Beneficial ownership … Shell companies … Shelf companies … What’s the Difference?
Since the Panama Papers, there seems to be an increasing interest in, and a corresponding mis-understanding of the concepts of beneficial ownership, numbered companies, shell companies and shelf companies.
Most lawyers who have done large M&A deals, including me, have created for clients, shelf, shell and numbered companies and have created beneficial ownership structures. In my case, it was for legal purposes. Here is our primer on what these terms mean.
1. Shelf Companies – one that literally “sits on a shelf”
A shelf company literally means a company sitting “on a shelf.”
This is an area that few people know much about. That is because lawyers are the creators, holders and protectors – in essence the gatekeepers – of shelf companies.
The way it works is this – lawyers incorporate private companies in which the law firm typically is the incorporator (the first shareholder holding one share). The company undertakes no business activity and the Minute Book for that company sits on a shelf for a number of years, sometimes ten years, like a bottle of wine aging and increasing in value. Eventually, the law firm will have a client who needs or desires a pre-existing company and it will sell to the client, one of its shelf companies. Law firms often have many shelf companies. On the rare occasion, a person will create their own shelf company but very rarely. Once a shelf company is sold, it ceases to be a shelf company.
In case you did not know, most law firms that practice business law have a Corporate Records Department, which is like a library with the Minute Books for every company the law firm represents or acts as the Records and Registered Office (the “Library“). The Library has another important collection of books – those are deal books, sometimes called closing books, that have every single piece of paper signed in respect of a financing or M&A transaction involving any of the companies for which the law firm holds a Minute Book. The closing books are material in respect of beneficial ownership, described below, because they often contain the documents evidencing beneficial ownership.
Shelf companies are created solely for the purpose of selling those companies at a later date for large sums of money. While a person could incorporate a new company, often a person will want a pre-existing company to demonstrate corporate longevity. The so-called longevity is a fiction because a shelf company may be 10 years old but in terms of business activity, it has not even been born yet.
Why would a person want corporate longevity? There are negative and positive reasons. The positive reason is that more money can be raised for a shelf than a non-shelf company because of its fictional longevity.
I’ll let you guess what the negative reasons are.
Specifically in respect of financial crime, this is an area of significant concern that is never looked at by the FATF, FIUs, banks or regulators because they tend not to have expertise in respect of corporate financing or M&A law to be familiar with what shelf companies are, how they are used, and why and by whom. Moreover, they often confuse shelf with shell companies.
Unfortunately, transnational criminal organizations, including those from the Middle East that are engaged in terrorist financing, have been known to use shelf companies. I’m sure you can guess why. The good news on this front, is that an AML / CTF lawyer can tell after spending a minute of time on due diligence, if a company was a shelf or not.
Although law firms are the creators and gatekeepers of, shelf companies, once a shelf company transitions from shelf to non-shelf, it becomes a regular company to the outside world and lawyers are no longer the gatekeeper of such a company.
There are two misconceptions about shelf companies that are worth noting:
(a) It is not accurate that nominees are used for shelf companies – that is an example of where NGOs and people confuse shelf companies with shell companies; nominees are used in shell companies but not in shelf companies.
(b) It is not accurate that shelf companies are used when a person needs a company that is “ready to go”. In modern jurisdictions, it takes mere minutes to register a company online with a law firm. Obtaining a company that is “ready to go” is not the purpose shelf companies serve in 2016.
2. Numbered Companies – relax, they’re perfectly fine
Some jurisdictions, such as British Columbia, allow the incorporation of numbered companies, as opposed to a company that has a name. People object to numbered companies without any basis. There is nothing the matter with, or suspect about, a numbered company.
A numbered company in British Columbia, for example, looks like this – BC1568796. But every company in British Columbia, even those that have actual names, such as Ocean View Holdings Inc., also has a corresponding number and is legally also known as BC1568797, and therefore its legal name is Ocean View Holdings Inc., BC1568797. It is no different than the company that is a solely numbered company, BC1568796.
