How to effectively mitigate the potential for a tug of war between the duty to the Company and the duty to the Principal/Nominator
BY KERRY-LEE FOX, ASSISTANT LEGAL COUNSEL
While there is no lack of theoretical discussion on the need for more transparency in the ownership and control of companies, taking a more practical approach, this article’s aim is to explore the use of nominee/corporate director services, highlight the challenges inherent in relationships of this nature and how the arrangement can be practically and effectively managed so as to ensure the desired outcomes for both the service provider and the principal.
Definition and Uses
Traditionally there has been a distinction made between de jure directors i.e. directors who are validly appointed and registered as directors and third party (de jure) directors i.e. persons who act in accordance with the directions or instructions of an interested party. In other words, the term ‘nominee director’ is convenient shorthand for an individual or corporate entity who is appointed on the understanding, whether formal or informal, that he represents the interests of some person other than the company, usually the person(s) who nominated or, by some means, appointed him (commonly referred to as the ‘principal’ or ‘UBO’).
One of the main drivers behind the need and use of third party directors is to ensure that the names of a company’s true directors or beneficial owners are not disclosed in any records, thus ensuring privacy. Concerns around asset protection are a significant driver behind why clients seek privacy and the use of third party directors can be an effective way to add a much needed layer of protection for those seeking to keep their assets safe from corrupt governments or individuals, potential future creditors or from the threat of corporate espionage. Other uses for a third party corporate director are simply that such is required by the particular jurisdiction to fulfil a statutory requirement for a local resident director.
While it is a perfectly legal device recognised by most jurisdictions, the real challenge lies in how third party directors balance the duties owed to the company and the duty to protect and act in accordance with, the interests of the principal/UBO who appointed them.
While directors owe an overarching legal (and in most cases, statutory) obligation to serve in good faith in the best interest of the company on whose board they are members, they are also proscribed from placing themselves in positions where their duties to the company conflict with their personal interest or with duties they owe another person. Clearly then, a third party director acting on the instructions of a principal occupies a position with the greatest potential conflict.
To act ‘in good faith’ is to act honestly or sincerely, without an intention to deceive. This is also known as acting bona fide. A decision made by a third party (or any) director in good faith can be defined simply as: a decision where there is a genuine belief on the part of the (third party) director that it will be for the benefit of the company as a whole and not merely for their or another’s personal interest. However, this does not mean the decision cannot also benefit a third party. A decision that benefits both the company as well as an interested third party is not necessarily one made in bad faith.
However the fact remains that the duty owed by a director is first and foremost to make decisions they genuinely believe to be in the best interest of the company. A few cases which illustrate this are:
Dairy Containers Limited v NZI Bank Limited & ORS; Dairy Containers Limited v Auditor General & ORS, New Zealand Court in 1994, held that reporting by nominee director to the nominator is natural and comes out of loyalty. However, in case of any conflict of interest, the loyalty to the company overrides the loyalty to the nominator.
Similarly, in Bennetts v Board of Fire Commissioners of New South Wales ((1995) 7 BOND L R), the following remark was made: “In particular, a board member should not allow himself to be compromised by looking to the interests of the group which appointed him rather than to the interests for which the board exists. He is most certainly not a mere channel of communication or listening post on behalf of the group which elected him.”
Moreover, the potential shifting landscape as it concerns where the ‘mind and management’ of a company resides, presents its own unique challenges in the context of third party directors and is therefore an important consideration when looking to appoint third party directors. Despite the traditional rhetoric and distinctions made between de jure and de facto directors, in truth, the distinction is much more nuanced and goes beyond how someone simply refers to themselves or in what capacity a person was appointed. In deciding whether a third party director occupies the position of a de facto director most judicial body’s will look at the circumstances and functions of the third party director to determine whether or not they have assumed the status and function of a de facto company director at one point or another.
Given the above and the fact that corporate tax obligations are often linked to where a company is considered to carry on its ‘real’ business and this in turn is considered to be where the central management and control actually abides, it is important to consider the potential tax implications of appointing a third party director.
Managing the Relationship
One of the aims of Southpac’s corporate management offering is to effectively balance its fiduciary duty to act in the best interest of the company and the duties owed to protect and act in accordance with, the interests of the principal/UBO who appointed them.
Due to the nature of the fiduciary and legal duties of a manager/director of a company, which cannot strictly be contracted out of and the specific challenges imposed on corporate directors, Southpac adopts a situation-specific analysis at the on-boarding stage. Some of the key aspects that can inform a decision are:
- motivating factors i.e. why a nominee relationship is being sought;
- the administrative impact e. if a corporate director is best suited to add value;
- the stage of maturity of the company and its overall purpose;
- type of company we are dealing with, the nature of expected business/transactions and the skills required by corporate director at the present phase of the company’s development;
- the particular expertise and knowledge of the UBO/principal upon whose instruction it is proposed Southpac will be acting; and
- potential tax implications associated with ‘mind and management’.
Assuming our base line risk assessment points to the feasibility and appropriateness of entering into a corporate management relationship, Southpac will look to enter into a corporate management agreement with a principal which will essentially govern the relationship.
Our approach to mitigating the potential for a tug of war between competing interests and duties is to ensure that requests pursuant to the corporate management agreement are managed and considered on a case by case basis and appropriate checks and balances are being observed. Southpac’s approach is that any instructions of a principal will be carried out subject to the corporate manager’s review of applicable laws, company laws (via operating agreements/articles of operation) and its fiduciary duties. Further, where the review of an instruction provides that the transaction carries risk for the corporate manager, the corporate manager may request additional information or documentation (including member’s minutes authorising the transaction or a transaction-specific indemnity).
There are many reasons why third party corporate director services are sought. Where such motivators centre round privacy and asset protection the scope and use of such directors can be an effective tool to provide a much-needed layer of protection for clients.
Due to the nature of the fiduciary and legal duties of a manager/director of a company and the fact that distinctions between third party directors and de facto directors is much more nuanced in today’s legal landscape, there are a number of considerations that need to be taken into account in order to effectively understand and mitigate any potential risks associated with such appointments, tax or otherwise.
An effective corporate management arrangement can ensure that expectations are managed and prevent unintentional tugs of war between the duty the corporate director owes to the company and the duty it owes to the principal/nominator. This is achieved by having a risk mitigation process in place by which corporate management arrangements are on-boarded, followed by a more issue-based and continuous risk assessment approach thereafter.
For more information on Southpac’s Corporate Management Services please contact us