What is a shadow director? Definition and duties

When we think of directors of a company, we usually think of the people registered at Companies House. These are the people who have been formally appointed as directors of the company, and they make decisions on behalf of the company. They are known as ‘de jure’ directors, or registered directors.

However, you do not have to be registered as a director on Companies House to be a director of the company. You can assume certain responsibilities and be a shadow director or a de facto director.

In this article, we’ll look at how you may be deemed to be a shadow director, how to avoid that role if you do not want it, and how to manage your risks as a shadow director of a company.

What is a shadow director?

A shadow director is defined by section 251(1) of the Companies Act 2006 as “a person in accordance with whose directions or instructions the directors of a company are accustomed to act”.

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In other words, it is a person who habitually directs the board, and their input shapes company decisions, even without their formal appointment as a de jure director. To avoid confusion, a de jure director is often referred to informally as a ‘registered director.’ They are the same thing.

They can be:

• A shareholder who has considerable involvement in the company.
• An investor whose input carries weight in the business.
• A management consultant, if they take a particularly involved role in the business, including becoming a signatory on the company’s bank account and negotiating with third parties on the company’s behalf.
• A spouse who is particularly involved in the running of the business.

It all depends on the level of involvement that the person has in the business, particularly when it comes to making decisions on the company’s behalf.

What qualifies someone as a shadow director?

There is no all-encompassing tick-box exercise to determine if a person is a shadow director. It will depend on the particular facts at play.

Generally speaking, the factors that may indicate that someone is a shadow director include:

• They have real influence in decisions about the business
• The other directors listen to their directions and instructions and usually act on them
• They regularly attend board meetings

Overall, a shadow director is somebody who directs the company, and the company tends to act on those directions.

Can investors be shadow directors?

Yes, investors may be considered shadow directors if their directions and instructions are typically acted upon by the company’s directors.

However, just being an investor does not automatically make one a shadow director.

Can professional advisers be shadow directors?

When you look at the definition of a shadow director in legislation, you might think that professional advisers can become shadow directors. Lawyers and accountants are regularly advising the company, and the directors usually act in accordance with their advice.

However, section 251(2) of the Companies Act provides an exemption for this. It says that a person is not to be regarded as a shadow director by reason only that the directors act on advice given by him/her in a professional capacity.

In most cases, professional advisors will not be shadow directors. If they become more involved than they usually would and start assuming additional responsibilities within the business, then it may be possible that their role morphs into that of a shadow director.

What is a de facto director?

A ‘de facto’ director is literally a ‘director in fact.’ It is a person who has assumed responsibility as a director but has never been validly appointed. They are not registered as a director with Companies House.

It may be that the admin hasn’t kept up with the company’s evolution. In startups, longstanding employees may gradually take on director-level responsibilities, even if not formally appointed.

This can also happen in family businesses, when an adult child starts to take on more responsibility for the business.

Shadow vs de facto director: What’s the difference?

The main point of difference between a shadow director and a de facto director is that a shadow director does not generally hold themselves out to be a director (although this may not always be the case).

For all intents and purposes, a person dealing with a de facto director thinks that they are dealing with a registered director.

A shadow director, on the other hand, is more likely to be in the background in the company’s activities.

That said, the concepts are fairly blurred, and there is overlap between the role of a de facto director and a shadow director. It is even possible for a person to be both a shadow director and a de facto director at the same time.

Do shadow directors have legal duties?

A shadow director can owe the same statutory and common law duties to the company that a registered director does, although just being a shadow director does not automatically mean all duties and responsibilities immediately apply. Find out more about the role and responsibilities of directors.

This is why it’s important to know whether you are a shadow director. You have legal duties towards the company, and you can be personally liable if you are found to be in breach of those duties.

Shadow director responsibilities under the Companies Act

The general duties of directors (which are important for shadow directors to understand) are laid out in sections 171 to 177 of the Companies Act 2006.

The duties are to:

• Act within your powers
• Promote the success of the company
• Exercise independent judgment
• Exercise reasonable care, skill, and diligence
• Avoid conflicts of interest
• Not to accept benefits from third parties
• Declare interest in a proposed transaction or arrangement

Potential liabilities if the company becomes insolvent

If you’re a shadow director, you need to be aware of what might happen if the company becomes insolvent. Your statutory obligations extend to creditors once insolvency is likely or confirmed, as established under UK company law and common legal principles (such as wrongful trading). You need to think about the best interests of the creditors when you make decisions.

Once the company becomes insolvent, there will be a spotlight on the board to scrutinise the decisions that were made. As a shadow director, you could face the following liabilities:

• Liability for wrongful trading if the company continues while it’s insolvent.
• Personal liability for breach of duties. This means that you may have to account to the company for any loss of profit or benefit received as a result of breach of your duties.
• Disqualification proceedings. In the most serious cases, you could be disqualified from acting as a director or a shadow director again.

How to avoid being a shadow director

Given that shadow directors are held to the same standards as de jure directors, investors or consultants often seek to avoid the label.

To do that, the main thing to bear in mind is that you should not be seen as a decision-maker. In board minutes, you should be marked as “in attendance,” indicating that you are a non-voting guest or adviser. Those who are marked as “present” have voting rights.

If you are not a voting member, then that can act as evidence that you are not, in fact, a shadow director; you are simply an advisor, consultant, or investor.

You should document your role formally, in agreements and board minutes. Define your role carefully as an advisor without decision-making powers and then stay within those boundaries.

You can also go the other way and agree with the other directors that you should be a formal de jure director. This removes any ambiguity over your position.

How to reduce your legal risk as a shadow director

If you are seen as a shadow director in the company, the good news is that you can reduce your legal risk.

The best way to minimise risk is to comply with all your director’s duties. These essentially come down to good governance and acting in accordance with the articles of association and memorandum of association. So long as you act in the company’s best interests, you can limit your personal liability for decisions that didn’t turn out as you had hoped.

You should be fully versed on your duties to the company, and (again) document your role formally.

Understanding a shadow director’s real role

Being classed as a shadow director is not a problem in itself. You just need to be aware that you are held to the same standards as registered directors. You are assuming responsibility towards the company, and you can be liable for consequences if it goes wrong.

However, if you do not want these additional responsibilities or potential liabilities, avoid stepping into board-level involvement or influencing the company’s decision-making.

If you’re new to being a director or a shadow director, getting set up on the right terms helps you stay compliant from day one. At Rapid Formations, we help you formally appoint de jure directors and stay compliant with Companies House and HMRC requirements.