Shadow directors are not just creditors indicating a preference

In brief – NSW decision helps define shadow directorship

A recent decision in Buzzle Operations (in Liquidation) v Apple Computer has clarified the criteria to be met for a lender, secured creditor or other third party to be considered a shadow director.

What is a shadow director?

A shadow director is a person (or it can be a company) whose instructions and wishes others within the company are accustomed to obeying. To be a shadow director, one must exclude any residual discretion in a board. In other words, the nominal directors must effectively be doing one's bidding.

This can have serious implications if the company is engaged in insolvent trading, because a director can be liable for insolvent trading.

Until recently, it was often considered possible for someone who is not listed as a director to be regarded as a shadow director. A recent decision in the Court of Appeal has clarified the position.

When can a secured creditor be a shadow director? 

In Buzzle Operations Pty Limited (in Liquidation) v Apple Computer Australia Pty Limited [2010] NSW SC 233, the court had to consider whether or not Apple, a lender in this instance, was a shadow director.

The Court of Appeal accepted that there can be instances in which a secured creditor may in fact be a shadow director if two criteria are met.

First, it had to be shown that the company's actual directors were deferring their decision making to the lender or some other third party.

Secondly, it had to be shown that the directors were taking important decisions, such as decisions to continue trading while insolvent, because of the lender's wishes or instructions.

In this particular instance, the court said that the fact that the secured creditor was indicating its preference did not of itself amount to the existence of a shadow directorship.

Directors free to accept or reject third party demands 

The Court of Appeal approved of the trial judge's findings that:

A person or company is not within the definition (of shadow director) merely because that party imposes conditions on his or her commercial dealings with a company which the directors feel obliged to comply. A lender who is entitled to demand repayment of a loan and appoint a receiver can say, for example, that it will stay its hand only if the borrowing company sells certain assets. A supplier or buyer might impose conditions because of its superior bargaining power, the directors of the company with whom it deals might feel they have no choice but to comply with those conditions imposed... Unless something more intrudes, the directors are free and would be expected to exercise their own judgment as to whether it is in the interests of the company to comply with the terms upon which the third party insists, or to reject those terms, if, in the exercise of their own judgment, they habitually comply with third party terms, it does not follow that the third party has given instructions or expressed a wish as to how they should exercise their functions as directors. 

Creditor not a shadow director if directors can make own decisions

It follows then that if the directors have an opportunity to make their own decisions without a metaphorical gun to their head, then a secured creditor or landlord or someone who has leverage over the company should not be considered to be a shadow director.

The only thing I would add to that is that there is always a caveat. The court talks about there being a need for "something more". Be careful. You never know when the pressure being applied might tip you over into that broad unspecific category.