The dangers of lurking in the shadows: shadow director's liability for insolvent trading debts – Part II

The New South Wales Court of Appeal recently handed down its decision in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd [2011] NSWCA 109.

Background

Buzzle Operations Pty Ltd (Buzzle) was formed after six resellers of Apple products merged in September 2000. The merger was ultimately unsuccessful and Apple appointed receivers to Buzzle in March 2001. Liquidators were appointed in 2002.

The liquidators claimed (amongst other things) that Apple and its finance director, Mr James Likidis, were shadow directors of Buzzle for a certain period, and accordingly liable for insolvent trading claims.

Decision at first instance

At first instance, White J decided in favour of Apple, and found that:

• a third party will not be considered a shadow director merely because it imposes conditions on a company;
  
  
• there must be a sufficient causal connection between the directions of the third party and the directors’ conduct for a third party to be considered a shadow director; and
  
  
• there must be habitual compliance with a person’s directions for an extended period of time, in order for that person to be considered a shadow director.

Decision on appeal

In dismissing the liquidators’ appeal against the findings that Apple and Mr Likidis were not shadow directors, Young JA (Hodgson JA and Whealy JA agreeing) found the following five propositions relevant to determining whether a person was a shadow director:

• not every person whose advice is in fact heeded as a general rule by the board is to be classed as a de facto or shadow director;
  
  
• if a person has a genuine interest of his or her own in giving advice to the board, such as a bank or mortgagee, the mere fact that the board will tend to take that advice to preserve it from the mortgagee’s wrath will not make the mortgagee, etc, a shadow director;
  
  
• the vital factor is that the shadow director has the potentiality of control. The fact that he or she does not seek to control every facet of the company, or that from time to time the board disregards such advice, is of little moment;
  
  
• the evidence must show something more than just being in a position of control. The facts must show whether the capacity to control was exercise; and
  
  
• where the board of a company splits into majority and minority factions, the external person providing the influence may be a shadow director if the real decision makers act upon that influence.

The court held that there is a significant difference between a board assigning responsibility for the day to day running of certain activities, and formally delegating collective responsibility for decision making.

Lavan comment

This decision is important to insolvency practitioners and secured creditors alike as it provides useful guidance as to the involvement and level of control that a person is required to exert before they will be considered a shadow director. In this case the fact that Apple had the ability as a joint venture partner to control Buzzle’s decisions did not, of its own, amount to a finding that Apple was a shadow director of Buzzle.

It is not uncommon for investigative accounts and secured lenders to exercise similar levels of control over defaulting companies that are required to sell their assets in order to repay the secured lender.

The possibility of an appeal by Buzzle to the High Court remains open. We at Lavan Legal will continue to keep you updated of the progress of this case and any developments in the law regarding whether a person is a shadow director or not.

For further information please contact partner Alison Robertson on (08) 9288 6872 / alison.robertson@lavan.com.au or senior associate Joseph Abberton on (08) 9288 6765 / joseph.abberton@lavan.com.au.