Australia: Spotlight on the Shadows: Shadow Directors in Australia
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1. Shadow Directors

The definition of director in the Corporations Act 2001 (Cth) extends beyond those whose names appear on the records of the Australian Securities and Investments Commission. The Corporations Act defines a director as:

(a) a person who is:

(i) appointed to the position of a director; or

(ii) is appointed to the position of an alternate director and is acting in that capacity;

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

(b) unless the contrary intention appears, a person who is not validly appointed director if:

(i) they act in the position of a director or the directors of the company; or

(ii) or body are accustomed to act in accordance with the person's instructions or wishes.

The general proposition is that a person is a shadow director if the directors are accustomed to act in accordance with their instructions or wishes. There are two exceptions to the general proposition:

• the person who, in the proper performance or functions attaching to that person's professional capacity, provides advice to the directors who in turn act on that advice; and

• a person who has a business relationship with the directors or the company and provides advice upon which the directors act.

A number of principles can be derived from case law considering shadow directors:

• there is a distinction between a de facto director (who acts as a director) and a shadow director (who may command the directors to act);

• a shadow director need not exercise influence over the whole field of a company's corporate activities;

• it will suffice if a governing majority (but not all) of directors are accustomed to act in accordance with the person's instructions;

• a de facto director can also be a shadow director; and

• a company can be found to be a shadow director.

2. Buzzle and Apple

The recent case of Buzzle Operations Pty Ltd v Apple Computer Australia Pty Ltd [2010] NSW 233 clarifies and refines previous principles regarding shadow directors. In this case the court considered specific conduct that may lead to an inference that a person or a corporation is a de facto or shadow director.

Buzzle acquired the stock and business of six retailers of Apple computer products (the Apple Resellers). Apple's consent to the merger was required because Apple held a charge over the assets of the Apple Resellers, which were transferred to Buzzle. Apple consented to the merger. Merger deeds were entered into and Apple and Buzzle entered into a reseller agreement. Buzzle granted a charge to Apple and the Apple Resellers gave guarantees to Apple of the liabilities of Buzzle. The parties entered into a payments deed whereby Buzzle agreed to restrictions on its ability to incur financial commitments and Buzzle was directed to make payments to Apple which Buzzle intended to make to another vendor.

Buzzle's business ultimately failed. Apple appointed receivers and later an order was made for the winding up of Buzzle. The Buzzle liquidators brought proceedings against Apple (and its finance director) pursuant to which the liquidator claimed (in addition to the non-validity of the charge) that Apple was a [shadow] director of Buzzle and in that capacity had failed to prevent Buzzle from incurring debts whilst insolvent. The liquidator also alleged that Apple had received payments characterised as unfair preference payments.

The court considered the conduct of Apple and found that Apple was not a shadow director. In reaching the judgement, the court considered the following specific examples of actions and instructions given by Apple to Buzzle:  

• Apple imposed conditions regarding which non-Apple products Buzzle could sell: The court found that this did not constitute the giving of an instruction (as to how the Buzzle directors should act in their capacity as directors). This action was no more than a third party seeking to negotiate the terms of a contract.

• Apple mandated requirements and conditions as part of the merger discussions (for example, as to which parties might be included in the merger and certain Apple payment arrangements). The court found that the requirements were not instructions to the directors as to management of Buzzle's affairs but were part of the commercial negotiation. It had been open to the Buzzle directors to agree or to decline those terms.

• Apple directed Buzzle regarding payments for debts owed by Buzzle to Apple. The court found that a creditor cannot be found to be a shadow director of its debtor solely due to a demand for payment of debts (which is met).

• Apple required Buzzle to provide it with financial reports and debt collection information. The court determined that Apple had a right to this information under the Buzzle reseller agreement. Furthermore, if Apple was not entitled under the reseller agreement, Apple was merely asserting Apple's commercial position and not instructing the directors of Buzzle. The court found that in any event, Buzzle had been attempting to generate this information and collect its debts, irrespective of Apple's demands.

• Apple's finance director was provided with an office at Buzzle's premises. The court determined that notwithstanding that the finance director devoted time to personally drive' certain matters, the directors of Buzzle had not become accustomed to act on Apple's wishes. The interaction by Apple's finance director was principally with certain Buzzle executives rather than the directors.

