08 December 2020

Shadow owners should be wary of the Duomatic Principle when instructing agents

This article series was written by Barri Mendelsohn (Partner), Jenny Willcock (Senior Associate), Daniel Jones (Trainee Solicitor) and Jennifer Reyes Au (Trainee Solicitor) in the KWM London office.

Executive Summary

On 30 July 2020, the Privy Council confirmed in Ciban Management Corporation v Citco (BVI) Ltd & Anor (British Virgin Islands) [2020] UKPC 21 that the Duomatic principle is applicable to ostensible authority.  

For those needing to dust off their legal textbooks, the Duomatic principle under English law applies where all shareholders of a company who have a right to attend and vote at a general meeting unanimously agree to a matter informally, that unanimous assent is binding on the company just like a resolution at a general meeting - but without the need of passing the resolution at a general meeting.[1]

This case acts as a warning to all beneficial owners of companies that, if appointing agents to act on their behalf, whether to remain out of public view or not, this may come at a price whereby an owner’s appointed agent may instruct the directors of the company to act, without the owner’s knowledge, in a manner which the owner does not agree with. In this case, the action resulted in the sale of land owned by the company. 

Facts 

In 1997, Mr Byington authorised his friend and business associate, Mr Costa to acquire on his behalf, Spectacular Holding Inc (“Spectacular”), a BVI Company, which owned five parcels of land. The share capital of Spectacular consisted of 5,000 bearer shares, which, once acquired by Mr Costa were held by a lawyer on Mr Byington’s behalf. 

Citco (BVI) Ltd (“Citco”) was Spectacular's registered agent and Tortola Corporation Company (“Tortola”) was its corporate director. Mr Byington ran Spectacular’s business through Mr Costa who gave instructions to Citco and Tortola to issue powers of attorney (“POA”) in favour of several lawyers to act on Spectacular’s behalf. The reason for this elaborate arrangement was because Mr Byington did not want his ownership of Spectacular to be public knowledge. 

Subsequently from 1997 to 1999, Spectacular issued four POAs authorising lawyers to act on its behalf. On each occasion, Mr Costa communicated the instructions directly to Citco. In all instances, Mr Costa’s instructions were followed by the lawyers with no questions asked in respect of the instructing party. Each POA was issued by Tortola as director of Spectacular. Mr Byington approved all the corporate actions from the acquisition of Spectacular to the issuing of the fourth POA issued by Tortola. 

There was no evidence to suggest that Mr Byington had expressly told any of the professionals dealing with the corporate affairs that they could rely on Mr Costa’s instructions, nor was there evidence that any of these professionals had ever asked Mr Byington for confirmation of these instructions. 

In 2001, Mr Byington owed Mr Costa (a) USD 85,000 under a loan agreement; and (b) a certain amount of salary arrears. Without informing Mr Byington, Mr Costa instructed Citco to issue a further POA to sell the land belonging to Spectacular. Tortola passed the resolution and executed the fifth POA. After the sale of the land, Mr Costa wrote to Mr Byington to notify him of the sale and provided him with a breakdown of the sums he owed Mr Costa. Mr Byington then caused all of the POAs to be revoked and initiated proceedings in the BVI Courts through Spectacular in order to prevent registration of the sale of the land. 

Spectacular claimed that by failing to confirm that Mr Costa had authority to procure the fifth POA, Tortola was in breach of its tortious and fiduciary duty of care as a director of Spectacular and Citco was in breach of its tortious and fiduciary duty of care as agent of Spectacular. 

