What is a Nominee Shareholder?
Nominee shareholders are common in incorporated companies. In a corporate form, shares are easily divisible, making it easier to manage a number of investors. Usually there is a single public face to an incorporated company; the corporation itself, while sources of capital may come from many individuals and entities.
A nominee shareholder is an individual or an entity who holds a legal title to, but not the beneficial interest in, shares owned by another individual. The nominee is typically listed on the public records of the company as owning shares , but they do not exercise the rights associated with the shares on their own behalf (such as voting at shareholder meetings). For all intents and purposes, a nominee shareholder can be a completely invisible party in the corporate structure, and this is the intent.
The most obvious benefit of using a nominee shareholder is to create a degree of anonymity. No matter how small the shareholding position, if someone holds shares in a corporation, then their full name will be on the corporate register. While it is possible to use a corporation or trust as a shareholder, the nominee shareholder is meant to be listed on the public records.
Scope of Nominee Shareholders Agreement
A nominee shareholders agreement is utilized for a number of different purposes and there are benefits for both the shareholder and the nominee shareholder in entering into such an agreement. Firstly, it provides the investor (nominee shareholder), with a degree of privacy in terms of its shareholding interests in the company, in that the actual shareholder details, and thus the details of the beneficial owner or investor, do not have to be disclosed in the public records of the company and do not appear on the share register.
Secondly, it also provides an additional layer of legal protection to the investor’s shareholding in the company.
In the absence of such an agreement, the legal rights associated with a particular share will vest in the holder of that share. For example, a shareholder cannot instruct the company to make dividend payments to a person other than the shareholder named in the share register. Conversely, a co-shareholder would not, for example, be entitled to a dividend payment owing to the actual shareholder whether or not he holds proxies enabling him to vote at a meeting.
The nominee shareholders agreement seeks to regulate the legal and beneficial ownership of shares, setting out the respective rights of the shareholder, nominee shareholder, and/or any other parties to such an agreement.
Such agreements, depending on the level of formality, can be useful to provide comfort to the investor in circumstances in which a third party holds shares on behalf of an investor.
Some of the substantial issues helpful to consider or include in a nominee shareholders agreement are:
Formal nominee shareholders agreements are common in private equity transactions or when the parties seek or require strict adherence to the agreement.
Key Provisions in a Nominee Shareholders Agreement
A nominee shareholders agreement should incorporate a number of critical elements, such as:
Rights and Obligations
The rights and obligations of both the nominees and the underlying owner should be clearly set out in the agreement. In particular, the underlying owner should ensure the nominees are required to sign all documents or take all steps when called upon to do so by the underlying owner to transfer, dispose of or pledge the shares as the underlying owner may direct. They should also be obliged to attend and vote at company meetings and notify the underlying owner of any correspondence they receive from the company.
Remember that for the nominee arrangements to be effective, the underlying owner must be in a position to deal with the company. In Singapore, companies have mandatory mandatory disclosure requirements in relation to the members of the company (i.e. the nominees) and the nominees are not registered as shareholders of the company. This is not the case in certain other jurisdictions. For example, in England, shareholders could be registered at Companies House or in a private register. It is important to understand the disclosure requirements of the relevant jurisdiction when drafting provisions regarding rights and obligations in a nominee shareholders agreement.
Indemnities
The underlying owner should indemnify the nominees against any legal or other liabilities which may arise out of any act done or omitted to be done as a shareholder at the request or direction of the underlying owner (provided that the liability was incurred in good faith). The nominees should also indemnify the underlying owner against any losses suffered by it as a result of any breach of its obligations under the nominees shareholders agreement or any bad faith, fraud or improper conduct by the nominees in relation to the exercise of their rights, duties and powers in relation to the shares.
Confidentiality
Any information or materials shared between the underlying owner and the nominee(s) should be regarded as confidential and should not be disclosed to any third party without the prior consent of the other party.
Put and Call Option
A nominee shareholders agreement will sometimes have a put and call option for the underlying owner (put option) or the nominees (call option) to buy out shares held by the nominees in certain circumstances. These are common in joint venture arrangements. The nominee, being the registered shareholder, will be under pressure to exercise the put option, whereas the underlying owner is incentivised to have the put option exercise in circumstances which is beneficial. The agreement should therefore specify the circumstances in which the put/call option can be exercised and the exercise mechanics, exercise notice, price, payments, etc.
