Secretary of State for Trade and Industry v. Deverell and anr. case

Introduction

The case was decided in 2001. The Judgement was given by Learned Judge Morritt. The present company statutory rule imposes a number of responsibilities and duties on the Directors and lay down certain rules for them to adhere to, that broadly speaking, set certain limitations and checks on their acts as Company directors and regulate issues and disputes between the company’s interests and their personal interests. In case, these limitations are breached, the Directors are held personally liable for any loss that the company incurs on account of the acts of the Directors and may be disqualified from being a Director and may even, in certain cases, face criminal prosecution. It has to be kept in mind that these rules and limitations are applicable only to the formally and legally appointed Directors of the Company i.e. the “de jure Directors”. It is easy to identify the de jure directors as they are appointed through a proper formal procedure. The difficulty lies in identifying the de facto and shadow directors, especially while differentiating between them and those who contribute in the company’s business. The Court of Appeal in of Secretary of State for Trade and Industry v Deverell[1], throws light on the present and prior interpretation of the statute definitions of the de facto and shadow directors. The Learned Judge in this case, adopted a broader approach while interrelating the definition than that has been done in the previous cases, thereby opining that advice by a person that the other Directors of the company are accustomed to follow, is a sufficient basis to find someone to be a shadow director. This approach has become a landmark authority on the proper interpretation of the definition of shadow and de facto directors.

Brief Facts of the case

A company went into creditors’ voluntary liquidation. With regard to creditors, the estimated deficiency was £4.46m. In the meantime, the Secretary of State applied for disqualification orders of the aptly appointed Directors of the company-Euro Express Ltd, under section 6 of the Company Directors Disqualification Act 1986[2] . He also applied for disqualification orders against John Deverell and Peter Hopkins alleging that they were “shadow directors”, i.e .“persons in accordance with whose directions or instructions the directors were accustomed to act”, and to whom section 6 would be applicable by virtue of section 22(4). Judge Roger Cooke upon applying a strict test to the definition of “shadow director”, refused to make the orders that were sought by the Secretary of State. The Secretary of State appealed against the judgement of Judge Roger Cooke on the ground that there have been several errors in his observations. Morrit LJ reconsidered the facts of the case and weighed them in the light of the provisions of the statutes. It was found that both Deverell and Hopkins were heavily involved in the management of the Company and all the major decisions were taken on the basis of their advice or direction. They also took part (though not always formally) in the major financial steps and decisions taken by the company. Thus, Morrit LJ declared John Deverell and Peter Hopkins as “shadow directors” and reversed the order of Judge Roger Cooke.

Issues in the case

Whether Judge Roger Cooke has correctly interpreted the definitions given in the statutes
Whether Judge Cooke on finding of the right facts regarding Deverell, correctly interpreted and applied the definition to find Deverell to not to be a shadow director
Whether Judge Cooke on finding of the right facts regarding Hopkins, correctly interpreted and applied the statutory definitions to find out Hopkins was a shadow director or not.[3]

Arguments on behalf of the Appellants (Secretary of state)

It was argued that the Judge applied a very strict test in the issues that were identified. The definition given in the statute aims at identifying the actual influence in the company’s corporate affairs, whatever label is given to the flow of communication between the board and the Shadow. Therefore, the most important requirement is what is told by the shadow to the other directors or the board, particularly not in the form of any professional advice but is followed routinely for a long time. That is to say that mere non-professional advice that is obediently followed by the directors would be sufficient to prove that a person is a shadow.

Judgement

Order passed by Judge Roger Cooke: The Judge applied a strict test to determine whether Deverell and Hopkins were Shadow Directors and in doing so he interpreted the statute definitions in a very strict sense. He held that a person merely giving advice would not per se imply that person to be a shadow and it would only be held relevant if that advice is given as a “direction” or “instruction” and that the board or directors are accustomed to act on that advice. It was further held that the work of the court was to determine whether, while acting on the advice given by the shadow, the board exercised any judgement of its own. On the basis of these observations, the orders sought by the Secretary of State against Deverell and Hopkins being “shadow” directors, were refused.
Judgement given by Morritt LJ, on appeal by the Secretary of State: It was held that “shadow director” in the general manner to effectuate the intention of the parliament. The purpose of the Act was to protect the public and given the fact that the statutory definition was being used in different legislative contexts, the definition need not be strictly interpreted. The aim of that Act was to bring out those who have actual influence on the directors regarding the corporate matters of the company, these people being someone other than professional advisers. It was not mandatory to show that that influence is being used on all the corporate matters. In the light of given facts and evidences, the court had to objectively ascertain whether any sort of communication from a person alleged to be a shadow, be it by words or behaviour, was to be treated as an “instruction” or “direction”. Even though it would be enough to show that on the basis of those “directions” or “instructions”, the directors of the company put themselves in a subservient role and did not exercise any judgement of their own to reach a decision but acted solely on the directions or instructions of the shadow, it is not necessary to do so in all the cases as it would put a limit on the extent to which the statutory provisions can be interpreted. The judge while deciding upon these additional ingredients laid down certain qualifications that are not mentioned in the statute. Any “non-professional” advice also falls under the statutory definition as “advice” falls within the concept of “instruction” or ‘direction” It was further held that to recognise a shadow it is not necessary that the shadow director should “lurks in the shadows” and not publicly accept his role as an effective member of management. A person may be a shadow director irrespective of whether he makes an effort to conceal the part he performs in the company’s affairs or not. On the basis of the ascertained facts, the Judge held Deverell and Hopkins to be shadow directors and declared them unfit to manage the affairs of the company.

