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:
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.
For more information about insolvency and reconstruction, please see the website of CBP Lawyers or email Peter Harkin at pjh@cbp.com.au.
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