper performance of functions attaching to the person’s professional capacity, or the person’s business relationship with the directors or the company or body.

The first matter to note is that until the introduction of the Corporations Act 2001 the definition was an inclusive definition. That leads one to ask: what is the meaning of the word director in its ordinary meaning? It is suggested that because of the expansive definition that has grown over time the ordinary meaning must be a director is a person who has been validly appointed and continues to validly hold the office of director. The expanded definition then includes a person who has not been validly appointed or a person who has been validly appointed but ceases to be a validly appointed director. This may occur if he or she has not been validly re-elected[5] or he or she ceases to qualify to be a director.[6]

The second matter is that the earlier definitions refer to a person occupying the position of director. This is different to a person holding the position of director. As Mason J explained:[7]

To say that a person occupies a position or office is to say something more than that he holds the office. The first statement denotes one acts in the position, with or without lawful authority; the second denotes one who is the lawful holder of the office.

Thus a person who has been validly appointed and continues to be validly appointed as a director holds the position. On the other hand a person who is not validly appointed or having been validly appointed ceases to be so is said to occupy the position.

Thirdly it is to be noted that the concept of a person occupying the office of a director was introduced in 1943. This type of director is colloquially known as a de facto director. The concept of a person in accordance with whose directions or instructions the directors of a corporation are accustomed to act was introduced in 1961. This type of director is colloquially known as a shadow director.

In summary there are three types of directors. The first is a validly appointed director, the second is a de facto director and the third a shadow director.

This paper concentrates on the concept of a shadow director.

  1. Directors validly appointed

Usually there is not much doubt that those who have been validly appointed as directors will be directors for the purposes of the Corporations Act 2001.

The listing of a person in the ASIC database as a director constitutes proof of that fact unless the contrary is established: s1274B Corporations Act 2001. In Kocic v Deputy Commissioner of Taxation [2011] NSWCA 322 the New South Wales Court of Appeal agreed that the trial Judge was correct in determining that the appellant had failed to establish that he had not been appointed as a director of the relevant company.[8]

  1. De facto directors

 A person may be considered as a director if he or she is engaged in the company’s affairs. In Mistmorn Pty Ltd (in liq) v Yasseen (1993) 14 ACLC 1387; 21 ACSR 173 at 182, Davies J said this:

In all these ways, Mr Yasseen involved himself in the affairs of Mistrom as only a director of the company would have been expected to do. I do not say that he held himself out to be a director, for, as I have said, I think he intended not to be a director, but he dealt with the matters one would expect a director to handle.

The first observation that can be made from those words, and the cases generally, is the subjective view of a person is not relevant. It did not matter that Mr Yasseen did not want to be a director. The test is an objective test.

The second observation is that in attempting to prove that a person is, or was, a de facto director one will have to lead evidence of the acts carried out by the person that one would expect a director would handle. Thus in Yasseen the liquidator of Mistmorn led evidence of such things as Mr Yasseen negotiating a lease for the company, lodging a development application of premises, obtaining insurance for the company, arranging for fitting out of the company’s shop premises, arranging printing of promotional material for the company and arranging for the local mayor to open the shop premises. In Deputy Commissioner of Taxation v Austin (1998) 28 ACSR 656 the Deputy Commissioner lead evidence of Mr Austin’s dealings with the tax officer that gave the impression that he was in charge of the company, his signing of company cheques and his dealings with other creditors.

In this regard it is important to bear in mind that the type of activities that the person exercises must be “what might be called the actual (and statutorily extended) top level management functions”[9]. However this will depend on the size of the company or “will vary with the commercial context, operations and governance structure”: Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6 at [66].  It is dangerous to attempt to describe what activities may be relevant. For example, the negotiating of a lease of premise may be indicative for a small proprietary company but not for a large multi-national where such a task would usually be carried out by a subordinate.

It is not necessary to show that the person performed duties that could only be performed as a director.[10]

What is clear is that there is no one single decisive test of when a person will be found to be a de facto director.[11]

There may be scope for an in-house counsel to be considered as a de facto director but this paper focuses on the concept of a shadow director and how in-house may be considered to be a shadow director.

  1. Shadow directors

 The term “shadow director” does not appear in any of the company’s legislation that has applied in Western Australia. It is a term borrowed from the English Insolvency Act 1986.

A person may be considered a shadow director, and hence a director for the purposes of the law, if the directors of the company are accustomed to act in accordance with the person’s instructions or wishes.

In Australian Securities Commission v AS Nominees Ltd[12] Finn J made a number of findings of fact in relation to a Mr Windsor and then found that he was a shadow director. His Honour concluded:

Given the findings I previously have made, I conclude that Windsor has exercised control over the affairs of ASN and Ample. However that control has been primarily of a strategic character and, of recent times, increasingly so as he has pursued off-shore dealings. Nonetheless, that control has defined the context in which the companies have operated. It has contrived the transactions of significance in which they were to be involved. In my opinion it cannot be said that in those matters in which Windsor intruded, the boards of either company exercised an independent role at all. The first Fawkner Centre transaction is the Ample board’s testament to its servility. The Securities and Constant loans, to the pliability of both boards.

