What is the Purpose of a Nominee Agreement?
A nominee agreement is used to explicitly create a nominee relationship, often followed by one person acting on behalf of another. In effect, it is an agency or an act for another. In terms of corporate entities, a nominee director or a nominee shareholder will hold the relevant office or shares for the benefit of someone else. Indeed, the statutory duties and fiduciary duties of the individual do not apply to the entity for whose benefit the individual is acting.
Nominee agreements create obligations and rights on the part of the nominee and the nominator. They are, in effect, a mandate by which the nominee agrees to act for the benefit of the nominator. Oftentimes, the nominee does not keep the assets they are holding or the benefits of their service to themselves. By using a nominee agreement, it allows the actual owner or beneficiary to hide their identity, although in most instances, this is a function of database issues, such as the Companies Registry.
For example, a nominee director of a company will know all information pertinent to the management of the affairs of the company, and will act according to the instruction of the principal. It is important therefore in corporate situations where the nominee is a director , to have a very clear and unequivocal nominee agreement in place. The nominee agreement should expressly state the extent and the limitations of the power of the nominee e.g. the nominee’s duties and the circumstances in which the nominee should act at their own discretion and when they should act according to instructions given by the principal.
In a nominee shareholder situation, the beneficial shareholder will be able to control the voting at shareholders meetings and will be entitled to dividends. This arrangement is frequently used in Singapore in order to avoid having the real shareholders’ names in the register of members of a company.
The nominee relationship may be contractual. It clearly signals the intent of the parties to be subject to the terms and conditions expressed in the document. It may be used in various scenarios: Notwithstanding the fact that a nominee agreement is binding in the absence of any express statutory provision that a particular agreement is otiose or void in certain circumstances, it may nevertheless be disregarded by a court of law on public policy grounds. The nominee relationship operates as a shield for the investor, providing him/her a thorough level of privacy, but obviously "working" only if the whole transaction is legitimate or if the entire transaction satisfies the relevant legal requirements.
How a Nominee Agreement Functions
The Mechanical aspects of nominee agreements are not very complicated. The principal executes a nominee agreement and usually a power of attorney appointing the nominee to serve as the principal’s agent with regard to the assets described in the nominee agreement. In most typical nominee agreements, the nominee agrees to hold or manage the property of the principal in the nominee’s name.
The nominee then simply holds title to or manages the property on behalf of the principal. The high risk event that would cause significant harm to the principal would involve the nominee misappropriating the assets, failing to carry out the owner’s intent, or being forced to sell the assets to pay creditors of the nominee, or for some other reason.
The typical terms of a nominee agreement include a description of the property to be subject to the nominee agreement, the duties of the nominee with respect to the property, how the nominee may be compensated by the principal for the nominee’s services, the rights of the principal to terminate the nominee agreement, the rights of the principal to revoke the power of attorney, and the duties of the nominee upon termination of the agreement or revocation of the power of attorney (for instance, return of the property to the principal).
A nominee agreement can also provide for providing a power of attorney to the principal’s spouse, partner, children, or other persons. Many times, the desire for the nominee agreement is simply that the owner wants another person to serve as his agent for the property. There is little need for creating some purchase-sale transaction to accomplish a change in ownership if the grantor just wants some one else to be empowered to buy or sell the property for him.
Advantages of Using a Nominee Agreement
Nominee agreements are important strategic tools that offer a number of benefits. They provide individuals and companies with a private and confidential way to record their agreement. The terms of the agreement and the party named as a nominee are not recorded in public registries. The existence of the agreement may be unknown to others than those who have direct knowledge of it.
There is no obligation to record nominee agreements, which means that it is possible to keep ownership details private (i.e. those details are not on the public record). Nominee agreements preserve privacy in ownership details during the existence of the nominee concept. Many companies choose this option because they may wish to prohibit the sale or transfer of shares or other interest in the issuer. In the case of real estate, for example, usually it is the contract of purchase and sale that is registered, rather than the nominee agreement.
An individual or company may choose to keep the ownership details of an interest confidential and therefore elect the use of a nominee agreement. In business, a nominee agreement may be a useful tool, entrusted to the nominee only during the width of time that the two parties allow. Depending on the terms of the nominee agreement, the beneficiary may have the right to direct the nominee to act in a specific manner.
In the event of a potential losing judgment, a company may use a nominee agreement to transfer an interest, so that the judgment cannot be collected on that property. Since the nominee technically owns the property, a judgment creditor cannot register any liens against the property, because that would be against the nominee. It is not uncommon for nominees to be created in order to avoid judgments, so if you suspect nominee agreements are being used in a case where you wish to pursue a claim, you should be prepared to counter it.
With respect to tenancies in a residential context, the rights of landlords under the Residential Tenancies Act, S.O. 2006, c. 17 cannot be avoided through the use of nominee agreements. While it is true that a landlord may not be able to collect rent directly from a tenant on the basis of the nominee being the legal owner, in all situations, the tenant has the obligation to pay rent to the landlord.
For investors in real estate, the use of nominee agreements can be a very useful way to house legal ownership of the real estate and to record the agreement without the agreement being a matter of public record.
A nominee agreement can be a beneficial tool in structuring investments in real estate, where the parties agree to nominal investment, and one party is ultimately obligated to reimburse the other for the cost of the property, upon the sale or other disposition of the property.
Legal Considerations and Associated Risks
Not only is a nominee technically (and legally) the registered holder, but the nominee will often be a registered foreigner. Any issues with the nominee slipping through the net, could suddenly make the beneficial owner the person in a lot of trouble!
