Shadows of pe

What is a shadow director?

As previously discussed in our Talking Business blog post, if the directors of a company are accustomed to act in accordance with someone else’s instructions, that person will be a ‘shadow director’.

A shadow director may be someone who is openly involved in managing a company or someone who lurks ‘in the shadows’ behind the scenes.

The courts will take a wide definition of who might be a ‘shadow director’. It is enough that the shadow director has a real influence over the company’s affairs, and that the majority of the board acts on their instructions over a period of time.

What would make a lender a shadow director?

Banks and other lenders do not normally have a role in the management of a company. Where a company begins to have financial difficulties, however, lenders often step in to take a more active role.

If the lender is simply setting conditions for its continued financial support, problems are unlikely – the directors can exercise their own judgment about whether to comply.

Shadow directorship is more of a concern if the lender is actually making decisions for the directors, or the directors are letting the lender’s wishes substitute for their own judgment.

The court considered in one case[1] whether a lender had become a shadow director of one of its borrowers. In that case, the lender’s representatives had attended weekly management meetings of the company, and the lender had exercised a veto over which payments the company would make. However, the lender was found to have been acting within its role as a secured creditor, and not as a shadow director.

What happens if a lender is found to be a shadow director?

Shadow directors are subject to various duties and requirements, in the same way as  any director. As a lender’s shadow directorship is most likely to arise where a company is having financial problems, the potential for a claim against the lender by a future liquidator will be of most concern.

For example, the burden of proof in relation to preference claims will be reversed by the lender’s shadow directorship. If the company took any action before liquidation which put the lender in a better position, the lender would have to prove that the company did not intend to do so.

If the lender became aware that the company had no reasonable prospect of avoiding liquidation, a liquidator might also bring a claim for wrongful trading against it as director. This could force the lender to contribute to the insolvent company’s assets.

What should lenders do?

Realistically, no lender has yet been considered a shadow director in any reported English case. However, the potential consequences should encourage caution. The lender should make clear that any conditions or recommendations it presents are for the board to consider at their discretion, and not instructions which the lender can dictate.

[1] Re PFTZM Ltd (in liquidation) [1995] BCC 280

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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.