Storm in a Teacup: Nominee Directors & Liquidated Companies

Background  

Over 80% of start-up businesses fail in the first five years. One of the tasks accountants in public practice deal with is assisting clients when this occurs. Liquidation is the insolvency process related to companies and formally deals with those going through this stressful process. Liquidators are appointed and take control of the company and, if appropriate, they hold directors accountable for their actions.

During the last week, GRA has been approached by a reporter regarding the practice of appointing what he calls “dummy directors” (we call them “nominee directors”) to companies being liquidated. GRA has explained this option to insolvent clients over the years, and some clients have acted on it. The reporter’s questions have prompted us to publish this blog.

In short, the law allows shareholders of failed companies to appoint different directors at any time, including at the eleventh hour just before they go into liquidation. This does not in any way reduce the outgoing directors’ liability; they can (and do) get sued for their actions while holding office. Simply, nominees merely reduce the public’s visibility of the former directors during the liquidation process. 

Aussie Director Scam v Nominee Directors in Context

Changing a director and immediately liquidating should be contrasted to a situation where a nominee director takes office and continues to trade / dispose of assets etc. In such circumstances, that director would be answerable for their actions while holding office, because they were trading or making decisions. A few years ago, this area received some publicity in Australia where shady businesspeople put the homeless into companies, then continued to trade and committed tax scams while hiding behind the dummy directors. You can read about that disgraceful situation HERE.

This is completely different to appointing a nominee director at the 11th hour, and immediately liquidating. The nominee directors don’t continue to trade; they do nothing. Such action is purely about reducing the visibility of the outgoing directors after the liquidation is complete.

Q & A

Some key questions:

1. Are the appointed nominee directors at risk, where they are appointed and immediately liquidate? Our (extensive, peer reviewed and explicit) legal advice says it doesn’t expose them to risk if they are appointed and the company immediately liquidates, with the directors taking no other action. They are a token placeholder during the liquidation, nothing more.
   
   
2. Are the outgoing (former) directors off the hook for their actions? No, they are still liable for their actions while holding office. They are often sued by the liquidator and face financial claims. If they have acted criminally, they still carry that liability. They also cannot hide from their actions because their removal and replacement is gazetted and published. You cannot hide from published information. The effect of appointing a nominee director merely reduces visibility of former directors at a veneer level; there is no other legal effect or benefit.
   
   
3. The reporter who has been questioning us about the practice of appointing nominee directors seemed to believe it exploits vulnerable people in the community, on the grounds that some of the people selected by the recruitment business to whom we refer clients are beneficiaries.
   
   
4. So are vulnerable people in the community being exploited? We put this to the recruiter of these people that we refer to. He said they are not at risk because he has received similar legal advice to us. It’s not illegal, and they are not liable for the actions of former directors, if they are appointed, do nothing, and the company immediately liquidates. So how are they being exploited when they are being paid for carrying no risk, other being associated to a liquidation? He went further to say none of his nominee directors have ever been spoken to by a liquidator; liquidators always interview the former directors, as they are the ones responsible for the company’s actions. He also gave an example of court action where the judge ignored the nominee director and focused on the former directors in office during the applicable trading period. He said that it appears the word ‘beneficiary’ is often conflated with uneducated or vulnerable, which is not the case in these circumstances. He himself is a beneficiary but pointed out that doesn’t mean he is stupid or vulnerable.
   
   
5. Is appointing nominee directors legal? Yes.
   
   
6. Is appointing nominees at the eleventh hour, and immediately liquidating, a legal loophole? No, it’s the shareholders’ right at law. If the government wish to change the law, the position will change.
   
   
7. Have we discussed this practice with IRD? Yes. And their technical legal unit acknowledged that it was legal, but they said they didn’t like it. Other creditors have taken the same line (this is not about IRD, it’s about insolvency in general). All creditors want the maximum punishment for directors.
   
   
8. Is changing directors at the eleventh hour distasteful? Possibly. If you think a person with an insolvent business should be named and shamed, using nominee directors will most likely be uncomfortable.

Professional Duties

We have a professional duty to advise our clients of all the options available to them. Insolvency has always been an uncomfortable process, and many feel ashamed because they have failed. Reduced visibility is in a client’s favour; that’s why we bring the option to their attention. They can still get sued, prosecuted or, if appropriate, be banned from being a director. Simply, they still face the consequences of their actions.

While we don’t really do much in relation to insolvency work (we are not insolvency practitioners), we do refer clients to liquidators and make sure our clients do everything they can to minimise the damage that may result from the process. It’s in our clients’ interests to do that, and it’s our professional duty to assist them with all the information they need to make the best decision for their circumstances. 

We think the practice of appointing nominee directors is one that is lawful, at no risk to the nominees, and not uncommon in New Zealand. It is probably new to the reporter who has been questioning us, but we say – complicated as it is – it is actually a storm in a teacup.

Matthew Gilligan | John Rowe | Salesh Chand