Is your client acting as a de facto director?

The telltale signs to watch out for.

As a trusted advisor, you can play a critical role in informing your clients about their obligations under the Corporations Act 2001 (Cth). One area often overlooked is the potential for a client to be deemed a de facto director, even if they have not been formally appointed.

In a file which is currently being handled by our Brisbane office, ASIC (Australian Securities and Investments Commission) has provided funding for Public Examinations to be conducted of the registered director of a company as well as several of their family members who were involved in the operation of the business to determine whether they could be considered de facto directors. While that matter is ongoing, it has highlighted the potential serious legal and financial consequences, particularly in insolvency scenarios, that an individual can face if they assume the duties and responsibilities of a director without holding the title.

What is a de facto director?

A de facto director is someone who acts in the capacity of a director, even though they are not formally appointed. The courts have provided clear guidance on what constitutes acting as a de facto director, emphasising that it is the substance of their actions, not their official title, that determines their status. Key indicators include:

1. Performing functions exclusive to directors
   Taking on roles or decisions that only an officially registered director or board can perform.

2. Autonomous decision-making
   Operating independently as a primary decision-maker in the company.

3. Corporate representation
   Being held out by the company or perceived by third parties as a director.

4. Directorial participation
   Actively participating in or influencing strategic, financial, or operational decisions typically reserved for directors.

Warning signs for advisors

When working with clients, be vigilant for these behaviours, which could signal that they are acting as de facto directors:

1. Involvement in major decisions
   Are they signing contracts, approving budgets, or negotiating significant transactions?

2. Financial oversight
   Are they involved in managing cash flow, approving expenditures, or ensuring compliance with financial reporting obligations?

3. Strategic leadership
   Do they influence the company’s strategic direction, including risk management or regulatory compliance?

4. Engagement with stakeholders
   Are they interacting with shareholders or external parties in a manner that suggests authority over company affairs?

5. Operational responsibility
   Are they supervising senior management, directing day-to-day operations, or serving as the go-to authority within the company?

Legal consequences under the Corporations Act

If a liquidator identifies someone as a de facto director, they could face the same statutory duties and liabilities as formally appointed directors. These include:

1. Directors’ duties breach (Sections 180-184):

   • Duty of Care and Diligence (s180)
     Acting with due care and diligence in managing the company.

   • Good Faith and Proper Purpose (s181)
     Acting in the company’s best interest and for proper purposes.

   • Prohibition of Improper Use of Position (s182)
     Avoiding misuse of their position for personal gain or detriment to the company.

   • Prohibition of Improper Use of Information (s183)
     Preventing misuse of company information.

2. Insolvent trading (Section 588G)
   Personal liability for debts incurred if the company trades while insolvent.

3. Uncommercial transactions (Section 588FDA)
   Being held liable for transactions deemed unfair or uncommercial before insolvency.

Best practices to protect your clients

As their trusted advisor, you can help your clients mitigate these risks by:

• Clarifying roles
  Ensure clients understand their formal role within the company and avoid activities that resemble directorial functions.

• Documentation
  Advise clients to document decisions and ensure proper delegation to formal directors or managers.

• Corporate governance
  Promote clear corporate governance frameworks to delineate responsibilities.

• Insolvency awareness
  Encourage proactive measures to prevent insolvent trading, including seeking external advice when needed.

Final thoughts

While helping your clients navigate their business responsibilities, be alert to the signs that they might be crossing into the realm of a de facto director. The consequences of being deemed a director extend far beyond title and can include significant personal liability, especially in insolvency proceedings. Early identification and proactive advice can protect your clients from unintended breaches and liabilities under the Corporations Act.

Although not covered in detail in this article, advisors should also be alert to whether a client is acting as a shadow director. A shadow director is someone who is not validly appointed as a director, but whose instructions or wishes the officially registered directors are accustomed to acting in accordance with, or a person who has influence over the director or board. A shadow director faces the same potential consequences of being deemed a director of a company that a de facto director does.

If you suspect a client is at risk, encourage them to seek legal advice to clarify their position and responsibilities. Your guidance can be a pivotal safeguard against potential legal exposure.