Requirements of the Law
The legal responsibilities of the nominee are generally set out in the Nominee Shareholders Agreement. It is vital that this Agreement contains all of the key details and establishes all of the key legal responsibilities of the nominee, or it could give rise to a number of legal problems down the track.
The nominee will usually have the right to dividends and other benefits arising as a member of the company, on the condition that they remit (this should be required in the Nominee Shareholders Agreement) these to the actual shareholder.
If the nominee indemnifies the actual shareholder against any loss it incurs under the Companies Act 2001 or otherwise, or the nominee agrees to pay to the actual shareholder any amount it must pay to the company under the Companies Act 2001, the actual shareholder must indemnify the nominee accordingly, unless the loss or payment arose from the nominee’s negligence.
The abilities and powers conferred on the nominee are only able to be removed by an ordinary resolution of the company, in this case, the actual shareholder would need to vote.
The potential problem with this sort of arrangement is that if the company is involved in some illegal activity, either the nominee or the actual shareholder may find themselves criminally liable. This could happen for example, if the nominee has not used due diligence and failed to meet their duty of care and fiduciary duty as a director of the company.
Comparative jurisprudence from other jurisdictions dealing with nominees indicates that nominees who do not have actual knowledge that their company is trading illegally and are acting in good faith, can escape criminal liability. However if they are negligent and fail to meet their duty of care and fiduciary duty requirements they can be held personally liable.
In addition to the potential criminal liabilities, these arrangements could also give rise to civil liabilities against the nominee which gives rise to damages and compensatory costs.
Common Applications & Scenarios
Nominee shareholder agreements are frequently used in various situations to clarify the relationship between a corporation’s beneficial owners and its registered shareholders.
- Commercial Purpose Companies often find themselves in need of a practical solution that will allow them to engage business advisors or to require confidentiality from key employees or their family members who may also be their corporation’s shareholders. The use of a nominee shareholder can address this concern because the nominee takes the title to the shares with the understanding that it will act at the direction of the corporation’s beneficial owners. For example, suppose a business is seeking advice from a lawyer and the lawyer has been offered an opportunity to take shares in the corporation. The lawyer does not want to own shares in the corporation for the same reason that the corporation’s owner does not want the lawyer to own shares – because it would curtail the lawyer’s ability to serve as counsel. A nominee shareholder structure resolves this issue by allowing the lawyer to take shares in the corporation indirectly, which preserves legal professional privilege.
- Tax Planning Registered shareholder is often an integral part of tax-strategies. For example, a client’s father is a shareholder in a company. His son would like to use the unused portion of his mother’s lifetime capital gains exemption or a spouse’s unused portion of a capital gains exemption. This is accomplished by having owning the shares in the name of the client’s mother. A nominee shareholder agreement may be used to show that the mother was a mere legal holder for the son who is the beneficial owner.
- Inheritance It is common to pass on family wealth in a gradual manner to be used for day-to-day living expenses. For example, a father, who is getting on in years but still wants to maintain control over his assets, transfers assets to his children using this structure. The parents’ need for security is protected while at the same time allowing the children to make day-to-day decisions in managing these assets.
- Real Estate One parent (or both) transfer property into a corporation and can specify if the property is to be distributed to the children on the equal basis or left to the children to manage on an ongoing basis.
Preparing Your Nominee Shareholders Agreement
Drafting a shareholder agreement to govern the relationship between a company’s nominee shareholder and other shareholders effectively is critical to minimizing compliance risks down the road. There are several fundamental issues an issuer must address in the agreement, including: (i) the number of shares owned by the nominee; (ii) economic rights to dividends and liquidations proceeds; (iii) voting rights; (iv) transfer restrictions; (v) share pledge provisions; and procedures for bringing dividend or liquidation distributions through to the beneficial owner of the shares. Many companies also choose to include a robust convention regarding the number of shares that a nominee effectively holds for any parent company. A nominee service provider may refuse to accept indemnification provisions , so litigation expenses should be addressed as well, preferably by making it a liability of the issuer. Shareholder agreements must also address termination of the agreement by outlining how a beneficial owner can identify the termination of the agreement to the issuer.
Pitfalls & Concerns
The use of nominee shareholder arrangements can give rise to a number of risks and challenges which the investor ought to be aware of.