The reason people object to numbered companies is because it’s harder for them to recollect the name of a numbered company than a company without a number. In terms of purpose, structure, shareholders and organization, there is no difference whatsoever between a numbered and a non-numbered company, and there is moreover, nothing nefarious about any numbered company arising solely from the fact that it does not have a corporate name attached to its corporate number. There is also no evidence to suggest that numbered companies are used for financial crime in greater numbers than non-numbered companies.
3. Shell Companies – there are two meanings
A shell company has two meanings.
In the securities law context, it means a company that no longer has business activities, although it once did have business activities, hence it is now a “shell” of its former self, as in “an empty shell.” In the public company context and in the securities law context, a shell company is legitimately used for the listing or re-listing process, or when there is a change of material business activities. There is nothing the matter with this type of, or reference to, a shell company.
In the corporate law context, a shell company has a different meaning. A shell company in this context means a company created to obfuscate ownership of shares (the beneficial ownership issue) and the purpose may be criminal or not.
If a person sets up a company in the Cayman Islands, a well-known tax evasion and money laundering jurisdiction, it is not necessarily a “shell company.” It all depends upon how the company is organized in a structural sense and what it is used for.
The key to determining whether a shell company was established with a criminal intent, or is used criminally or to obfuscate ownership for a criminal intent, is to look at beneficial ownership. Not all companies created to obfuscate ownership are criminal either – many people who run companies purposely use nominees to protect their privacy.
4. Beneficial Ownership
Beneficial ownership refers to the beneficial owner of the shares of a private company, as opposed to the legal owner of shares of a company, namely the de jure versus de facto ownership of shares.
To be technical, beneficial ownership is a common law concept used to distinguish rights held by persons with a beneficial interest in property from those who hold those interests legally (i.e., in name only). In the case of shares, a person can hold shares legally (in their name) or beneficially (as a nominee shareholder – meaning for the benefit of another person).
Canadian corporate law protects both de facto and de jure ownership of shares of private companies because it is not possible to find out the legal or beneficial owner of the shares of a private company. That information is held and maintained by law firms and are in the Library, both in Minute Books (where the legal owners of shares are listed) and deal books (where beneficial owners may be recorded in financing documents, such as in a pledge of shares).
It is not just companies – this is also the case with LLPs, partnerships, funds, charities and trusts.
In addition to the fact that in Canada, the shareholder records are maintained in law firms, they are further protected by privilege which only the client is entitled to waive for access. Canada has the strongest privilege protection laws compared to anywhere else in the world. Coupled with the fact that in Canada, lawyers are exempt from anti-money laundering law compliance, beneficial ownership has another layer of unintended protection.
Beneficial ownership confusion
The term beneficial ownership is widely misused.
Here’s why; groups are calling for legislative changes around the world to solve what is called the “beneficial ownership problem” by eliminating corporate secrecy by requiring the disclosure of the names of the shareholders of private companies on public registries. But if governments do that, all they are doing is requiring the public disclosure of the legal owner (e.g., the person whose name is on the securities register) of the shares of private companies. It does nothing to help determine beneficial ownership. You can only determine beneficial ownership of private companies by accessing the records of law firms where such records are held. And protected.
It would be more clear for NGOs to say they are seeking the establishment of public registries of private companies, which will yield the name of legal shareholders and to refrain from using the term beneficial ownership altogether since the public registries they are seeking will not yield the names of beneficial owners and does not advance financial crime mitigation.
The Offshore Company Problem
The offshore problem is that people set up shell companies with beneficial ownership structures and obfuscate their connections to those companies to stash or move money illicitly, in which nominee directors and nominee shareholders are paid to act as fake directors and shareholders, when in reality, the real owners of the shares and the real control persons behind the companies are usually politically exposed persons chilling in places like Vancouver, Hong Kong or New York buying up expensive real estate.