THE DANGERS OF LURKING IN THE
SHADOWS
By K P C Rao.,
LL.B., FCS., FICWA.
kpcrao.india@gmail.com
BACKGROUND
This
article is written in the light of the arguments before the Supreme Court on 27th
March, 2014 put forward by a bunch of senior advocates headed by Ram
Jethmalani, appearing for Subrata Roy and the Sahara group in the contempt
proceedings.
It
is an admitted fact that Sahara Group of companies viz., SIRECL and SHICL had
floated OFCDs schemes in 2008 and 2009 respectively, and collected huge amounts
of money running into crores of rupees from the public under the shadow of some
Collective Investment Schemes and violated SEBI regulations. Later on it was
detected by SEBI in 2010.
The
SEBI contended that these fund raisings violated several laws, including the
Companies Act and the SEBI Act, 1992. Subsequently, SEBI barred the two Sahara
group companies from further raising through these instruments from any other
investors. Sahara group then challenged the SEBI order and the case has reached
the Supreme Court.The Apex Court has directed the Sahara to refund the money to
the investors within a time frame and the direction of the Apex Court was not
complied by Sahara as to the refund of investors money. Thereafter, the SEBI
has moved the contempt petition before the Supreme Court.
ISSUES
RAISED IN THE APEX COURT
In
the course of arguments in this case Ram Jethmalani told a bench of justices K
S Radhakrishnan and J S Khehar of the Apex Court, which had passed detention
order of Subrata Roy that:
“The Petitioner is a shareholder of Sahara
India Real Estate Corporation (SIRECL) and Sahara Housing and Investment
Corporation Limited (SHICL). The Petitioner holds 0.03 percent shares in SIRECL
and 0.112 percent shares in SHICL. Further, the Petitioner is neither a
Director of either of the two companies, nor is he an Officer-in-charge of the
two Companies. Also the Petitioner is in no manner involved in nor responsible
for the day to day affairs or conduct of business of the said Companies"
He
further added to his argument stating that it's (S.C) approach is
"biased, illegal and
unconstitutional." "It
is the gravest mistake of law committed by any court in the country. I wish to
submit with greatest respect that there is an error of law," "Has any person been sent to jail without
knowing what crime he has committed and under what provision he has been
punished"
Of
course, the Bench has refused to grant relief.
NEED TO
DRAW DISTINCTION BETWEEN DE FACTO DIRECTOR AND SHADOW DIRECTOR
Now
the question is how to draw a distinction between ‘de facto directors’ and ‘shadow
directors’ and how they are to be dealt with differently under the statute. The
former is one who acts as a director whereas the later is one who commands
directors how to act. A Shadow Director is an “officer” within the definition of
the terms in Section 2 (30) of the Companies Act 1956 as it includes, "any
person in accordance with whose directions or in structions
the Board of directors or any one or more of the Directors is or are accustomed
to act.” Even the Companies Act, 2013 acknowledges the same vide clause 2(59)
and does not define either a Shadow Director or a Deemed Director.
The
Companies Act 1956 as well as the Companies Act, 2013 deal with such Shadow
Directors under various sections. Still the controversy remains as there is no
clarity on the subject either under the Companies Act, 1956 or under the
Companies Act, 2013.
As per UK Companies Legislation, a shadow director is a
person in accordance with whose directions or instructions the directors of a
company are accustomed to act. Under this definition, it is possible that a
director, or the whole board, of a holding company, and the holding company
itself, could be treated as a shadow director of a subsidiary.
A founder or significant shareholder who wishes to escape
the disclosure requirements of a directorship might still be counted as a
'shadow' director and held responsible for actions as if he or she were a
formal director.
CASE
STUDIES
1.
Secretary
of State for Trade and Industry V Deverell[1]
The term has been elaborately defined in Secretary of State for Trade and Industry V
Deverell as follows:
a) The purpose of the legislation was to identify those (other
than professional advisers) with real influence in the company's corporate
affairs, but this influence did not have to be over the whole field of its
corporate activities.
b) Whether a communication, by words or conduct, was to be
classified as a "direction or instruction" had to be objectively
ascertained by the court in light of all the evidence.
c) It would not be necessary to show the subservient roles of
the properly appointed directors.