Issues around liability – as explained above it’s not uncommon for the nominee to effectively be the registered owner of the shares but not the beneficial owner. This can be an issue particularly where the nominee is a registered company, as many of the owner’s benefits and liabilities are likely to flow through that company. Sometimes the nominee can become liable as a de facto director to creditors of the company.
Issues around taxation – this can be an issue not so much from an income tax perspective as there is often a practical approach whereby the company takes into account the nominee’s beneficial ownership and applies the tax as if it was the beneficial owner where appropriate. However, there can be issues from an inheritance tax perspective given the company’s accounts and the nominee’s (or ultimately the beneficial owner’s) IHT position can sometimes be in direct conflict with each other.
Issues around fraud – the most important thing to do as part of the due diligence will be to ensure the nominee is who they claim to be. It is important to ensure that whoever you are dealing with, that you have ascertained their true identity. The registration process in Hong Kong is a very thorough one however, it is good practice to ask for proof of identity of the nominee.
Issues around criminal liability and cartels – any contract entered into without the proper authority may be deemed to be invalid. Even when the authorities have granted registration approval, the contract must still be executed correctly to be binding. Indemnities are therefore included to protect directors and the company from any future liability due to the contract.
Issues around the validity of nominee agreements – reliance on nominee agreements can bind the parties to do something that they did not intend to.
Setting Up a Nominee Agreement: What to Know
The process of drafting a nominee agreement starts with the facts. The drafter should begin by determining the overall framework of the nominee arrangement, including how long the nominee is to serve in that role and other similar factors. Additionally, it is important to delve into the plan document itself to determine whether any specific provisions may apply. For example, does the plan document require a consent of a plan participant to the arrangements set forth in the nominee agreement? Do the parties believe an amendment to the plan document is necessary to reflect the nominee agreement? These issues should be considered early in the process and revisited at various points along the way, as changes in the nominee agreement may implicate changes in the plan document. The agreement should be drafted to capture all the terms of the nominee relationship, from the roles and responsibilities of each party to the actions that will trigger the end of the nominee relationship, and everything in between. Such provisions may cover , among other items: the scope of the nominee relationship, including whether the nominee will delegate his or her responsibilities under the agreement; the compensation for serving as nominee or, on the other hand, whether such service is acting as an independent contractor; dispute resolution and governing law; and other matters that will govern the relationship. As noted previously, there may be matters that must be addressed in the nominee agreement (e.g., particular indemnification provisions) or in a plan document (e.g., time delays for approval of transactions). Given the range of issues implicated by a nominee agreement, it is essential to obtain legal advice in the creation of these agreements. While not all of the points that should be covered every time are highlighted above, it should be clear that there are significant issues that may arise if best practices are not followed. The amount of risk involved will vary amongst the parties depending on the facts, but there are undoubtedly key issues that must be addressed, regardless of the parties involved.
Myths and Truths Regarding Nominee Agreements
One of the most common misconceptions about nominee arrangements is that they are illegal. This misconception stems from the fact that most people assume that nominee structures are put into play purely for tax evasion purposes. However, when done correctly, nominee arrangements are perfectly legal and in fact are often encouraged by governments. The main reason for this is because nominee arrangements allow foreigners to acquire asset ownership in places with capital controls. This helps such countries channel foreign investments back into their own countries.
Another misconception about nominee arrangements is that they are commonly known as "holdbacks". The truth is that holdbacks are a form of security, whereas nominee agreements are a form of ownership. So that begs the question: what happens when the parties in a nominee arrangement part ways? In such an event, for the purpose of withdrawing assets from the nominee entity, the parties must first execute a prescribing a mechanism by which the assets shall be divided.
One of the most damaging misconceptions of nominee arrangements is that they are not enforceable under law. While some form of nominee agreements are unenforceable, those that are not intended for support and furtherance of money laundering, tax avoidance, terrorism financing, etc., are perfectly enforceable.
Real-World Examples of Nominee Agreements
Nominee agreements are flexible instruments that can be adapted to fit a wide range of situations. Below are some case studies that illustrate some of the diverse uses of nominee agreements.
A California company doing business in China had been approached by a Chinese company looking to purchase the merchandise from its online stores. The Chinese company was unable to purchase from the California company because it was not located in China. To solve the problem, the companies entered into a nominee agreement whereby a Chinese national would use his name to purchase the merchandise they needed at low prices in the United States and resell it in China at a profit. That way, the nominee could make a profit and the California company could enter the Chinese market without creating a permanent establishment there. The nominee also entered into an advisory agreement with the California company to receive commissions for the sales by the Chinese company.
A real estate company from the Middle East purchased several luxury hotels in Dubai through the use of nominee agreements to take advantage of the privacy inherent in such arrangements. The nominees were either individuals or corporate vehicles in offshore jurisdictions where the identity of the beneficial owner of the shares was opaque. The agreement also allowed the buyer to benefit from corporate tax residency in the offshore jurisdictions , while acknowledging the nominee as a director and shareholder of the target. The annual fees for maintenance of these nominee vehicles were included in the purchase price of each hotel.
An electric car manufacturer wanted to protect itself from potential bankruptcy or US trade sanctions, which could block the importation of its cars into the United States, by transferring its intellectual property to an offshore trust established either in Panama or the British Virgin Islands. It argued that this would prevent creditors from seizing the offshore invested assets to fulfill their claims against the company in the event of bankruptcy or a seizure from the United States government. The offshore jurisdiction would also provide greater privacy for the client’s assets. The trust and trustee would be a nominee for the client.