When one looks to the aggregate of the transactions analysed it cannot properly be said that the case is merely one of directors acting on the advice of a manager in the proper performance of his duties; CL s 60(2). What so often was asked of, and conceded by, the boards was either to act partially towards Windsor or to act in ways which, in furthering his designs; required the dereliction of their own, and of their trust company’s, duties.

In these circumstances it can and should be found that Windsor is a director of both ASN and Ample as a result of s 60. This finding does not, in my opinion, require it to be shown that formal directions or instructions were given in those matters in which he involved himself. The formal command is by no means always necessary to secure as of course compliance with what is sought. There is no reason to construe the section so as to deny this; cf CL s 109H. The idea of the section, as Wells J noted of its predecessor in Harris v S (1976) 2 ACLR 51 at 64, is that the third party calls the tune and the directors dance in their capacity as directors. This aptly describes Windsor’s role.

As Finn J observed it is not necessary that the influence extend to all board decisions. However it seems to me that there must be some number of directions or instructions that the board has followed to give the word “accustomed” some work to do. It is difficult to imagine that if the board followed one direction of a person that it could be said that the board was “accustomed” to act in accordance with the person’s instructions or wishes. Thus by reference to the Oxford Thesaurus, Chesterman J was of the view that for the definition to be satisfied the board must habitually, or routinely, regularly or commonly have acted in accordance with the wishes of the shadow directors.[13]

It is not necessary that there be directions or instructions embracing all matters involving the board.[14]

  1. Company Secretary and General Counsel

For completeness it is desirable to consider the High Court’s decision in Shafron v Australian Securities Commission.[15] That case arose out of a prosecution by ASIC of, inter alia, the company secretary and general counsel of James Hardie Industries Ltd surrounding the establishment of a fund intended to compensate victims of exposure to asbestos supplied by James Hardie.

Before the High Court Mr Shafron sought to distinguish his responsibilities as a company secretary, in which case he would be an officer for the purposes of section 9 of the Corporations Act 2001 (Cth) and liable under section 180(1) for failing to exercise his powers and discharge his duties with care and diligence, and his responsibilities as general counsel. In the course of the plurality’s reasons, their Honours said this[16]:

In this case, Mr Shafron’s responsibilities were found by both the primary judge and the Court of Appeal to have included the tendering of relevant advice (including legal advice) about disclosure requirements. As the Court of Appeal rightly said:

“A company secretary with legal background would be expected to raise issues such as potential misleading statements (in relation to the draft ASX announcement) and disclosure obligations (in relation to the DOCI) with the board. Ordinarily it might not be the same with respect to a matter such as the JHIL cash flow modelling, which required particular expertise. But Mr Shafron had a quite close involvement with the cash flow modelling, and raising the limitations of the cash flow model [based on the material Mr Shafron had obtained from Trowbridge] is by no means a legal matter for the attention of general counsel; the involvement, and raising the limitations, in our view fell within Mr Shafron’s responsibilities as company secretary. (emphasis added)

That is, Mr Shafron’s “responsibilities within the corporation” extended to the several subjects identified. Once it was found that his responsibilities extended to those subjects, the question became whether Mr Shafron undertook those responsibilities with the requisite degree of care and diligence. (footnotes omitted)

The High Court summarised Mr Shafron’s submission that his obligation of care and diligence was limited to performance of those responsibilities that attached to the office as company secretary without regard to any powers or duties as general counsel. Thus if there was a lack of care and diligence in his role as general counsel, and not as company secretary, he could not be liable under section 180(1) of the Corporations Act 2001 (Cth). The High Court did not accept this argument and the plurality held[17]:

The proposition that some distinction could be drawn between the “capacities” in which certain tasks were undertaken by Shafron assumed, wrongly, that the work he did “as company secretary” could not, and did not, overlap with the work that he did “as general counsel”. It is greatly to be doubted that the tasks that Mr Shafron undertook could be divided in this way. That may be reason enough to reject this aspect of Mr Shafron’s argument (although there are other, more fundamental, reasons to do so).

As Heydon J remarked[18]:

It is not possible to sever Mr Shafron’s responsibilities into watertight compartments, one marked “Company Secretary” and the other marked “General Counsel”.

So if you, as a legal practitioner, hold two roles within an organisation including a role which may render you an “officer” for the purposes of the Corporations Act 2001 (Cth) it is going to be very difficult to escape liability for lack of care and diligence by saying I carried my responsibilities out in that regard as counsel and not as an officer.

  1. Practical Tips

 Consider whether you should be company secretary

The company secretary of a company is an officer of the company[19] and may contravene section 188 of the Corporations Act 2001.

The company secretary is deemed to have contravened various sections of the Corporations Act 2001 (Cth) if the company has contravened those sections.[20] These mainly deal with the lodgment of reports and notices required to be lodged under the Act.

