Where offshore intermediate holding companies are used as part of a corporate group, it is not uncommon to find that the local directors are appointed by, and follow the orders of, its parent company. The recent Privy Council case of Central Bank of Ecuador and ors v Conticorp SA and orsprovides a striking illustration of how, in the use of offshore companies managed by nominee directors, care must be taken to ensure those companies are run properly as separate and independent legal entities.
Conticorp SA, a company based in Ecuador, owned Groupo Financiero Conticorp SA (GFC) and in turn, two banks (the Banks). Through the Banks, Conticorp had invested heavily in Interamerican Asset Management Fund Limited (IAMF), a company based in the Bahamas.
IAMF held itself out as an independent investment management fund, with an individual - Mr Taylor - as its sole director and nominated investment advisor. However, through its various holdings, Conticorp in reality owned and controlled IAMF and Mr Taylor acted in accordance with the instructions of Conticorp.
Following financial uncertainties in late 1995, the Central Bank of Ecuador (Central Bank) provided emergency subordinated loans to the Banks in order to keep them from collapse. The Central Bank thereby became a major creditor of the Banks.
Over the course of three transactions executed during 1995/1996 (the GDR Transactions), IAMF transferred to Conticorp substantially all of its assets, comprising a valuable loan portfolio and interests in various companies with an aggregate face value of more than US$190 million (thePortfolio). In return, Conticorp procured that certain Global Depository Receipts and other securities in its subsidiary, GFC, were issued to IAMF.
The central point was that the Global Depository Receipts and other securities received by IAMF turned out to be worth substantially less than the value of the Portfolio. At the time the Portfolio was transferred, GFC and its subsidiary entities – the Banks - were in significant financial difficulties, and accordingly the Global Depository Receipts and other securities “could not honestly have been thought to have value, or at least value in any way commensurate with that of the[Portfolio]”. Further, it was determined that there was no realistic prospects of IAMF selling the Global Depository Receipts on the open market – so in essence, IAMF paid $190 million for securities which were worthless.
On those facts, it seems a clear case of a transaction orchestrated by shareholders – Conticorp – in order to illegally extract value from its failing subsidiaries before the Central Bank exercised its rights as a creditor to seize the remaining valuable assets. This is of course precisely the kind of mischief that most insolvency legislation seeks to guard against.
The Central Bank eventually became the ultimate owner of GFC, and therefore the Banks and IAMF. Having analysed the circumstances of the GDR Transactions, the Central Bank joined IAMF in a series of claims against Conticorp and certain individuals who were part of the family that ultimately controlled Conticorp (the Respondents) seeking to recover some or all of the assets lost by IAMF through the GDR Transactions.
The Central Bank’s claims were dismissed at first instance, and again in the Court of Appeal, but the claims were successful on further appeal to the Privy Council. In the Privy Council, the claims were distilled down to an analysis of: (a) whether, by carrying out instructions given ultimately by Conticorp, without exercising any independent judgement, Mr Taylor had acted in breach of his director’s duties to IAMF; and (b) whether Conticorp and the other Respondents were guilty of dishonestly assisting in the breach by Mr Taylor of his duties.
We look at both of those crucial points further below, but first, a point on procedure.
Although the Privy Council accepted that only in very limited circumstances should it should interfere with findings of pure fact made by a trial judge, in this case the lower courts had made a number of glaring errors. In particular, they had “failed to appreciate or address a central aspect of IAMF’s case on dishonesty”, focussed on irrelevant aspects of the circumstances of the case, and were “fundamentally flawed”. Critically, the courts below had failed to analyse whether the Respondents believed, or could honestly have believed, that the value received by IAMF pursuant to the GDR Transactions was at least equivalent to the value of the Portfolio transferred by IAMF in return and, in turn, whether the GDR Transactions could honestly have been regarded as in the best interests of IAMF.
Accordingly, given such flawed earlier judgments, the Privy Council reopened the analysis around the probity of the Respondents in this case: “The Board [of the Privy Council] regards it as necessary, in the…circumstances, to review for itself whether there was a sound basis for the general finding of honesty which was made by the courts below, when this finding was made without analysis of the factors … indicating that the transactions, when agreed, served no purpose of IAMR’s and no useful purpose of anyone other than the Respondents.”
Nominee directors and fiduciary duties
When appointed, Mr Taylor would have been fully aware of the fact that Conticorp did not want or expect him to question their instructions as to how IAMF was to be run. The Privy Council concluded that “from all the evidence, IAMF at all times acted, and acted only, on and in accordance with the instructions of the Respondents” (para 111).