The primary risk faced depends on the motives behind the need for nominee arrangements. Usually there is an element of privacy or confidentiality in a person wanting to hold shares through another person and its boilerplate in nominee documents that the nominee is not the real owner. There is also a risk to share ownership if the relationship between the parties deteriorates and a listed company may have further risks impacting its share price from having a "secret" owner.
There could be a risk to the investor’s ability to enforce its rights if the agent refuses to comply with its instructions. Even though there is no fiduciary duty owed to the investor by the agent there could still be a breach of contract in the agent failing to abide by any instructions from the investor to it to comply with agreements regarding the shares.
Some companies have policies in their articles of association restricting the holding of shares by nominees and they need to be reviewed on a case by case basis. These restrictions may not be strongly enforced and may relate more to contravening the confidentiality policies than a full prohibition on ownership by nominees. In any event, the shareholders of a company are neck-deep in statutory entrenchment and the courts and companies tribunal are now even more empowered to assist in the enforcement of statutory, common law and constitutional obligations of companies.
If you wish to ensure a decisive right to disclosure of confidential information, you ought to complete your own due diligence on the underlying assets at the same time that you enter into your nominee arrangements.
The rights of a company to request disclosure from a shareholder recently came under the spotlight, requiring them to furnish a list of nominee shareholders of its shares upon the request of a shareholder.
There are a number of solutions to mitigate the above risks, including an undertaking from the nominee to comply with all instructions of the investor. You should remind the nominee of this obligation and insist that they terminate the services if they fail to do so. Additionally, the nominee upon being appointed ought to provide the investor with a right of termination in the event of requested compliance with its fiduciary duties, backed by a right to specific performance.
Although nominees may not owe a fiduciary responsibility to the investor, you could entrench obligations and responsibilities of the nominee in a shareholders’ agreement or a nominee shareholders’ agreement. The power of attorney granted to the nominee ought to be expressly limited to the exercise of rights in accordance with its fiduciary duties.
Nominees may be required to disclose such information to the investor’s attorneys upon appointment and, failing which, the power of attorney to act in respect of the shares ought to be restricted until they have done so.
Relevant Case Law and Past Rulings
The matter of nominee shareholding agreements has been before the courts on a number of occasions and several legal precedents have been set. This article looks at some of the relevant divisions in the Companies Act and a few case studies which are of significant interest.
One of the most relevant divisions of the Act in governing nominees is section 53, which deals with the power of contracts to bind successors-in-title in the event that a company merges, is acquired or its assets are sold. The section essentially provides that this successorship is subject to the company’s articles of association. It is important to bear in mind that there is a distinction between a commercial sale of shares as part of business acquisition and the acquisition of shares with a view to an investment. The former is governed by sections 53(2) and (3) of the Act which deal with the question of whether the purchaser can require the company to register the transfer of shares in the name of the purchaser, in which event the company must comply. Section 53(3) states specifically that this power is not available if it is opposed by a special resolution of the nominees binding the company. These provisions are of particular relevance to nominee shareholding agreements, often taking the foreign investor one step closer to his objective.
A useful example that illustrates the implications of section 53(3) of the Act is Cape Pacific Ltd v Lubner, so let us take a look at it. Cape Pacific Ltd (Cape) was the shareholder of D’Amercia Unity Ltd (D’Amec), also a South African company, which owned and controlled a number of businesses and managed properties. In terms of the articles of agreement, any change in shareholding was subject to a right of first refusal (RFR) in favour of fellow shareholders. Cape concluded an agreement for the sale of its shares to a company called Captain Limited (Captain). The share transfer was resisted by three shareholders of D’Amec who held special rights and therefore invoked the RFR. Cape was dissatisfied with the RFR procedure and sought to terminate its nominee agreement with regard to D’Amec’s shares. Its contention was that its interest in D’Amec did not extend beyond a bare trust, which had been terminated by the sale of its shares. The court found that an RFR could not be applicable to share transfers, or at least those containing substantial changes in the nature of business operations, and Cape’s termination of the nominee agreement was without prejudice to its rights under the nominee agreement regarding the shares.
