A Nominee Agreement may be ‘a shield, but it is not a sword”

Last week, a judgment delivered by the Dubai Court of First Instance confirmed that nominee arrangements for share ownership are recognized by equity and not by the law.

The background

As we all know, the UAE Commercial Companies Law limits foreign ownership in UAE companies to forty-nine per cent. We also know that these limits have never dissuaded foreign investors’ appetite, who have long used nominee arrangements with UAE nationals.

Foreigners and UAE nationals become parties to a bare trust through which the latter holds the legal title to shares. However, the former absolutely owns both the income and capital, i.e. the shares and dividends earned from it.

By definition, a nominee or bare trustee has no active duties to perform regarding the shares other than to transfer the shares to the beneficiary when required. The trustee is merely the nominee. However, many nominee agreements impose positive duties on nominees, which are more than bare.

The nominee shareholder in the UAE must follow the (lawful) instructions of the beneficial foreign owner concerning the shares.

In the case before the Dubai Court of First Instance, a dispute arose between the UAE national (“Nominee”) and the foreign investors (“Beneficiary”) because the Nominee was not listening to the directions of the Beneficiary. The Nominee’s inaction to cast votes as directed by the Beneficiary caused losses to the Beneficiary.

The Beneficiary filed a claim against the Nominee for damages, with the knowledge that once the nominee agreement is revealed, the court will order the dissolution of the so-called company.

Preface to the Judgment

Legally, there is nothing wrong with a nominee arrangement itself. The law recognizes the existence of bare trusts and enforces them as well. Asset managers, investment funds use them to conveniently manage the beneficial interests of a large pool of investors. Instead of each investor becoming a shareholder of a fraction of the company, exercising votes, and attending meetings, a bare trust between the asset manager and the investors allows them to achieve their objectives.

Nevertheless, what if the bare trust or nominee agreement is not used for itself but to hide an apparent agreement.

Article 395 of the UAE Civil Code expressly allows parties even to use bare trusts to conceal their actual contractual positions:

“If the contracting parties conceal a true contract with an apparent contract, the true contract will be the effective one as between the contracting parties and a special successor.” 

The question, however, then becomes, to what extent can the parties contractual freedom be upheld? The law is universal in its application, but it cannot be applied universally in each case.

For example, a patriarch might favour one son over the other and may want to conceal a true contract that he gifts his collection of watches to his favourite song. However, to all others, he says that the watches will be distributed equally amongst all sons. Article 395 will uphold the father’s actual contract because it is required for the strict application of the law and because the father had the legal right to gift the watches to whomever he wanted. His sons had no claim to the watches. Both the actual and apparent contracts are a matter of the father’s private and lawful affairs.

However, many of the privileges and rights in law created for the convenience and benefit of its users are equally utilizable to deceive people in private law matters and hide the breaches of public laws.

Judges face these questions every day. However, they cannot tell litigants to go away because they do not have an answer or that the law is contradictory and overlapping. Judges must apply the laws and construct them justly.

The judge in this matter, whose name I do not know at the time of writing this article, delivered a judgment in the Dubai Court of First Instance last week, which beautifully and logically fits the legal rules and the application of equity.

The Judgement

The judgment has three facets, two of which are considered common practice, but one which develops the law in this area one step further.

Dissolution

When foreign shareholders reveal nominee arrangements to the court, they admit that their attempt to increase the percentage of their company ownership violates the limitations of the commercial companies law and often reveal this with the very aim that the judge orders liquidation of the company.

True beneficial ownership

Courts also recognize that the nominee agreement is evidence that the beneficial or rightful ownership of the economic benefit of the nominee held shares belongs to the foreigner. As per the unjust enrichment laws, property returns to its rightful owners upon dissolution of a contract. The dissolution process recognizes the foreign investors as the rightful beneficiary of the assets that remain after dissolution.

The court ordered the liquidator to dissolve the company’s assets and whatever remains after payment to creditors belongs to the foreign beneficiary.

Nominees duties under the agreement

The judge did not entertain the claim made against the Nominee for breach of his duties under the nominee agreement. He remained silent on the point.

Interpretation of the Judgment

However, there is more to the judge’s decision than meets the eye.

Many legal practitioners opine that the private agreement between the nominee and the beneficiary is ineffective against the company because it is contrary to the companies law. However, as a purely contractual arrangement, the agreement is valid vis-a-vis the nominee and the beneficiary and is enforced like any private contract.

The author respectfully disagrees with this point of view.

The courts do not recognize the nominee agreement as a valid and binding contract even vis-a-vis the parties. When the court orders that the economic value of the nominee’s shareholding should go back to the foreigner beneficiary, the court is not enforcing the nominee agreement between them.

