What is a De Facto Director? Why does it matter?

A company is unlikely to know that it has a de facto director until there is a problem, often involving company litigation or proceedings against the individual who is alleged to be a de facto director.

In this article, our corporate solicitors look at the definition of a de facto director and analyse the recent court case of Aston Risk Management Ltd v Jones & Others (Rev1) [2023] EWHC 603 (Ch) (20 March 2023).

We offer some helpful tips on avoiding the accidental ‘appointment’ of a de facto director.

What is a De Facto Director?

Companies formally appoint directors (directors in law) but an individual can inadvertently become a company director. A de facto director (a director in fact) is a person who assumes the responsibility of a director without formal appointment by the company.

However, even without a formal appointment, a de facto director has the potential to cause reputational damage to the company and to any company where the person is a director in law.

A de facto director has the same statutory director’s duties, authority, and powers to bind a company as a formally appointed director in law. Accordingly, a de facto director can be found to be in breach of their statutory duties under the Companies Act 2006 and held to be personally liable for their breach of duty.

De facto directors create confusion about the company’s decision-making structure and who has the authority to bind the company.

There is no single test for identifying a de facto director. In the Aston Risk Management case, the Court considered various factors to decide if an individual was a director or not.

How is a De Facto Director created?

To avoid the risk of a person being held by the Court to be a de facto director, it is important to have an understanding of the outcome for Lee Jones (LJ) in the case of Aston Risk Management Ltd v Jones & Others.

LJ was a director of a holding company but he was not formally appointed as a director in its subsidiary company. The High Court held that he was a de facto director of the subsidiary because of his significant involvement in its operational management.

Although a shareholders agreement was drawn up setting out how the holding company and the subsidiary would conduct their business, LJ became increasingly involved in its day-to-day operations. For example, LJ led negotiations and issued instructions, often convening and holding management meetings on behalf of the subsidiary.

The High Court found that LJ was part of the subsidiary’s corporate governance system, that he had carried out functions that only a director could perform, and he was the dominant personality in the business behind the day-to-day decision-making.

The activities of LJ passed by unremarked until the subsidiary company went into administration. It was argued that LJ was a de facto director of the subsidiary company and in breach of his statutory duties. LJ contended that he had acted in his capacity as a director of the holding company and not as an individual director of the subsidiary.

The Court found that LJ was a de facto director of the subsidiary because of his actions. For example, attending management meetings of the subsidiary and appointing lawyers on its behalf in connection with the administration.

The Court reiterated three important principles from the  case of Smithton Ltd v Naggar [2014] EWCA Civ 939 (10 July 2014), namely a de facto director:

1. Assumes the status of a director and becomes responsible as if a director;
2. Is part of the corporate governance system of the company;
3. Is someone who may have individual or shared ultimate control of the management of a company’s business.

LJ’s belief that he was not a de facto director was of limited relevance as the Court applied an objective test to determine his status. However, a Court is more likely to find that someone is a de facto director if they hold themselves out, or the company holds them out, as a director and third parties consider the person to be a director.

The outcome in Aston Risk Management Ltd might have been different if the Court had found that the holding company was a corporate director of the subsidiary and therefore had its own legal role in the corporate governance of its subsidiary.

Avoiding the appointment of De Facto Directors

It is in the interests of both the company and the individuals concerned to avoid an individual becoming a de facto director.

From the individual’s perspective if they become drawn into the operation of a company they may end up with personal responsibilities and liabilities and face the penalty of director disqualification.

Tips for avoiding de facto directors include:

1. Create and follow a clear corporate governance structure and ensure that decisions are taken at board meetings with minutes of the board meeting recorded;
2. In the event of a holding company, ensure that the directors of the holding company have a limited right of approval in the subsidiary and only non-operational involvement in the subsidiary;
3. Authority should be clearly defined with no ambiguity over roles or titles of senior management. Referring to an employee as a director as part of their job title and giving them the authority to sign contracts may inadvertently give the impression that a senior manager is a company director. Ensure that third parties are aware that an individual is not a formally appointed company director in law.

How can Morr & Co help?

If you have any questions or would like any further information on the content of this article, please do not hesitate to contact our Corporate & Commercial team on 01737 854500 or email info@morrlaw.com and a member of our expert team will get back to you.

Disclaimer
Although correct at the time of publication, the contents of this newsletter/blog are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. Please contact us for the latest legal position.