Offshore jurisdictions increasingly place regulatory demands for the formation and maintenance of offshore companies, which are not easily met by the offshore investor. The primary cases include the following:
#1. There might be a minimum amount of shareholders or directors, which are not available in the investor’s team.
#2. There might be corporate residency requirements in the offshore jurisdiction, although the business model does not require local staff.
#3. There might be tax residency requirements for the applicability of a double tax treaty (economic substance test).
#4. Under the place of effective management and control principle, there might be a corporate income tax liability in the jurisdiction where the only director is a resident.
#5. There might be banking requirements for one or more persons to act as signatories on the bank account.
#6. The unwanted publicity of the non-private company register with the right to inspection without the proof of legitimate interest might discourage the investor to take over these functions by himself.
#7. Other cases not to be disclosed here.
The industry standard to fix this issue is to use a dummy shareholder, dummy director, and/or dummy bank account signatory. Such straw persons are provided by so-called “nominee services” against a yearly fee. Nominees promise an additional layer of distance and privacy. Typically the service providers assure that the nominee’s role will only be a formality to keep the books clean and the government happy, but that the business will not be managed by the nominee. “It’s always worked out fine before.”
Under a nominee agreement, an individual agrees to hold shares or to act as an appointed director without having the burden and benefit from this legal position. This includes the voting power respectively power of representation and dividends and profits, except his nominee service fee. When entering into such a nominee agreement, the investor should consider three aspects, which might be essential for his investment:
- Is this legal?
- Does this work in practice?
- Is he sufficiently protected?
KYN: Know your nominee and understand his role and purpose
Under certain local laws, it might be simply illegal to act as a nominee. The laws might require registering the true decision maker as director and the beneficial shareholder in the company register. The purpose of such a law might be clarity, or for example certain foreigner restrictions. The legal effect might be invalidity of the nominee agreement with all its restrictions, or the whole arrangements might be deemed to be a criminal act.
To hide the true director and the place, where business decisions are made, might be tax evasion in the investor’s home country and even in the offshore jurisdiction because the director`s place of residence usually determines the final taxation outcome. A nominee typically does not qualify as a residential local manager. At least formal registration requirements may be not properly fulfilled.
If the nominee opens a corporate bank account, this might trigger certain KYC (know-your-customer-) requirements and violate banking laws. In the time of anti-money-laundering provisions and special anti-terror financing rules, the legal effects might be surprisingly strict and harsh.
The contractual relationship with the nominee
The nominee is the body double for the ultimate beneficial owner or the shadow director, who intends to hold and manage the offshore company through the nominee. They have an apparent conflict of interest in three areas:
- The person behind (the “backman”) demands that the nominee acts by following all orders and requests. The nominee has to avoid any illegal activity and needs indemnity for any damages caused during his nominee position. These aspects could be agreed in one nominee contract, but are typically separated in a “letter of indemnity” for the benefit of the nominee and a “declaration of trust” for the benefit of the backman.
- The backman requires a power of attorney which puts him (at least as a backup) in a legal position near to a real director or shareholder. The nominee has the authority to act for the company but needs certain information rights for his own compliance and risk management.
- The backman feels comfortable with a non-dated (blank) resignation or termination letter, signed by the nominee. The nominee might in some cases ask for a non-dated letter of acceptance by the backman, to be used to jump the ship in the event of an emergency.
All these documents are not at all standards but should be designed per the specific situation. To wave for a review and adjustment of the forms presented by the offshore service provider is no winning strategy.
If the nominee structure is implemented to hide the ultimate shareholder and to let the real company manager stay in secrecy, the question is whether this will also work under a stress scenario. A nominee director or shareholder “typically” will not do anything unless instructed by the investor. However, the nominee might be approached by angry business partners of the company, by his own or a foreign revenue service, or someone gonna make him an offer he can’t refuse. The pressure might not come from third parties but the nominee himself. He may ask for additional secrecy fees and has an excellent negotiating position to be successful in blackmailing the investor.