• Apple participated in interviewing and approval of appointment of the financial controller for Buzzle. The court found that the appointment of accounting staff was not a matter which was considered by Buzzle's board or a majority of directors. Buzzle employees implemented Apple's recommendations although this did not amount to evidence that Apple gave instructions on which Buzzle's directors became accustomed to act.

Justice White confirmed that there must be a causal connection between the alleged shadow director's instructions or wishes and the action taken by the directors. The directors must collectively be accustomed to act on that person's instructions or wishes, although it will be sufficient that the governing majority of the directors are so accustomed. These requirements were not satisfied in this case.

The court determined that instructions from Apple formed part of a commercial negotiation at arm's length. In his decision, Justice White observed that it is usual for a supplier or buyer such as Apple to impose conditions on a purchaser and, due to the supplier's superior bargaining position, the purchaser's directors might "feel" they had no choice but to comply with the conditions imposed.

3. Key Lessons

His Honour provided a number of useful guidelines as to what advice can be given and the level or type of influence exercised before such actions would be deemed to be those of a shadow director:

• a person or a corporation may be deemed as a shadow director if the directors of a company 'are accustomed to act in accordance with the person's instructions or wishes';

• a shadow director need not control all the directors of a company, only a governing majority of the directors, as this will in any event give him or her effective control over the company as a whole;

• it is not necessary that the instructions or wishes of a shadow director be given over the whole field of corporate activity for which the directors are responsible. A person or corporation may still be found to be a shadow director if their influence is limited to particular areas of corporate activity;

• a third party who has commercial dealings with a company will not be found to be a shadow director because they insisted on certain terms for their continued support of a company and those terms are accepted; even if there was habitual compliance over an extended period of time ;

• 'in accordance with' in these circumstances is understood to mean that the cause of action was the shadow director's instructions or expression of wishes; and

• de facto directors and shadow directors are treated differently under the Corporations Act. The former is one who acts as a director (without the title or appointment) whereas the later is one who commands other directors how to act. Both de facto and shadow directors have the same statutory liabilities as directors.

4. Conclusion

The Buzzle decision offers comfort and guidance to persons and companies which impose conditions or trading terms on another company or require certain standards of management. While it does not conclusively outline all the circumstances a person or a corporation will be held to be a shadow director, the decision provides a guideline as to the specific and special types of involvement with a company that could lead to a finding that a corporation was a shadow director.

Nevertheless, persons involved in decision making with a company should ensure that it is clear that any conditions, requirements or proposals are a matter of consideration by their own board. Justice White suggested that a clear statement that the relevant third party was not involved in the company's corporate decision making and simply attended meetings as an observer or adviser, which was not contradicted by actual conduct, may be of assistance in establishing the third party is not in fact a shadow director.

The liquidator appealed the decision and the parties await the decision of the appellate Court. Further clarification of the law may arise from the appeal.

5. Commentary

The effects of GFC in Australia and worldwide has seen increased participation by corporate lenders ("interference" or "interest") in the commercial activities of its customers. The widely reported restrictions on lending meant that many directors and senior managers involved their financiers in corporate activities in order to ensure that short to medium debt commitments were rolled over. This decision comes as a welcome relief to those financiers that their increased involvement due to stressed financial circumstances will not, in and of itself, support a finding of shadow directorship.

One final note of caution. The majority of directors' and officers' insurance policies do not provide indemnity for de facto or shadow directors. Moreover, a company that acts as a shadow director will be unlikely to receive the benefit of indemnity from its own directors' and officers' policy.

The Court's decision in Buzzle reinforces the doctrine of transparency when applied to corporate activities. Creditors and customers are entitled to know the actual parties making the decisions or pulling the strings in a company so that those customers and creditors can make informed decisions about their engagement with that company.

Truman Hoyle is a Sydney based law firm serving the new economy industries across the Asia Pacific region. Australasian Legal Business has recently ranked the firm's Telecommunications, Media & Technology and Intellectual Property practices as top-tier in Sydney. The firm was named Australian Law Firm of the Year in 2005 and again in 2006, for firms with 50 lawyers or less. In 2009 our firm was awarded the prestigious ACOMM Award for Professional Services Excellence at the annual Australian telecommunications industry awards.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.