Another important case is A & A Jossy Trust (Pty) Ltd and others v King and others. In this case, A and B were directors of Wyatt Ltd and shareholders of Future Holdings Ltd. Upon discovery of discrepancies in the accounts of Wyatt by the auditors, A and B would not allow the auditors to make their final report. They subsequently terminated their nominee agreements with Wyatt in order to sell their shares in Future Holdings to JB. The shareholders of Future Holdings had no choice but to accept the offer. The main issue in dispute was whether or not A and B could terminate their nominee agreements in order to sell their shares in Future Holdings to JB. In this case, the court found in favour of A and B and held they were entitled to terminate the nominee agreements and proceed with the sale to JB.
The discussion that follows highlights the aforementioned distinctions between nominee shareholding agreements. In the matter of Socimi v AEG Capital Management, AEG Capital Management (Pty) Ltd (AEG) was to acquire shares in Socimi (Pty) Ltd from Universal Healthcare (UK) Ltd (Universal) and Altracinx (Pty) Ltd (Altracinx), two nominee shareholders, as part of a proposed, complex transaction. But Socimi sought to withdraw the agreement, mainly on the basis that AEG was supposed to undertake due diligence on Socimi, but was unable to do so. The court found that the nominee shareholders had no obligation to provide AEG with information for the purposes of due diligence because it was not expressly included in the agreement. Any failure by the nominee shareholders to provide such information could not breach their agreement because this too was not expressly stated as an obligation.
A variation of this discussion is found in Visser and another v Hemat Finance Corporation (Pty) Limited. In this case neither the nominee purchaser, Hemat (Hemat), nor the seller company, Gys Visser Jr, could be regarded as shareholders of Advanced Mining Technologies (Pty) Limited, because the nominee shareholding was for financing purposes only. As such, there could not be valid opposition to the proposed sale by fact which aced to prevent it. Even though the nominee shareholders of Advanced Mining Technologies (Pty) Ltd had no right to oppose a sale, the nominee shareholder of AfriCity (Pty) Ltd did, and Hemat failed in its bid to acquire AfriCity because it failed to inform the nominee shareholder of AfriCity about the intended sale.
A last example is that of Quintec Ltd and others v Xari Investments Co Ltd and others. Quintec Ltd and others (Quintec) entered into a service agreement with Xari and others (the respondents). The service agreement stated that the respondents had to acquire all of Quintec’s shares in certain companies by way of various written agreements, after proper due diligence had been conducted. The respondents did not conduct due diligence on Quintec’s shares in the companies. However, a special resolution of Quintec required the remaining shareholders to sell their shares to the respondents. Quintec thus sought to stop the respondents from acquiring its shares in the companies on the grounds that it had not received due diligence papers and that its shareholders had not consented to the transfer of its share. The court ruled in favour of Quintec, highlighting that by virtue of the exclusion in Article 53(3), the transfer of the shares could not be executed against Quintec’s will, no matter whether or not the listing shares were not encumbered.
Conclusion and Common Practices
Best Practices
For shareholders on the Canadian register, the proceeding best practice is to seek legal advice in the initial stages of developing both the Nominee Shareholders Agreement and the corresponding Beneficial Ownership Agreement, if requested, with their corresponding nominee.
The drafting of the Nominee Shareholders Agreement requires a detailed analysis of the risks involved in entering into such agreement and a thorough review of the associated corporate documents. Shareholders should also be mindful of the disclosure requirements under the Income Tax Act and the associated risks in the event those requirements are violated. If the specific circumstances of each of the parties involved are carefully considered in drafting the Nominee Shareholders Agreement , many of the difficulties will be avoided. It is also important to periodically review the terms and conditions of the Nominee Shareholders Agreement should changes in law and circumstance arise over time. The history of Canadian corporate law has shown that the Canadian government may take a more aggressive and assertive approach towards issuing tax reassessments for tax years in which the terms of such agreements were supported by substantial authorities from the courts. Accordingly, careful planning and drafting of the Nominee Shareholders Agreement will result in a minimal risk of future issuance of tax reassessments. Successful nominees will invariably be those who communicate frequently with their corresponding shareholders and discuss any significant changes in their circumstances and those changes that will affect the business or affairs of the corporation.
Overall, there is a need for increased transparency with all parties involved as failing to disclose the relationship may not only be subject to sanction by Canada Revenue Agency but could be seen as untrustworthy behavior resulting in a breakdown of the working relationship between the parties.