As Lord Denning said in his well-known speech in Boulting v Association of Cinematograph Technicians , there is nothing wrong with a director being nominated by a shareholder to represent his interests ‘so long as the director is left free to exercise his best judgment in the interests of the company which he serves. But if he is put upon terms that he is bound to act in the affairs of the company in accordance with the directions of his patron, it is beyond doubt unlawful.’
Based on the principle set out by Ungoed-Thomas J in Selangor United Rubber Estates v Cradockthat a director ‘who acts without exercising any discretion, at the direction of a stranger to the company is fixed with the stranger’s knowledge of the transaction’, Mr Taylor was deemed fixed with the knowledge of Conticorp and specifically its knowledge that the Global Depository Receipts were worth much less than the Portfolio.
On this basis, the Privy Council had no difficulty in concluding that Mr Taylor had breached his duties to IAMF: in particular, his duty to exercise independent judgement, and his failure to act in what he considered to be in the best interests of IAMF. Had he exercised independent judgement and considered whether the GDR Transactions were in the best interests of IAMF then, being fixed with the knowledge of Conticorp as to the value of the Global Depository Receipts and other securities, he would surely have concluded that the GDR Transactions were not, and would not have caused the company to enter into them.
The fact that Mr Taylor was appointed as a nominee director and paid only $2,500 per annum for his services was held irrelevant: the level of remuneration paid, and the circumstances and manner of a director’s appointment, cannot exempt or in any way relieve a director from the duties he owes.
Thus far, IAMF would only have had a claim against Mr Taylor personally – which might have bankrupted him but which would not have enabled IAMF to recover anything like the full value of the Portfolio. However, IAMF went on to make claims against Conticorp and the other Respondents on the basis that they had dishonestly assisted in a breach of fiduciary duty by their nominee, Mr Taylor.
Lord Mance summed up this head of claim at para 50: “Acting as an officer of one company, a person may dishonestly procure or assist a breach of duty by the director of another company, in which case such person may make liable for dishonest assistance both himself personally and the company of which he is an officer. Otherwise, individuals acting as officers of a company could never commit any wrong tortious or equitable. What matters in the present context are, in short, the factual questions whether the Respondents procured or assisted Mr Taylor’s breaches of duty, what knowledge they had when giving such assistance, and whether any honest person(s) in their position giving such assistance with that knowledge could have believed that the relevant transaction was in IAMF’s interest.”
That Conticorp procured Mr Taylor’s breaches was readily established.
As to their knowledge, Conticorp would have been well aware of the financial difficulties of the Banks, of the value of the Portfolio, and of the risk that if it did not intervene the Portfolio might be lost to creditors of the Banks. The Privy Council therefore found that the GDR Transactions were, when entered into, not transactions which persons in the Respondents’ position could honestly have considered to be in IAMF’s interests, in the light of what they knew. Further, IAMF was regarded as a tool used by the Respondents at their behest and for their own purposes, without thought being given to what was in the best interests of IAMF as a separate entity.
The Respondents were therefore liable for having dishonestly assisted Mr Taylor in his breach of duty and were liable to repay the full face value of the Portfolio, amounting to some $192 million.
The sting in the tail
In addition to awarding that the full face value of the Portfolio be repaid to the Central Bank, the Privy Council also awarded compound interest by way of equitable compensation which, based on US$ prime rates, amounted to an extra $382 million, plus costs.
GDR Transactions aside, the circumstances of this case are very common. Many international corporates use offshore holding entities as part of their group structures and often for good reason. What lessons can be learned from the case?
(Although the following is based on the rules applicable to directors and shareholders of UK companies, it would be prudent to assume that similar rules will apply in other jurisdictions, as was the case in Conticorp.)
Lessons for appointing shareholders and parent companies
- When setting up an intermediate holding company and appointing directors to the board, a parent company must remember that the holding company is a separate legal entity, and that the directors are likely to have duties to act in the best interests of the company. The directors must therefore be allowed actually to direct – i.e. decide for themselves, using their independent judgement, what is in the best interests of their company. Appointing someone as a director who is simply a “stooge” is very likely to put the director himself in breach of duty, and could well cause the appointing or controlling shareholder to be liable too.
- In circumstances where the interests of the company do not coincide with the interests of the parent, both the directors of the company, and the parent, will expose themselves to liability if they simply cause the company to do the parent’s bidding. The risk is multiplied if the company is facing financial difficulties and carries out a course of action that is designed to benefit the parent company at the expense of the company’s creditors.