Also Read A.P Jain v. Faridabad Metal Udyog Pvt. ltd. Case

Analysis of the Case

The situation before the Derevell Case

The definition given in the S. 251 of the Companies Act 2006[4]of the term shadow director is “a person in accordance with whose directions or instructions the directors of the company are accustomed to act.”. The proviso in S. 251(2) adds that “a person will not be a shadow director by reason only that the directors act on advice given by him in a professional capacity.”[5] In Hydrodam (Corby) Ltd, [6], Morritt LJ had observed that the involvement of the alleged shadow directors in Hydrodam’s affairs in that case was not relevant and since the liquidator did not prove any cause of action against the alleged shadow directors, had allowed the appeal. He had made some important observations regarding the de facto and shadow directors stating that “A de facto director is one who claims to act and purports to act as a director, although not validly appointed as such while a shadow director, by contrast, does not claim or purport to act as a director and On the contrary, he claims not to be a director.” An important point to check was that “He lurks in the shadows, sheltering behind others who, he claims, are the only directors of the company to the exclusion of himself.” Thus, it was held by him, then, that- the difference between a de facto and a shadow director is that the former accepts his role and influence on the board while the latter shies away or denies being associated in any management affairs of the company, though actually being involved in it.

Re Unisoft Group Ltd[7], it was said regarding the shadow directors that “the shadow director must be, in effect, the puppet master controlling the actions of the board and the directors must be the ‘cat’s-paw’ of the shadow director i.e. they must be people who act on the directions or instructions of the shadow director as a matter of regular practice.”

In the instant case

In the other cases like the Hydrodam case, the facts were quite straightforward but in the Deverell case, the facts seem to be much less clear and straightforward which caused the Court to go beyond the general statutory definition of a shadow director and re-understand and adopt a broader meaning of the same. The facts of the instant case suggest that Mr. Deverell was heavily involved in the senior management and was behind all the major decisions taken but he denied being so and called himself only a “consultant” to the company. Mr Hopkins too had taken upon the managerial role regarding a part of the Company and had played some active part in some major company decisions. It was also seen that the advice given by him was often agreed to and acted on.

Judge Cooke, while applying the reasoning set forth in both Unisoft and Hydrodam Case, noted that “advice does not in itself amount to direction and instruction as it does not have the necessary mandatory effect, and that, in order to find that the pair were acting as shadow directors, the board must have “cast itself in a subservient role” to them and exercised no independent judgment of its own”[8]

Meaning of “directions” and “instructions”

The most important distinction between the Deverell Judgement and previous judgements is the interpretation of the terms “instructions” or “directions”, these terms being an important determiner of the nature of communication between the board and a shadow director. Both these terms seem to carry two meanings. Instruction means “to teach or impart knowledge”, and the act of “making known to a person what he is required to do” or to issue “a direction, an order, a mandate.”[9] Direction means “to guide or supervise”, as well as “an instruction of how to proceed or act; an order to be carried out”[10]. The Judgement holds that “advice” is a part of both the terms “instructions” and “directions”. However, if we look closely at the meaning of all the three terms, “advice” may be a mere suggestion minus the element of obligation. However, “instruction” or “direction” may carry an element of obligation with them. However, in this judgement, emphasis is more in how these terms are used rather than what they literally mean. If an advice is follow by the board as a ritual or as a general pattern, then that advice may be taken along with the other two terms.

The Pattern of behaviour of the Directors

Going by the statutory definition, the board must be “accustomed to act” on the advice or instructions of a shadow director. In the Hydrodam case, it is crucial for the board to not have their independent judgement and act only on the words of the shadow directors. However, in the Deverell case, it is observed that there needs to be some “causative link” between directions and the eventual acts of the board. This, however, doesn’t mean that the board took a decision which they themselves couldn’t have taken based on their judgement, but, that they reached that particular conclusion due to the directions given by the shadow directors i.e. “the reasoning or motivation behind the decisions came from the direction or advice.”

This sets out the difference between the Deverell and Hydrodam approaches. In the Hydrodam Case, the directors following or acting on the advice, because they consider it proper, is not sufficient, but that the instructions are given in such a way, that they need to be mandatorily followed is what forms the deciding factor. In the Deverellcase, directions and advice do not demand that the directors become subservient to the shadow director and surrender their independent judgement but it is sufficient if the board accepts the reasoning behind the advice and acts on it.

Conclusion

For a company to perform efficiently, the Directors of the Company need to be efficient and have an independent judgment of their own. When the directors or the board of directors adopt a subservient role and accept every advice coming from a person who is not formally in a position to give advice, those persons need to be identified. The company laws often deal with the de jure directors but the provisions for de facto or shadow directors are mostly absent. However, this case serves to be a landmark case on issues of identification of a shadow director. This case, though has strayed from the approach adopted in the previous similar cases, has set a clear rule for the identification of a shadow director. This case has changed the view that the shadow director always has to lurk in shadows and has laid down that “advice” is a part of the terms “instruction” or “direction”. This Judgement has thus set clear ground rules for future cases with similar issues.

References:

[1] Secretary of State for Trade and Industry v Deverell [2001] CH 340.

[2] Company Directors Disqualification Act 1986.

[3] Secretary of State for Trade and Industry v Deverell [2001] CH 340.

[4] Companies Act 2006

[5] the Companies Act 2006

[6] Hydrodam (Corby) Ltd, In re [1994] 2 BCLC 180

[7] Re Unisoft Group Ltd [1994] BCC 766.

[8] Secretary of State for Trade and Industry v Deverell [2001] CH 340.https://thecorporate.ninja/wp-admin/post.php?post=2057&action=edit

[9] Instruction, Oxford Dictionary( 2nd Ed.2003)

[10] Direction, Oxford Dictionary( 2nd Ed.2003)