A shadow director is someone who, although not formally appointed as a director, effectively 'calls the shots' for a company. This could be somebody who is either openly involved in managing a company’s affairs or someone who is lurking, less obviously in the background – in the shadows.
This piece looks at the potential ways in which a lender could be deemed to be acting in this way. But do not fear – there are ways to minimise the risk of this happening, so read on…
How may a lender be at risk?
If a lender finds that it is making decisions for a company’s directors, or that the directors are allowing their own judgment to be clouded by the lender’s preferences, there is a risk that the lender may be classed as a shadow director.
A director has a range of duties and responsibilities towards a company and a shadow director is also subject to these. The main concern for anyone found to be a shadow director is that they become open to a potential claim by a liquidator if the borrowing company does not recover from its financial problems and the directors have caused or contributed to these.
Banks and other lenders do not usually have a role in the management of a company but, if a company enters into financial difficulties, a lender may step in and take a more active role to protect its own position. If a lender is merely setting conditions for continued financial support, it is unlikely that it will be deemed to be acting as a shadow director provided the company’s directors can still exercise their own skills and judgment in deciding whether to comply. It will become more problematic where a lender begins to make decisions for the directors or if the directors allow the lender’s decisions to substitute their own judgment.
If a liquidator’s claim is successful, the shadow director lender may be required to contribute to the insolvent company’s assets. So, for example, if the company took action before its liquidation which put the lender in a better position (i.e. gave it preference), the shadow director lender would be required to prove that this was not intended. This is contrary to the usual position where it is for the liquidator to show there has been an unfair preference, not for the lender to show there has not.
In addition, if the shadow director lender had become aware that there was no reasonable possibility of the company avoiding insolvent liquidation and failed to take every step to minimise the losses of the company’s creditors, the liquidator could also bring a claim for wrongful trading against it as a director.
What can a lender do to avoid this?
Realistically, it is unlikely a lender would be found to be a shadow director, however, the potential consequences encourage taking sensible precautions.
Avoid attending board meetings. If the lender believes it has to for some reason then it should make clear that it (or its representative) is only there as an observer. The lender should not take part in making any decisions on behalf of the company.
If the lender wants the company to take certain steps then it should make clear that these are not instructions to the directors but an outline of the lender’s conditions that it needs satisfied if it is to continue lending. The conditions should be based on protecting the lender’s position only. Ideally the directors would take independent professional advice when considering whether or not to accept the conditions.
A well-meaning desire to be helpful can be a risk. Make clear in any correspondence with a borrower in difficulties that you are considering your position as lender only and that your intention is not to make any decisions or give instructions to the company.
If you need further advice in respect of this, please get in touch.