WHO IS A SHADOW DIRECTOR?

In the times following the judgment in the case of Republic v. Ibrahim Adam & Others (FT/MISC 2/2000, 28/4/03), also known as the Quality Grain Case, the issue as to who is a shadow director of a company came up for discussion with some considerable difference of opinion. The judge had referred to Professor Mills, then the immediate past Vice-President of Ghana, and Ghana’s current President, as a shadow director of the Quality Grain company. The Professor was not amused. At the time, it appeared that prior to this decision, the term ‘shadow director’ had not been discussed in any relevant Ghanaian statute, decided case or legal literature, save a brief mention in an article by one Dr. Mweda Kenneth Kaoma on Zambian law but published in [1996-1999] Vol. XX University of Ghana Law Journal. The humble purpose of this piece when I first had it published in the Ghanaian Times was to attempt to shed some light on the concept of ‘shadow directors’ with the view of informing that debate.

Directors
In law, a company is known as an artificial entity, the persona ficta. As an artificial person (as opposed to a natural person) the company can only act by agents. Usually, the persons by whom a company acts and by whom the company’s business is carried on and superintended are called “directors”. Section 179 of Ghana’s Companies Code therefore defines a director as any person who is “appointed to direct and administer the business of the company.” This section constitutes the Board of Directors into the supreme and original authority in matters of regular business management. Directors are the chief administrators, and have invested in them, by law, the power and duty to manage and superintend the ordinary business of the company. Under section 137(4) of the Companies Code, the directors are not servants to obey directions and orders given to them by the shareholders, although the management and control of the company are entrusted to the directors for the benefit and protection of all the shareholders.

Definition & Scope
By virtue of having such wide powers entrusted in them, section 179 of the Companies Code imposes on directors a duty not to act on the directions or instructions of any other person. However, the reality is that in some situations directors are subject, or allow themselves to be subjected, to the exercise by another people of considerable control and authority over the company and its business and affairs. The effect of this is that while the law holds directors personally liable for their acts and decisions, those acts or decisions may in fact be dictated, imposed or controlled by some other person who has not been appointed as a director but who, through some means (e.g. a controlling shareholder or even the government) is the driving force behind the company and the acts of the directors. Directors who allow such a state of affairs are in breach of their duties as directors.

But the law, not being blind to the existence of such a state of affairs and frowning upon the existence of shadow directors, provides under section 179 that a person “on whose directions or instructions the duly appointed directors are accustomed to act” is subject to the same duties and liabilities as a duly appointed director. Note that the law does not say that the person also has the same rights of a director. What it does is to impose on him a director’s “duties and liabilities”.

Further, the Companies Code does not expressly call such a person by the name “shadow director;” but that is the name by which such persons are generally called in Company Law. A shadow director is therefore not a director properly so-called. He does not have the rights of a director, and is an interloper in the affairs of the company. But the law recognises his existence and imposes upon him the duties and liabilities of a director by virtue of his control over or domination of the directors of the company.

The fact is that a shadow director does not claim or purport to act as a director, and the company does not hold him out as a director. He rather lurks in the shadows and shelters behind others who are the duly appointed directors. The generally accepted test in ascertaining whether a person is a shadow director is as follows:(1) Who are the directors of the company?(2) Did the ‘third party’ direct those directors how to act in relation to the company?(3) Did the duly appointed directors act in accordance with such directions?(4) Were the duly appointed directors accustomed so to act?

Accordingly, central to a determination as to whether a person is a shadow director is, first, there is a board of directors claiming and purporting to act as such; and, second, there is a “discernible pattern of behaviour” in which the board did not exercise any discretion or judgment of its own, but acted in accordance with the directions of the third party. If these are answered in the affirmative, then that third party is a shadow director. Accordingly the definition of shadow director presupposes that there is a board of directors who act in accordance with instructions from someone else, the èminence grise (literally the “wise old man.”) Another appropriate illustration of a shadow director is that he is, in effect, the puppet master who controls the actions of the board, and the directors are his ‘cat’s paw’.

“Accustomed to act”
The use of the phrase “accustomed to act” in section 179 would also suggest that the directors must be people who act on the directions or instructions of the shadow director as a matter of regular practice. It therefore applies to instances where the third party is shown to issue instructions and directions, and the directors are shown to comply with such, as a regular course of conduct over a period of time. Reference must therefore be made, not to acts on an individual occasion, but over a period of time and as a regular course of conduct. Simply put, a one-off instruction and compliance will not satisfy the “accustomed to act” criterion.

However, it is not necessarily required that there be directions or instructions embracing all matters involving the board, or extend over all or most of the corporate activities of the company. It is also not necessary to demonstrate a degree of compulsion in excess of that implicit in the fact that the board was accustomed to act in accordance with them. Rather it only required that as and when the directors are directed or instructed, they habitually and regularly obey and act accordingly. The idea is that the third party ‘calls the tune’ and the directors ‘dance’ in their capacity as directors. It is therefore sufficient to show that the duly appointed directors had cast themselves in a subservient role or surrendered their discretions in the face of the directions or instructions. What is important is that the third party is shown to have exercised real influence in the corporate governance of the company, and the key question is: Where, for some or all purposes, is the locus or place of effective decision-making? If the answer to this question is a person other than the board of directors, then it is open to find that that person is a shadow director.

Illustrations
Directors of Parent Companies: Flowing from the above discussion, it has been held that the directors of a parent company per se would not make themselves shadow directors of the subsidiary if they act in their capacity as the board of the parent so as to give instructions to the directors of the subsidiary. However, individual and personal instructions from a director of the parent to the directors of the subsidiary could bring that director within the definition of a shadow director.

Creditors: In one English authority, the activities of the company were financed by a loan. The security for the loan was a 125-year lease of the company’s premises, which the creditor then leased back to the company. The rent payable was to be used to amortise the loan. Subsequently the company became insolvent and could not pay the rent. Thereupon, weekly management meetings were held between the managing director of the company and officers of the creditor with a view to rescuing what the creditor could out of the company (e.g. making terms for the continuation of the credit in the light of the threatened default). It was held that the officers of the creditor were merely defending the creditor’s interests and imposing terms for the protection of those interests. That did not constitute them into shadow directors, especially when it was clear that the directors of the company were quite free to take the offer or leave it.

Conclusion
Section 179 of the Companies Code constitutes statutory recognition that effective legal control over the central management of companies requires restrictions that may extend beyond the regulation of those formally appointed by the company as its directors. The law disapproves of the existence of such a person, who, not having been appointed as a director, yet becomes one on whose instructions and directions the directors are accustomed to act. It therefore provides that directors have a duty not to obey such third parties, and imposes the duties and liabilities of a director such third parties.

To be able to make a conclusive finding that a person is a shadow director of a company it may be ascertained that there is a discernible pattern of behaviour or a relevant regular course of conduct over a period of time that supports the conclusion. It may also be shown that the directors have cast themselves in a submissive and compliant role or given up their discretions in the face of the directions or instructions.

In sum, the answer to the question, “who is a shadow director?” lies in yet another question, to wit, “who is the effective corporate decision-maker?” There are no problems if the answer to this question points to the Board of Directors. However, if the answer directs us to a person other than the Board, i.e. a third party, that third party is a shadow director – the èminence grise, (in normal Ghanaian parlance the “BIG MAN”); and that person is subject to all the duties and liabilities (but not the rights) of the duly appointed directors.