The BVI Courts dismissed Spectacular’s claim on the basis that neither Citco nor Tortola had breached their duty of care (owed to Spectacular) to check that Mr Costa was duly authorised to issue the fifth POA

Spectacular appealed the BVI Court decision on the grounds that:

  1. Tortola or Citco had breached their duty of care by failing to confirm that Mr Costa had authority to issue the fifth POA; and 

  2. Mr Costa did not have ostensible authority to act on Spectacular’s behalf under the Duomatic principle. 

Decision of the Privy Council 

Given the context and the previous pattern of behaviour, the Privy Council held that it was reasonable for Tortola to accept instructions from Mr Costa. Although Mr Byington never issued any document to that effect, the mode of operation was for Tortola to follow Mr Costa’s instructions on the basis that he was conveying Mr Byington’s instructions. As Mr Byington never raised any issues about Mr Costa’s instructions before, Tortola could reasonably expect that Mr Costa had authority to issue the fifth POA. 

It was held that by choosing to “remain in the shadows”, Mr Byington took the risk that Mr Costa could betray him; and such risk should not be transferred to Tortola. Therefore, the Privy Council held that there was no breach of duty of care. As for Citco, it was further held that it was not in breach of duty of care owed to Spectacular as it was only providing cooperation agency services and was not acting as a de facto director of Spectacular.

Applying the Duomatic principle, the Privy Council noted that Mr Byington, as the sole shareholder of Spectacular, had consented to Mr Costa’s authority to give instructions and consequently, Spectacular would have been bound by the first four POAs. As for the fifth POA, Mr Byington did not consent to give Mr Costa authority. The question put before the Privy Council was whether the Duomatic principle covered ostensible authority. 

The Privy Council held that if actual authority could be conferred informally by unanimous shareholder consent, there is no reason preventing the same applying to ostensible authority. Mr Byington’s informal consent to Mr Costa’s representation by conduct (that he had authority to give instructions to issue the fifth POA), bound Spectacular. 

The Privy Council also explored recognised qualifications to the Duomatic principle: 

  1. The Duomatic principle does not apply where the shareholders did not consent to the relevant act[2]. Although one can argue that Mr Byington did not consent to the issuance of the fifth POA, Mr Byington’s mode of operation meant that he took the risk that Mr Costa could betray him and he could not deny that authority had been given to Mr Costa. 

  2. The Duomatic principle can not be used to permit the shareholders or the directors to commit a fraud against the company[3]. The Privy Council found that "the whole of Mr Byington’s set up – and the clothing of Mr Costa with ostensible authority - was taking the risk on behalf of the company, albeit informally, that Mr Costa would use that apparent authority for his own purposes, including dishonest purposes."

  3. The Duomatic principle will also apply where it was the beneficial owner, rather than the registered shareholders, who consented to the relevant transactions[4]. However, please note that the distinction between Mr Byington as the ultimate beneficial owner and his lawyer who held the bearer shares on his behalf was not raised as an issue in this case.

As a result of the above, the Privy Council held that the Duomatic principle did apply, Mr Byington had conferred ostensible authority to Mr Costa resulting in Spectacular being bound by such authority. Consequently, the Privy Council dismissed Spectacular’s appeal. 

Key Lessons 

This case acts as a stark warning for those beneficial owners who use offshore companies, directors and powers of attorney to “stay in the shadows”, a choice needs to be made as to whether such shareholders would risk of being betrayed by an agent to the company providing instructions to the corporate directors. Even where the beneficial owner has no knowledge of the agent’s instructions, the ostensible authority given would bind the company and so the Duomatic principle applies to both express and ostensible authority.  

Consequently, when implementing or amending corporate structures, one does needs to consider the risks involved. One possible solution for beneficial owners to consider is making amendments to the articles of association of the company in question in order to ensure that approval in writing from the shareholders is required for key decisions of the company to prevent significant disposals or other key corporate actions are taken without their knowledge. Additional internal procedures can also be implemented in order to avoid inadvertently granting ostensible authority.  

[1]Re Duomatic Ltd [1969] 2 Ch 365

[2]EIC Services Ltd v Phipps [2003] EWHC 1507 (Ch)

[3]Bowthorpe Holdings Ltd v Hills [2002] EWHC 2331 (Ch)

[4]Shahar v Tsitsekkos [2004] EWHC 2659 (Ch)

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