Holding company directors – potential liability as director of subsidiaries?
Good Company October 2014 edition
- Corporate manslaughter cases in 2014
- Directors' personal guarantees
- Directors' duties in a third party fraud
- Holding company directors – potential liability as director of subsidiaries?
- Claiming for group losses
- The employee ownership business model
The Court of Appeal has recently considered whether a director of a holding company was liable to one of its subsidiaries for breach of fiduciary duties, despite not having been appointed as a director of the subsidiary company.
The fiduciary and other duties which a director owes to the company which appoints him apply equally to someone who has not been formally appointed but who nonetheless acts as a director (a "de facto director"). Company and insolvency law also impose liability on a “shadow director”, where the actual directors of a company are accustomed to act in accordance with the shadow director's directions or instructions. In the case of Smithton Ltd v Naggar, the Court of Appeal had to determine whether a director of a holding company was a de facto or shadow director of one of its subsidiaries.
The subsidiary was a joint venture, with the holding company owning just over 50 per cent of the shares and members of the subsidiary's management team holding the balance. There was a shareholders' agreement in place, which provided that the board of directors was to be made up of various members of the management team and three other directors nominated by the holding company. As is usual in joint ventures, the agreement also provided for certain information to be provided by the subsidiary to its shareholders, and for certain matters to be reserved for decision by the shareholders rather than by the board.
In the event, nothing much was discussed or decided at formal board meetings of the subsidiary. Important decisions were in fact taken informally by one of the management team and Mr Naggar, who was a director of the holding company but was not one of the holding company's nominees on the subsidiary's board.
The subsidiary entered into a number of contracts with people connected with Mr Naggar. It made a loss on those contracts, and brought a claim against Mr Naggar, alleging that he owed duties to it as a de facto or shadow director which he had breached in relation to the contracts. When the High Court dismissed its claim, it appealed.
The Court of Appeal referred to the leading case of HMRC v Holland, which concerned a number of trading companies which had another company as their sole director (the corporate director). In that case the Supreme Court decided that Mr Holland, who was a director of the corporate director, was nonetheless not a de facto director of the trading companies. He had acted only in his capacity as a director of the corporate director, even though he was involved in all the directorial decisions made on behalf of the trading companies.
The Supreme Court held that there was no one definitive test for a de facto director. The question is whether he was part of the corporate governance system of the company and whether he assumed the status and function of a director so as to make himself responsible as if he were a director.
Although there is no definitive test, in Smithton Ltd v Naggar the Court of Appeal noted a number of points arising out of the Holland case and earlier cases which are of general practical importance in determining who is a de facto director:
- A person may be de facto director even if there was no purported appointment which was for some reason invalid. The question is whether he has assumed responsibility to act as a director.
- To answer that question, the court may have to determine in what capacity the person was acting (as in the Holland case).
- The court will in general also have to determine the corporate governance structure of the company so as to decide in relation to the company's business whether the person's acts were directorial in nature.
- The court is required to look at what the director actually did and not any job title actually given to him.
- A person will not avoid liability if he shows that he in good faith thought he was not acting as a director. The question whether or not he acted as a director is to be determined objectively and irrespective of his motivation or belief.
- The court must look at the cumulative effect of the activities which are relied on as showing that a person is a de facto director.
- It is also important to look at the acts in their context. A single act might lead to liability in an exceptional case.
- Relevant factors include whether the company considered him to be a director and held him out as such, and whether third parties considered that he was a director.
- The fact that a person is consulted about directorial decisions or his approval is sought does not in general make him a de facto director because he is not making the decision.
- Acts outside the period when he is said to have been a de facto director may throw light on whether he was a de facto director in the relevant period.
The court then reviewed the High Court's findings on the allegations relied on by the subsidiary company against Mr Naggar. It agreed with the High Court that the subsidiary had not demonstrated that Mr Naggar was a de facto director.
The subsidiary claimed that the actual directors nominated by the holding company had simply acted as nominees of Mr Naggar since they took decisions to him for approval. It was, however, natural for those directors to consult him since they wanted group support for those decisions.
Mr Naggar was shown certain confidential information which would normally only be available to directors, but his interest in this information was justified by his position as a director of the holding company.
Mr Naggar had given instructions to the subsidiary's employees, but these were found to be readily explicable either on the basis of Mr Naggar's role as a client (on behalf of the people connected with him who were counterparties to the contracts with the subsidiary), or as a director of the holding company or because they were one-off incidents arising from a particular situation.
His role as client or holding company director also explained his involvement in making decisions about important aspects of the subsidiary company's business.
In conclusion, although Mr Naggar did not dispute that he had performed "directorial acts" in relation to the subsidiary, he had at all times acted in a different capacity from that of a director of the subsidiary. He was therefore not a de facto director. Further, on the basis that he was protecting his or others' interests in some other capacity, he was also not a shadow director.
The case is helpful both in relation to joint venture companies and to groups. Directors of investing or holding companies will not generally be held to be de facto or shadow directors of joint venture or subsidiary companies unless their actions go beyond what can reasonably be regarded as appropriate to their position as director of the investing or holding company. For joint venture companies, the management provisions of the shareholders' or joint venture agreement can also be helpful in ensuring that liability as a de facto director is avoided.
Jonathan Brooks is a Partner in Fieldfisher's Corporate Group in London.