- Broadly speaking, the more a parent interferes in decision-making by the board of the company – in terms of both the frequency and magnitude of its interference - the greater the risk of the parent being liable to compensate the company if it suffers loss as a result. Such liability could arise through (among other things) the parent being found to have dishonestly assisted in a breach of duty by the directors (as in the Conticorp case) or through the parent being treated as a “shadow director” of the company. In effect, such interference could cost the parent the protection it would otherwise have had through using a limited liability holding company.
- However, there is usually nothing wrong with a parent or appointing shareholder conveying to its nominee how it would like him to act, or what course of action it considers would be in the best interests of the company, provided that the director is then allowed to make up his own mind. But if the circumstances are such that the director has little choice but to do what the parent “wishes”, even if no direct instruction is given, both the director and the shareholder will expose themselves to the risk of liability.
Lessons for nominee directors
- In the UK at least, there are no special rules for “nominee” directors – i.e. those who are appointed by one or more shareholders to represent their interests. They are subject to the same director’s duties as any other director. Surprising as it may seem, a nominee director of a holding company being paid £100 per year will owe the same fiduciary duties to his company as the CEO of a FTSE100 company.
- Before accepting an appointment, ask yourself whether the level of remuneration you will receive from acting as a director is sufficient to compensate you for the risk of personal liability that you will assume. Note also that following recent amendments to the UK Company Directors Disqualification Act 1986 you could be disqualified from acting as a director of a UK company for up to 15 years if you are found guilty of an offence relating to the running of an overseas company: for further details see our LawNow articles on the amendments and the original proposals.
- Take advice from lawyers who are qualified to advise on the company law of the country in which the holding company is incorporated on matters such as:
- what are the duties of a director, and how do they compare with international best practice;
- to what extent can these duties be cut down or modified – e.g. by means of provisions in the company’s constitution;
- to what extent can the company or its shareholders release a director from breach of duty either in advance or retrospectively, or indemnify him against any liability he incurs for acting in breach of duty;
- whether the company can purchase directors and officers insurance.
- Remember that if you act in breach of duty, it is possible that you could be liable to pay money to the company even if it suffers no loss.
- Make sure you will have access to sufficient information about the business, activities and financial position and prospects of the company to make an informed decision about what is in its best interests. In particular, you will need to know about any commitments or events that could threaten the company’s ability to continue trading on a solvent basis.
- Be particularly cautious about approving any course of action that seems to provide little or no benefit to the company, either directly or indirectly – e.g. where the company is being asked to assume or guarantee a liability of its parent or a sister company - or where the consideration or other quid pro quo to be provided by the counterparty in return for a transfer of the company’s assets may not be worth its face value – e.g. where (as inConticorp) the consideration is in the form of securities or other assets that are illiquid and/or difficult to value.
- Remember that it is not just where the company goes insolvent that you could be at risk of a claim being made against you. If your company is sold, and the new owner considers that, for example, the company’s position or prospects were worsened by transactions that you approved, they could cause the company to bring claims against you. And, depending on the company’s activities, a regulator might be able to bring criminal or civil proceedings against you – e.g. where your company or its subsidiaries have been involved in breaching legislation relating to bribery, anti-competitive practices or environmental damage.
- Record in the board minutes or related documents the reasons why you believe a course of action is in the best interests of your company. Consider obtaining confirmation or advice from an independent third party – e.g. to value illiquid assets.
- Under UK law at least, you are entitled to take into account the interests of your appointing shareholder provided that ultimately your decision as to whether the company should follow a course of action is based on your own independent view of what is in the best interests of your company. Often you may be able to decide that the course of action preferred by your appointing shareholder is also in the company’s best interests. But where the best interests of your company differ from those of your appointing shareholder, you must do what is in the best interests of your company - even where you risk incurring the wrath of your appointor, losing your appointment and/or damaging your career prospects.
- If in doubt, ask the company’s shareholders to approve the relevant course of action. Such an approval is unlikely to completely protect a director against personal liability, particularly if the course of action is plainly not in the company’s best interests and/or the company is or may be insolvent, but in some circumstances it may help. Taking local law advice is of course also a good idea.
- Avoid referring to yourself as a “nominee” director, because the term “nominee” tends to connote a person who is appointed solely to carry out a task (e.g. to hold and deal with property) for the benefit of another and who will act only in accordance with the other’s instructions. Referring to yourself as a “nominee director” could therefore create the impression that you have surrendered all discretion to your appointor, which might encourage, say, a liquidator or regulator to bring a claim against you for breach of duty and/or a claim against your appointor. Instead, refer to yourself as a “nominated director”, “shareholder-appointed director” or something similar.