In Buzzle Operations Pty Ltd v Apple Computer
Australia Pty Ltd case which came up before the New
South Wales Supreme Court, Justice White concerned whether or not Apple (as an
independent corporate entity) was to be deemed a shadow director of Buzzle
Operations Pty Ltd (Buzzle)
pursuant of the Corporations Act, 2001 and thus liable as a
director for insolvent trading debts.
In
mid-2000, six Apple resellers merged to become Buzzle. As Apple was the
supplier and provided a number of sureties for the merger it also participated
in the negotiations and subsequent formation of the company. Through these
negotiations Apple made Buzzle’s financial obligations clear to them and the
trading terms to which they would have to comply to ensure Apple’s continued
support. Buzzle unfortunately soon become insolvent and failed to fulfil these
obligations. The liquidators of Buzzle subsequently attempted to claim that
Apple was liable for a number of insolvent debts incurred as a ‘shadow
director’ of the company.
In dismissing this claim, Justice White provided a number of useful guidelines as to what advice can be given and what influence can be exercised before such actions would be deemed to be those of a shadow director:
In dismissing this claim, Justice White provided a number of useful guidelines as to what advice can be given and what influence can be exercised before such actions would be deemed to be those of a shadow director:
(a)
a person or a corporation may be
deemed as a shadow director if the directors of a company 'are accustomed to
act in accordance with the person's instructions or wishes';
(b)
a shadow director need not control
all the directors of a company, only a governing majority of the directors, as
this will in any event give him or her effective control over the company as a
whole;
(c)
it is not necessary that the
instructions or wishes of a shadow director be given over the whole field of
corporate activity for which the directors are responsible. A person or
corporation may still be a shadow director even if the directors exercise
discretion or judgment in areas which the shadow director does not give
instruction or express a wish;
(d)
the directors of the company must be
accustomed to act in accordance with the person or corporation’s instructions
or wishes as to 'how they should so act' in 'their
capacity as directors' of the company. That is to say, a third party
who has commercial dealings with a company will not merely be deemed a shadow
director because they insist on certain terms for their continued support of a
company and those terms are accepted; even if those terms are habitually
complied with over an extended period of time by the company;
(e)
'in accordance with' in these circumstances is understood to mean that the
cause of action was the shadow director’s instructions or expression of wishes;
and
(f)
a bright line of distinction is to
be drawn between de facto directors and shadow directors as they are dealt with
differently under the statute. The former is one who acts as a director whereas
the later is one who commands directors how to act. Both, however, have the
same statutory liabilities as directors.
Apple
was ultimately found not to be a shadow director because, at the time of its
involvement with the directors of Buzzle, they (the directors) were not then
deemed to be acting as directors. Apple was found to be merely imposing
conditions on its commercial dealings with Buzzle, rather than controlling the
directors.
This
decision does not exclusively or conclusively outline all scenarios in which a
creditor, financial institution with insolvent corporate clients, investigative
accountant or any other person or corporation’s actions may make him, her or it
liable as a director for insolvent debts. It does however provide a guideline
as to the specific and special types of involvement with a company that would
lead to a finding that an independent corporation was a shadow director.
CONCLUSION
The
rationale for the concept of “Shadow Director” is to prevent the evasion of
obligations/liabilities by persons who control the company but choose to remain
in the shadow.
Therefore,
if a person or corporation is found to be a shadow director, he or she or it
owes statutory duties to act in good faith in the best interests of the
company, and with the reasonable care and diligence of a director of that
company. A shadow director is also legally responsible for all statutory
liabilities that a director would be held responsible for.
The object of emphasizing the requirement of some Directive
on Shadow Director(s) is nothing but to put those to accountability, who,
because of certain practical issue which have not been dealt with in/by the
statue, have resorted to various escape routes to avoid their responsibilities
especially towards the stakeholders of an entity. It must, nevertheless, be
appreciated that it is virtually impossible to address all practical business
issues while writing a regulation, it is, however, expected that an ethical
compliance of the statute in its true spirit and objective be assumed/ensured
by the citizens of a State.
Therefore,
we need to bring clarity in law on the liability of a shadow director in India.
Atleast, the Supreme Court being the Apex Court in the Country should come out
with detailed guidelines on this subject. This would befittingly address the
need of the hour i.e. better transparency and the investor’s confidence.
*****
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