Look before you leap

Investors in BVI-held companies need to be aware of what can happen when things go wrong and think seriously before doing business offshore.

Look before you leapThe British Virgin Islands (BVI) has an estimated population of 24,000, yet has incorporated between ;700,000 ;and 800,000 private companies. This is the offshore incorporation centre.

It all started in 1984 with the creation of the ‘international business company’. For the next 20 years the BVI stacked them high and sold them cheap, until everything from apartments in Kowloon to oilfields in the former Soviet Union were owned by BVI companies.

By 2004 it was time for an upgrade and, amid some nervousness, a new state-of-the-art product was launched, the ‘BVI ­business company’ (BVIBC).

The BVIBC is ­considerably more sophisticated and its ­legislative framework anticipated some of the changes introduced by the English ­Companies Act 2006. Out went objects clauses and authorised capital, in came ­segregated portfolio and joint-venture ­provisions. An amendment brought a suite of minority shareholder protections. The rate of incorporations continued to accelerate. From 1 January 2006, all new incorporations were BVIBCs. That year saw 65,284 ­incorporations against 58,337 in 2005. Still accelerating, the total for 2007 was 77,022.

But from the BVI perspective, it sometimes seems that little thought goes into identifying it as the offshore jurisdiction of choice. One suspects that the BVI is chosen simply because the client or its adviser has heard of it, or perhaps it featured in an inflight ­magazine. More importantly, however, the client’s banker in Zurich ­recognises BVI structures as familiar and safe. A jurisdiction is only as good as the options it gives the investor when something goes wrong and the BVI is undoubtedly one of the safer ­offshore jurisdictions, boasting a workable companies statute and an independent and sensible court system. If all else fails, it has a modern insolvency regime. It is moot, however, to what extent clients consider these issues in any detail.

Judging from the reactions of most ­litigation clients, there has been little ­appreciation of how the inherent qualities of BVI companies are a risk when transactions go bad or investors quarrel, or of the inherent vulnerability – incorporate ­somewhere and you can be sued there. There is little warning: ex parte orders are common and registered agents are not always prompt in forwarding claim forms.

Most business structured through BVI companies is free of trauma with happy investor outcomes, but the very virtues of offshore companies – confidentiality and flexibility – can lead to very unhappy ­outcomes. A high volume of shareholder disputes sees the manipulation of ­corporate governance to gain control of the valuable assets held offshore. 

Joint venture breakdowns commonly ­feature in the litigation landscape. Until 2007 this meant just and equitable winding up. New remedies along the English model are now available, yet so too is an opt-in provision allowing joint venture parties to nominate directors to serve their interests, rather than those of the company as a whole. There is also a 51 per cent shareholder’s ability to pass a written resolution to issue further shares without notice being given to the minority shareholder.

For example, a UK-listed company with a substantial share in a foreign company that is held via a BVI company could see its shareholding massively diluted by shares issued to a fourth company, and the asset could be sold and a dividend declared.

The beneficial owners of the fourth ­company could be unknown and there could be nothing, aside from the transaction itself, to link them to the majority shareholder in the BVI company. The fourth company could in any case prove a house of straw. The only thing known for sure is that recovering the investment will be slow, difficult, ­uncertain and expensive.

Access to information about a BVI company, even your own company, is hard to obtain as little is publicly filed. The Register of Members is not available on a company search. Registered agents – those who incorporate and maintain the offshore companies – hold all the registers. Registered agents are, however, notorious for refusing to ­communicate with anyone other than their client of record. Even if you are demonstrably a director of the company, you may be ignored if you are not the client of record.

Typically, the majority interest fields the client of record. Sometimes the client of record holds powers of attorney from the beneficial owner. The registered agent’s ­attitude will be useful for them if they choose to run off with the company. Financial ­information will be held onshore, where the ­company trades. A member’s right to ­information is limited. In the 1984 act this could be summarised as a right to ask, rather than a right to receive. The provision was not reproduced in 2004’s BVIBC. If something untoward is happening, spotting it in real time may prove impossible.

With a transatlantic credit crunch and high-risk emerging markets, BVI companies will continue to produce significant litigation fallout. The question for investors and their lawyers is: “Did we see it coming?”
James Hilsdon is a partner at The Khan Partnership