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South African law is failing to make sure that ‘shadow directors’ are held accountable

24 May 2021

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South Africa has become notorious for corruption in many of its state-owned entities. In particular there’s been mounting evidence that utilities such as Eskom, which supplies power, and South African Airways were ‘captured’ when a small group of people influenced the state’s decisions to their own benefit and hijacked state organs to channel public resources their way.

State capture is not unique to South Africa. For example, there have been allegations of state capture in Bulgaria, Hungary and the Western Balkans.

In South Africa a great deal of evidence has been given to the Zondo Commission of Inquiry into corruption in the country during the Zuma presidency from 2009 to 2018. A major feature of some of the testimony has been about the awarding of contracts by state-owned entities.

Accusations of malfeasance include the awarding of contracts to companies linked to the Gupta family, the influence of third parties in the appointment of directors of state-owned entities, and the mismanagement of key state-owned entities such as the state utility Eskom, South African Airways, the transport utility Transnet and the South African Broadcasting Corporation.

An intriguing aspect about how decisions were made revolves around the role of their boards, and in particular what influence ‘shadow directors’ had over decisions. It may be arguable that some of those responsible for state capture are shadow directors.

A ‘shadow director’ is someone who secretly influences and controls directors of a company. They lurk in the shadows and hide behind others. Shadow directors don’t take up formal positions on the board. They want to remain anonymous. And avoid being held liable for the company’s actions.

A person may be a shadow director even if they influence and control only some aspects of the company’s business and not the whole business.

In my research on shadow directors I have found that the problem in South Africa is that its laws aren’t clear about how they should be managed, and what the accountability structures are around them. They aren’t properly identified as directors, which means that they are able to escape legal responsibility for their influence and control. Due to conflicting authorities and no clear court ruling on this issue, it’s unclear whether shadow directors are governed by the Companies Act.

Holding shadow directors accountable for influencing and controlling directors of a board would deter bad behaviour and improve corporate governance. It would go some way to addressing the issue of corruption and the abuse of state-owned entities for personal gain.

Directors

A ‘director’ is defined in South Africa’s Companies Act as a member of the board of a company, and includes anyone who occupies the position of a director. Even if a person is not formally appointed as a director and has another title, such as manager or consultant, under the law they are still considered to be a director.

If someone acts in the role of a director and performs the functions usually performed by a director, they will be subject to the same fiduciary duties as any other director.

These duties include acting in good faith, acting for a proper purpose and acting in the company’s best interests. If a director fails to comply with these duties they will have to account for the losses suffered by the company.

Whether someone is identified as a shadow director depends on the type of decisions they make and how often they are involved in the management of the company. Also relevant is the extent to which their instructions are automatically followed by the board and the scope of their influence.

Shadow directors pose their own set of challenges. The laws of some countries, such as the UK and Australia, ensure that their actions are also open to scrutiny. But South Africa’s Companies Act does not have a definition of a shadow director. This has raised questions about whether or not they are governed by the Act.

Yet another problem is whether professional advisers should be viewed as shadow directors.

A question of classification

In my view a shadow director ought to be governed by the Act because the words ‘occupying the position of a director’ should include a person who acts in the position of a director – with or without lawful authority.

A different view is that a shadow director is not a director but is a prescribed officer because of their influence on company decisions. A prescribed officer is not a director but controls and manages the whole or a significant part of the company’s business.

For example, the chief executive officer and chief financial officer are prescribed officers. They have to comply with the same fiduciary duties as directors.

In my view a shadow director should not be classified merely as a prescribed officer for three reasons.

First, to qualify as a prescribed officer, the person must control the whole of the company’s business or a significant part of it. In most cases the influence of a shadow director doesn’t extend this far. This would let them off the hook under the current definition of prescribed officers.

Secondly, a prescribed officer is a person who regularly takes part in the company’s business. This does not accord with the concept of a shadow director.

Thirdly, if shadow directors were prescribed officers, they could escape being declared delinquent. Delinquency grounds apply to directors, and not to prescribed officers.

Under a delinquency order a person is banned from being a director for at least seven years, or, in very serious cases, for a lifetime.

It’s therefore unfair, in my view, to be able to declare ordinary directors – but not shadow directors – delinquent.

Shadow directors and state capture

In the context of the inquiry into corruption in South Africa, one potential upshot of holding shadow directors liable for the same duties as ordinary directors is that they would have to account for the losses suffered by a company due to a breach of their duties.

For example, if a shadow director influenced a state-owned entity to award certain contracts to companies associated with them, they could be held responsible for losses suffered by the company due to their breach of the duties to act in good faith, for a proper purpose and in the company’s best interests.

Another upshot is that shadow directors could be held accountable for losses suffered by the company as a result of being a part of fraud committed by the company when the shadow director knew that the act was fraudulent. Where fraud is committed by the company, under the Companies Act a criminal action can be brought against those responsible, resulting in a fine or imprisonment of up to 10 years.

South Africa’s parliament needs to take urgent action to end the uncertainty about whether or not shadow directors are governed by the Companies Act. This will require amending the definition of a ‘director’ in the Companies Act so that it unambiguously recognises shadow directors.

Rehana Cassim does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.


Read the full article here.
This content was originally published by The Conversation. Original publishers retain all rights. It appears here for a limited time before automated archiving.By The Conversation

Covid-19 – Johns Hopkins University

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