Risks taken by shareholders in the shadows - Application of the Duomatic Principle to beneficial owners

17 November 2020, Litigation & Dispute Resolution, Newsletter by Paul Kwan, Mandy Pang

Nowadays, corporate structures are increasingly complex. It is not uncommon for individual owners to put in place arrangements to hide from public view his or her position as ultimate beneficial owner of a corporate entity or otherwise his or her assuming actual control of the corporate entity. The Privy Council’s decision in Ciban Management Corporation v Citco (BVI) Ltd & Anor [2020] UKPC 21 (Ciban) illustrates that by choosing such arrangement, the ultimate beneficial owner or controller is subject to the risk of being betrayed by an agent who is being used to pass on instructions to the director. The uniqueness of this case is the application of the principle of decision-making by shareholders by way of informal unanimous consent established in Re Duomatic Ltd [1969] 2 Ch 365 (Duomatic Principle) to beneficial owners conferring ostensible authority on their agent.

In the Ciban case, the ultimate beneficial owner had all along given instructions to a British Virgin Islands (BVI) company via his business associate. Unbeknown to the ultimate beneficial owner, the business associate issued a power of attorney for the sale of the BVI company’s landed properties. The Privy Council confirmed that the business associate was authorised to issue the power of attorney in circumstances where the business associate had previously issued certain powers of attorney under the direction of the beneficial owner. The ultimate beneficial owner’s informal consent to the representation by conduct, that the business associate had authority to instruct the director of the company in relation to the power of attorney, was binding on the BVI company.

Background

In 1997, Mr Byington asked his business associate, Mr Costa, to acquire a BVI company called Spectacular Holding Inc (Spectacular). The sole purpose of Spectacular was to hold various parcels of land with Mr Byington as the ultimate beneficial shareholder. Citco BVI Ltd (Citco) was a registered agent of Spectacular and Tortola Corporation Company Ltd (TCCL) was the sole legal director of Spectacular. Such an arrangement was put in place because Mr Byinton did not wish anyone to find out or even to be able to find out that he was Spectacular’s owner. 

Between 1997 and 1999, Mr Costa instructed Citco to issue four powers of attorney on behalf of Spectacular and the powers of attorney were issued by TCCL as the director of Spectacular. Mr Byington gave his approval for all the corporate acts carried out on Spectacular’s behalf up to the issue of the last of these powers of attorney, although there was no evidence that Mr Byington had confirmed those instructions.

In 2000, Mr Byington faced financial difficulties and borrowed money from Mr Costa. Mr Byington subsequently defaulted on the loan. 

In 2001, without telling Mr Byington, Mr Costa instructed Citco to issue a fifth power of attorney on behalf of Spectacular in favour of a Brazilian lawyer to sell the landed properties owned by Spectacular and the fifth power of attorney was executed by TCCL. The proceeds of the sale of the landed properties were used to pay off the sums owed by Mr Byington to Mr Costa.

When Mr Byington found about the sale of the landed properties, he caused the fifth power of attorney to be revoked. 

Legal Proceedings in the BVI

Spectacular commenced legal proceedings against Citco and TCCL, claiming that TCCL had acted in breach of its tortious and fiduciary duty of care as a director in failing to ensure that Mr Costa had the authority to procure the grant of the fifth power of attorney and that Citco had acted in breach of its tortious and fiduciary duty of care as an agent in failing to do the same. Citco and TCCL denied these allegations, claiming that their relationship with Mr Byington was governed by an implied contract to act on his instructions and that Mr Costa had ostensible agency authority of Mr Byington to give instructions.

The British Virgin Islands Commercial Court and Eastern Caribbean Court of Appeal dismissed Spectacular’s claims.  Spectacular appealed to the Privy Council.

The Privy Council

The Privy Council held that Mr Byington had intentionally set up a mode of operation on which Citco and TCCL reasonably relied on the instructions of Mr Costa. Applying the Duomatic Principle (i.e. the principle that anything the members of a company can do by formal resolution in a general meeting, they can also do informally if all of them assent to it), Mr Costa had been conferred with ostensible authority by Mr Byington, which also counted as ostensible authority conferred by Spectacular. Therefore, Spectacular could not be allowed to deny that it authorised Mr Costa to give instructions, as it was reasonable for TCCL to rely on the instructions of Mr Costa on the basis that he was conveying the instructions of Mr Byington as the ultimate beneficial owner. There would be no need to go through the formality of a company resolution ratifying the sale. By choosing to be in the shadows, Mr Byington was taking the risk that Mr Costa would use the apparent authority for his own purposes. On this basis, the Privy Council held that the qualification to the Duomatic Principle could not apply in saying that Mr Byington was not aware of and could not have consented to Mr Costa’s giving instructions for the fifth power of attorney, nor could what was being done in relation to the fifth power of attorney amount to dishonesty or otherwise lack of good faith, as this was not done outside the powers of the company. Further, such risk should not be transferred to TCCL and there was no breach of duty of care owed by TCCL to Spectacular.  

The Privy Council also held that Citco was not in breach of a duty of care owed to Spectacular. As Citco only provided corporation agency services, it was not acting as a de facto director of Spectacular, i.e. one who purports to act as a director but has not been validly appointed as director.

Commentary

The Ciban case shows that an ultimate beneficial shareholder who chooses to stay in the shadows cannot have the best of both worlds. They cannot choose to hide from public view and avoid the risks of being betrayed by the agent who conveys instructions to the director at the same time. Where an ultimate beneficial shareholder had chosen to hide from public view and had given informal consent to the representation by conduct that the agent had authority to instruct the director (i.e. ostensible authority), the agent’s instructions to the director regarding company affairs would bind the company by way of the Duomatic Principle. Even if the ultimate beneficial shareholder was not aware of and could not have consented to the agent’s instructions, the ostensible authority given would not allow the ultimate beneficial shareholder to deny that he or she had consented to giving authority to the agent.

Upon deciding corporate structures, owners should take into account the potential risk of being betrayed by the agent who conveys instructions to the director when deciding to become a legal owner or a beneficial owner.

It remains to be seen whether the Hong Kong Courts will follow the Privy Council’s application of the Duomatic Principle to beneficial owners other than registered shareholders in Hong Kong, in circumstances where the beneficial owner was not aware of and did not consent to the instructions given to the director of the company.