It is the offshore industry practice that the investor, who “buys” an offshore package including nominee services for a lump sum fee, does not have close contact with the nominee himself. It is just a name on some sheets of papers. Obvious questions arise:
- How to assure that the nominee does not misuse his power under the nominee agreement,
- How to find the nominee, if he steals the assets and hides on a sunny tropical island, and
- How to enforce the termination of the nominee agreement to take back the shareholder/directors/bank signatory position.
Blank share transfer agreements, letter of dismissal from duty, director’s resignation letters and other suitable declarations or pre-arranged transferring documentation, powers of attorney to the investor and declaration of trust to assure that all the instructions of the beneficiary in relation to the allocation of dividends, shareholders’ resignation, share transfer, etc. are duly fulfilled – do they work in an unfriendly business environment? Is a signed but undated blank agreement really legal under local laws? Is the investor sufficiently protected? Is a risk management system in place?
Nominee arrangements have the purpose to increase privacy. If the beneficial shareholder is not registered in the company register, he might not like the nominee to disclose his personal data to everyone on the first request. Therefore, the contractual agreement, under which condition such disclosure is permitted, is one of the imminent cornerstones of the contractual agreement with the nominee.
There might be the common practice to keep customer’s data confidential unless a local court injunction in the offshore jurisdiction demands a disclosure. Disclosure might be required and properly agreed vis-a-vis the offshore tax authorities or the banks. But what are the contractual obligations if, e.g.
- the Russian revenue department offers a finder’s fee as a reward for tax evaders,
- the U.S. lawyer approaches the nominee by e-mail with respect to a product liability claim,
- a British divorce lawyer asks for a notarized and apostilled declaration to be used in court by the beneficial shareholder’s greedy (ex-)wife, or
- a non-governmental anti-offshore organization asks for a list of ultimate shareholders to be published on an offshore-leaks website?
It is evident that these and other case groups need a clear contractual arrangement with the nominee and if the declaration of trust is silent in this respect, the nominee deserves neither confidence nor trust. Therefore, a list of non-disclosure covenants has to be agreed and a robust mechanism to be implemented if the nominee defaults under these covenants. It is not unreasonable to expect that the offshore service provider takes over the responsibility and liability for the nominee if he provides and controls such persons.
A similar need for clear agreements is given concerning the nominee director and the shadow director.
- The disclosure of the existence and identity of the shadow director might, above other legal and tax consequences, result in an ambition of his tax authorities in to enforce the tax liability of the offshore company in his jurisdiction under the management and control tax principle.
- By the Letter of Acceptance, the nominee director has a tool to install the shadow director as regular director and register him at the company register. But in which cases is he allowed to execute this instrument? A good industry practice implements reasonable clauses in the nominee agreement. A bad industry practice has no such definitions and the shadow director is at the mercy of the nominee.
The awkward enforcement of contractual rights against the nominee and the nominee hunt on tropical islands
The nominee might be an honorable, financially independent person, living in best health with a proper condition and in an orderly business and private environment. The nominee service company might be as long-established, respected and renowned as they declare on their glossy website. Or they may not.
Nominee profiles, as can be found on the Internet. Would you prefer the search engine optimizer or the tour guide to handle your top confidential offshore business and asset protection? Would you even buy a used car from them?
Contractual clauses and strict documentation of the do’s and don’ts does not prevent the nominee from his autonomous decision to “take the money and run”. It depends on the individual case, whether he/she will have direct or indirect access to valuable assets and whether there is a place to hide for him. It is not unusual that his hideaway simply consists of the fact that the stolen money had not been properly declared or taxed by the beneficial owner and, therefore, the criminal complaint would have worse consequences for the beneficial owner than the thief.
Long-time experience in advising on collapsed offshore structures and the hunt after luckily escaped nominees shows that many investors rely blindly on unknown nominees thousands of kilometers away and, as a consequence, have to learn the proverb “Trust kills faster than bullets” the hard way.