When being engaged by a corporation essentially in a legal role it may be appropriate to initially refrain from agreeing to being appointed as a company secretary. It is advisable to commence employment in the legal role and after “testing the water” to later take up the appointment. Of course this is going to be difficult if the role advertised includes company secretarial duties. If an immediate appointment cannot be avoided it is suggested that a thorough due diligence of the financial position of the potential corporate employer is warranted.

Employed or Independent Contractor

It may be possible to limit any personal exposure by contracting one’s services to a corporation through a corporate entity.

Although your corporation may be considered to be a shadow director[21] it may make it just that little bit harder to establish that you, personally, were a shadow director.

However it must always be borne in mind that this has other consequences such as any undertaking that may be given to the Legal Practice Board in relation to Professional Indemnity Insurance.

Responsibilities

The extracts from Shafron above note the importance of properly identifying your responsibilities within an organisation. This is important not only from a liability point of view but also from an organisational structure perspective and a remuneration perspective.

Obviously the most important time to clearly delineate one’s responsibilities is at the commencement of employment. However that is not to say this should be done on the first day in the office. Rather it should be explored at the time of interview and incorporated in one’s employment contract.

I appreciate that there is a balancing act between pressing a point in an interview and negotiations and that you are less likely to do so the more anxious you are to “get the job”. However there is a need to have clearly defined responsibilities rather than just accepting an appointment as “in-house counsel”. Certainly the more senior roles require clearly defined responsibilities to be expressly stated.

Responsibilities also change from time to time. There is a need to review your list of responsibilities from time to time. In properly structured organisations it would be appropriate to review you list of responsibilities at your annual performance review. This will be particularly helpful in terms of remuneration if your responsibilities have markedly increased in the year.

Separate Filing System

A properly constituted legal department within an organisation will have its own filing system, both in hard copy and electronically. The larger the organisation, the more easily this will be able to be achieved.

This is important in terms of confidentiality, privilege and waiver of privilege.

The more ‘independent’ one can appear the less likely the advice provided will be considered to be other than professional advice or advice the directors are accustomed to act in accordance with.

Memos to immediate superior and not the board

Consideration should be given to how you formulate your advice. If your terms of engagement do not require a direct reporting obligation to the board of directors, your advice should not be directed to the board but to your immediate superior, such as the chief executive officer. It will then be for your immediate superior to consider your advice and perhaps other advice (in the nature of technical, accounting, tax or human resource advice) and report to the board.

If this approach is followed it is less likely that you will be considered to be a person whose advice will be considered to be advice the directors are accustomed to act in accordance with.

Opinions and Advice

If you are reporting to the board, you may consider noting in any advice that the advice is your opinion and /or advice but the directors, as directors, must exercise your own judgment on what action to take.

Strength or character of the members of the board

Ultimately the strength of character of a chief executive officer or members of the board will determine the risk profile you will have to accept. A person with a strong or dominant character will invariably attempt to exert influence. There will be a balancing act between wanting to follow the board’s wishes and remaining independent.

My advice is to be true to yourself and keep your reputation intact.

Tim Kavenagh

Hunt & Humphry

Perth

2 March 2016

 

[1] Lennard’s Carrying Co Ltd v Asiatic Petrol Co Ltd [1914-15] All ER Rep 280 at 283.

[2] HL Bolton (Engineering) Co Ltd v TJ Graham & Sons Ltd [1956] 3 All ER 624 at 630.

[3] Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6 at [34].

[4] Morley v Australian Securities and Investments Commission [2010] NSWCA 331; (2010) 274 ALR 205 at [887] and Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6 at [45].

[5] For example, if the person was initially appointed to fill a casual vacancy but at the following annual general meeting did not stand for election.

[6] For example, if the person ceased to hold a share in the company when the constitution required such.

[7] Corporate Affairs Commission v Drysdale (1978) 141 CLR 236 at 242; (1978) 3 ACLR 760 at 764.

[8] An application for special leave to appeal was dismissed: Kocic v Deputy Commissioner of Taxation [2012] HCASL 59.

[9]           Deputy Commissioner of Taxation v Austin (1998) 28 ACSR 565, per Madgwick J at 569-570.

[10]         Deputy Commissioner of Taxation v Austin (1998) 28 ACSR 565, per Madgwick J at 569 and at 572.

[11]          Grimaldi v Chameleon Mining NL (No 2) [2012] FCAFC 6 at [60].

[12]          (1995) 62 FCR 504, 133 ALR 1; 18 ACSR 459 at 509; 13 ACLC 1822

[13]Emanuel Management Pty Ltd v Foster’s Brewing Group Ltd (2003) 178 FLR 1; [2003] QSC 205 at [265].

[14] Australian Securities Commission v AS Nominees Ltd (1995) 62 FCR 504, 133 ALR 1; 18 ACSR 459; 13 ACLC 1822.

[15] [2012] HCA 18; (2012) 247 CLR 465.

[16] At [20].

[17] At [11].

[18] At [41].

[19] Section 9 Corporations Act 2001.

[20] Section 118 Corporations Act 2001.

[21] Buzzle Operations Pty Ltd (In Liq) v Apple Computer Australia Pty Ltd [2010] NSWSC 233 at [231].

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