Fighting with your shadow – understanding the concept of non-executive and shadow directors

September 1st, 2020
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Picture source: Gallo Images/Getty

Before I discuss the concept of a shadow director and a non-executive director, I must first explain what a director is. Section 66 of the Companies Act 71 of 2008 (the 2008 Act) sets out what a director is by stating that the affairs of a company must be managed by its board, which has the authority to exercise all power and perform any of the functions of the company, except to the extent that the Companies Act or the company’s Memorandum of Incorporation (MOI) provides otherwise. The 2008 Act goes on further to prescribe the number of directors required for each type of company. This definition of director provides that a person who is appointed as a director of a company must be involved in the active management of the company’s affairs. There is also a level of authority conferred on the director to exercise their powers and to make binding decisions on behalf of the company within the requisites of the 2008 Act and the company’s MOI.

With regard to non-executive directors, the Companies Act 61 of 1973 (the 1973 Act), which was repealed by the 2008 Act made a distinction between an executive director and a non-executive director. Section 269A(4)(b) of the 1973 Act defined a ‘non-executive director’ as a director who ‘is not involved in the day to day management of the business and has not in the past three financial years been a full-time salaried employee of the company or its group’. The 2008 Act, however, does not have such a distinction, but s 200 refers to an executive director and defines it as a director who may be appointed by the Takeover Regulation Panel (the Panel) to perform the functions of the Panel. In addition, the executive director may appoint other officers and employees as may be required for performance of the functions of the Panel. From this definition of executive director, it is safe to conclude that the major or only difference between a director in terms of s 66 of the 2008 Act and an executive director in terms of s 200 of the same Act is that the executive director has an additional function as stated in the latter section. Apart from this, an executive director remains a director in terms of s 66.

The 2008 Act, in addition to defining what a director and an executive director is, provides for exofficio directors. Section 66(4)(a)(ii) states that a company’s MOI may provide for the appointment of a person as an ex officio director by virtue of the office that that person holds. For example, the Chief Executive Officer of a company may be regarded as an ex officio director. An ex officio director is, therefore, a director for all intents and purposes. As such, the ex officio director exercises ostensible management/power concerning the affairs of the company, which consequently warrants their appointment as director (ex officio). There is, therefore, a management and authoritative function that makes one’s office capable of being that of director as envisaged in s 66. I, therefore, submit that in absence of a clear description of the functions of a non-executive director in statute, the functions of a non-executive director are exclusively left to be decided through a contract between the company and the non-executive director.

Although the contract between a non-executive director and the company may provide clarity as to the role of the non-executive director within the company; can a contract then confer on the non-executive director the powers and functions of a director as defined in s 66 of the 2008 Act? If this is answered in the affirmative, should the company not then appoint a director in terms of s 66 rather than appoint a non-executive director, who has no ostensible management function apart from what would be set out in the contract, but could nevertheless be provided for in the company’s MOI where one is to be appointed as a director in terms of s 66? Furthermore, could it be that the distinction that was drawn between a non-executive director and an executive director in the 1973 Act was intentionally left out in the 2008 Act because of it being redundant? I am compelled to answer this in the affirmative.

The King IV Code on Corporate Governance (the Code) echoes the same definition of a non-executive director, which was defined in the 1973 Act. Principle 7 of the Code recommends that the board of a company must comprise of ‘the appropriate balance of knowledge, skills, experience, diversity and independence for it to discharge its governance role and responsibilities objectively and effectively’. To achieve this, the principle recommends that a company should invite competent persons to serve as non-executive directors and take part in board meetings in order to provide impartial and independent contributions into the affairs of the company and, also mitigate risk in the company’s decision-making process. I, however, submit that although this presents good intention and may, in the unique circumstances of a company prove practical, it still raises doubts as to the true nature of a non-executive director. As a non-executive director is not involved in the day-to-day management of the company, it means that a non-executive director, falls short of the definition of director as contained in s 66 of the 2008 Act, namely that a director must be involved in the management of the company. Perhaps the non-executive director may perform certain powers in terms of the company’s MOI and appointment contract, but I am not convinced that a ‘director’ who is not involved in the day-to-day management of the company may have sufficient knowledge about the affairs of that company to be able to make justified, independent contributions to the board. Instead, such a person depends on the information provided to them by the executive directors of the company. If this is the case, it thus cannot be said that a non-executive director can independently and with ‘sufficient’ knowledge contribute to making decisions for the company, because this perceived independence may most likely be tainted by the non-executive director’s reliance on information and records provided to them by those directors who are involved in the day-to-day management of the company. Furthermore, because the non-executive director, by definition, is not involved in the management of the company and probably has a function set out only in contract, I submit that a non-executive director is a metaphor, and the true role of a non-executive director is that of a professional adviser, whose advice may or may not be implemented by the company. So just like the shadow director, a non-executive executive director is no director at all. This now takes me to the discussion of a shadow director.

A shadow director is defined as a person upon whose advice, direction or instruction the board of a company is accustomed to act on or follow. The concept of shadow director has an English law origin. Section 251 of the United Kingdom’s (UK) Companies Act 2006 defines a ‘shadow director’ as a ‘person in accordance with whose directions or instructions the directors of the company are accustomed to act’. The section goes on further to state that a person is not to be regarded as a shadow director by reason only that the director acts on advice given by him in a professional capacity. Although English law forms the basis of the South African common law, the concept of shadow director has not been included in the 2008 Act. Nevertheless, the concept of shadow director may still be considered in terms of the common law. The UK courts have attempted to give a clear definition of a shadow director but do not seem to have been successful. In Kathy Idensohn’s article titled The Regulation of Shadow Directors’ (2010) 22 SA Merc LJ 326, she discusses the guiding principles on how to identify a shadow director, as was set out in the UK case of Secretary of State for Trade and Industry v Deverell [2001] Ch 340 (CA (Civ Div)). She further alludes to the case of Ultraframe (UK) Ltd v Fielding and Others [2005] EWHC 1638 (Ch) where the court held that the position as to whether shadow directors are fiduciaries, and, therefore, have a unique relationship of trust with the company, which is tantamount to the relationship between the company and its board of directors is not clear. It was thus generally accepted that a shadow director is not a fiduciary and the common exceptions to this general rule is when the shadow director ‘goes beyond the mere exertion of indirect influence’ on the directors of the company and takes voluntary control over the company. In addition, the shadow director exercises so much control over the board of directors that the board exercises very little autonomy in making decisions. It is my submission that it is inconceivable that a competent board would at any point not exercise absolute discretion in managing the affairs of the company. And, if this were not the case, then it would significantly place doubt on the competence of the board and ultimately, the director of a company may be held accountable for actions taken negligently and without applying the skill and diligence expected of a reasonable director. This is perhaps why the 2008 Act did not include the concept of a shadow director. Idensohn (op cit) further suggests that perhaps the concept of ‘prescribed officer’, which was introduced by 2008 Act, was aimed at including shadow directors. A detailed discussion on prescribed officers may possibly, on another occasion be relevant, but for now I do not deem it necessary.

Based on the above, I again submit that, just like a non-executive director, a shadow director is a metaphor, the characteristics of which are more aligned with those of professional advisers, whose advice may or may not be implemented.

In conclusion, the South African corporate space is quite broad and interesting. It does, however, appear that certain roles such as those discussed above may only serve for statistical purposes in relation to ‘independence’ and employment purposes but have no ostensible practical role as pertains specifically to the role of a director of a company.

Nokubonga Fakude LLB (UJ) is a legal practitioner in Johannesburg.

This article was first published in De Rebus in 2020 (Sept) DR 31.