18 Oct 2019

D&O policies typically provide cover for claims and investigations against directors including de facto directors. But exactly what does de facto director mean? We explain why it matters and examine a recent High Court decision which helps clarify this difficult question for insurers and insureds alike.

What is a de facto director and why does it matter?

In essence, a de facto director is someone who acts as a director but who has not been formally appointed and registered at Companies House as a de jure director (ie an official director).

Unlike an employee, a de facto director will owe the same common law, fiduciary and statutory duties to the company, shareholders and creditors as a de jure director. They are also at risk of criminal sanctions in the same way as de jure directors.

With the role of directors under increasing scrutiny in the context of high profile data breaches; cyber-attacks; GDPR; and the extension of the Senior Managers and Certification Regime, exposure to claims and regulatory investigations is on the increase.

Since de facto directors' duties are much more wide-ranging than those of employees, the issue of whether or not an individual is a de facto director may be critical in establishing the scope of that individual's duty and therefore liability. This analysis will in turn impact on policy response, reserves and available limits of indemnity for the other insureds which may be an issue in some cases.

It is not, however, always easy to establish if someone is a de facto director or indeed a shadow director (a person in accordance with whose instructions the directors are accustomed to act). Hacon J recently provided some helpful guidance in the matter of (1) J A Popely (2) A Popely v (1) R A Popely and others [2019] EWHC 1507 (Ch).

The case

An "unhappy dispute" in an "unhappy family" is how the court described the long-running litigation in various jurisdictions between brothers John and Ronald Popely and their extended families.

The brothers had been business partners who carried out business through a number of different trusts and companies. They fell out in 2001 when John accused Ronald of defrauding him of some £4.1 million in assets arising out of a business offering time shares in holiday properties. The ongoing dispute was complex as well as long-running as the claimants were beneficiaries under a trust meaning the claim was a "double derivative claim".

However, one of John's allegations was that although Ronald had not been formally appointed as a director of a company called Casterbridge Properties Limited, he was a de facto director which gave rise to a fiduciary duty to the company equivalent to that of a de jure director. John claimed that Ronald was in fraudulent breach of that fiduciary duty.

Was Ronald a de facto director?

Hacon J concluded that Ronald was not a de facto director. In coming to his decision, he referred to the earlier authorities including Revenue and Customs Commissioners v Holland [2010] UKSC 51 and Smithton Ltd v Naggar [2014] EWCA Civ 939 and summarised the factors to have in mind when determining if someone is a de facto director as follows:

  • Is the individual part of the corporate governing structure of the company? If so, this is a positive indicator that they are a de facto director
  • Did the person assume a role in the company which imposed on them the fiduciary duties of a director? This is a question of fact and degree and will be tested on an objective basis by an assessment of the available evidence. It does not matter what the individual believes
  • A de facto director will exercise real influence. Merely being involved in the management of the company or exercising a degree of influence over decision making is not sufficient to characterise an individual as a de facto director.

If it is decided that an individual is a de facto director then it will be necessary for the purposes of a D&O policy to establish if the alleged wrongful acts are undertaken by the individual in their capacity as a director. The decision provides some helpful guidance on the question of capacity as follows:

  • If the corporate governance of the company requires that a certain act can only be done by a de jure director then a person carrying out that act would be doing so in the capacity of a de facto director if not a de jure director
  • In establishing whether the act in question is that performed by a director it will be necessary to investigate the corporate governance of the company.
  • If the individual can carry out the act in some other capacity then they will not have done it as a de facto director
  • An act comprising directions or instructions to a de jure director will be an act undertaken in the capacity of a shadow director.

Practical implications of the decision

The issue of whether or not an individual is a de facto director will remain fact sensitive but Hacon J's guidance helps to provide clarity in that an individual who is properly acting in some other capacity is at a lower risk of being held a de facto director. It follows that there are risk management steps which can be taken by companies to ensure that non directors' terms of engagement and authority are clearly defined.

For insurers and insureds dealing with claims under D&O policies, the guidance may be helpful in establishing whether particular acts will be deemed to be wrongful acts, that may be covered under the policy. In turn, this will assist insurers in their evaluation of policy response, any claim reserve and the available limits of indemnity for other insureds, which will be an issue in some cases.