The nominee agreement is defective by illegality.

Article 126 of the UAE Civil Transactions law says that the subject matter of a contract can be anything thing “which is not prohibited by a provision of the law”

Article 127 also goes on to say that “A contract to do an unlawful thing is unlawful.” It is debatable whether creating a bare trust is unlawful if the legal effect of that trust is to breach the provisions of the law.

The consequence of a finding of illegality is that the contract is null and void. No action may be brought for compensation for non-performance, nor will order for specific performance be available. With such a harsh attitude taken to contractual performance, the pressure falls entirely on the law of unjust enrichment to sort out the mess.

In the author’s view, the judge recognizes the ownership of the foreign shareholder because the unenforceable nominee agreement evidences it.

The court, in this case, is giving the foreigner his economic interests by dispensing equity, not enforcing a legal right.

What is equity in the law?

The word “equity” “is not a synonym for ‘general fairness’ or ‘natural justice’. Equity is the practice of doing justice when the result of rigid legal rules does not produce a just result. Equity involves a departure from the rules of law but not a contradiction.

The rule of law requires judges to follow the law. However, the practice of equity permits judges to create fair outcomes when a strict but essentially correct application of the law produces harsh results – unjustly enrich one at the expense of the other, or provide a remedy that is not a relief for the plaintiff.

“Wherefore in some cases it is necessary to love the words of the law, and to follow that reason and justice requireth, and to that intent equity is ordained; that is to say, to temper and mitigate the rigour of the law. And it is called also by some men epieikeia; the which is no other thing but an exception of the law of God, or the law of reason, from the general rules of the law of men, when they by reason of their generality, would in any particular case judge against the law of God or the law of reason: the which exception is secretly understood in every general rule of every positive law.”

The Doctor and Student (1518) CHRISTOPHER ST. GERMAIN 

Equity in the UAE legal system

The dual system of law and equity developed under English law in the latter half of the 13th century. Equity was dispensed in the Chancery Courts, outside the King’s Courts of common law. By enacting the Supreme Court of Judicature Acts of 1873 and 1875, the dual court system was replaced by a single courts system administering both law and equity.

The development of equity in the United Arab Emirates is not different from that in England and other older legal jurisdictions.

As legal systems of sovereign kingdoms develop, the prerogatives and pardons of the kings, Emirs and rulers become less necessary and thus less common. Today, the robust development of equity under the UAE law is found in nearly every judgment.

Back to the judgement

The strict and correct application of the law would be to declare the nominee agreement null and void, as if it never existed, and recognize the legal titleholder of shares as the actual shareholder.

Therefore, the court applies the principles of equity to return what belongs to the foreigner back to him. There are three main reasons why no court of law dispensing justice would apply the law strictly in this situation:

  1. The law does not deprive a person of their property without the sanction of the law.
  2. The law cannot ignore the truth of the situation, which is evidenced by the nominee agreement.
  3. The law does not allow one to be unjustly enriched. , the question to ask the enriched party is – “Do you have basis to retain the benefit?”

Unjust enrichment

By application of the doctrine of unjust enrichment, the foreign beneficiary is not deprived of what is his.

As for the nominees would be estopped from asserting a right over the shares because that right contradicts what they previously said or agreed.

By the same notion, the foreign beneficiary may rely on equity to not be deprived of his beneficial ownership, but remember that equity is “a shield not a sword”, giving the nominee no right of action.

Cause of action against the Nominee

The last question that remains to be addressed is, why did the judge not give retribution to the foreign beneficiary for the loss it suffered because the Nominee failed to comply with the Beneficiary’s directions.

First, if we accept that the nominee agreement is void and unenforceable, then so are any obligations of the Nominee under it. The beneficiary has no contractual right to compensation for the breach.

Should the beneficiary have a right to compensation under tort or another legal basis? The answer is no.

The foreign beneficiary’s claim against the Nominee would arise either from the unlawful contract or from an arrangement made with the dishonourable intention of circumventing the laws.

The simplest way to explain it is through another handy doctrine of Ex turpi causa non oritur actio ( “from a dishonorable cause an action does not arise”).

Conclusion

The judge’s deliberations behind this judgment are commendable.

He confirms that nominee agreements are not upheld except in so far as is necessary to give justice in equity.

The judge also upheld the maxim that “He Who Comes Into Equity Must Come With Clean Hands.” The purpose of the maxim is to protect the integrity of the court. It does not disapprove only of illegal acts but will deny relief based on conduct that ought to be discouraged as a matter of public policy.

All in all the judgment pieces together many legal aspects of the use of nominee agreements in the UAE, and its treatment by the courts

Published by

Fareya Azfar
Partner at Fareya Azfar & Araoui LLP