Cayman Islands: The Importance Of Respecting The Corporate Integrity Of Special Purpose Vehicles Post Enron

Last Updated: 21 November 2002
Article by Margaret Boswell

Margaret Boswell is a Partner in the London office of Maples and Calder

The aftermath of the Enron scandal is not the first occasion that attempts have been made to set aside corporate structures, and it will not be the last. But leaving aside instances of outright fraud and wilful manipulation, the use of special purpose vehicles in complex financing structures is a perfectly legitimate use of a fundamental principle of corporate law.

Separate Legal Entity

That principle is that a company is, from the date of its incorporation, a separate legal entity distinct from its members and its directors. If we were in any doubt before 1897, the case of Aron Salomon, Hide Factor and Export Boot Manufacturer, decided the matter. After 30 years' successful business on his own account he formed a limited company in 1892 and sold his business to it, receiving debentures which finally ended up in the hands of the splendidly named Edmund Broderip. The business, at the time of transfer to the company, was in a sound condition but ultimately became insolvent due to a succession of strikes in the boot trade (cobbling was a tempestuous profession in those days, it seems). When Edmund Broderip instituted an action to enforce his security against the assets of the company a liquidator was appointed to protect the unsecured creditors. The liquidator sought to have the arrangements made by Aron Salomon for the formation of his company set aside as a sham, a fraud upon the creditors of the Company, on the grounds that Salomon had merely taken advantage of the legislation to carry on his own business, the other shareholders being family members and merely his nominees. The court upheld that once a company has been properly legally incorporated it must be treated like any other independent person with rights and liabilities appropriate to itself.

Special Purpose Vehicles

It is this aspect of incorporation that has led to the widespread use of special purpose vehicles ("SPVs") in international financing transactions. Once incorporated, the SPV is an independent legal entity distinct from its subscribers, shareholders, or the guys who had the idea to set the structure up. Often the primary concern is to ensure that the SPV is off balance-sheet - does not need to be reflected in the financial statements of any of the other parties involved in the transaction. The classic structure for an "orphan company" is to have the shares in the company held on trust for charitable purposes by one of the many offshore service providers. If the SPV can then not be said to be "owned" by anyone, the remaining concern is whether it can be said to be "controlled" by any person and the integrity bestowed by incorporation compromised in that manner.

Independence vs control

In the course of structuring a transaction, the tension between the need to respect the integrity of the incorporation, and the desire of the principals for "control" is often apparent. However, there is very definitely a limit to the extent to which principals can seek to influence the decision making of a Board of Directors without either causing those directors to be in breach of their fiduciary duties to the company; running the risk of compromising the integrity of the corporation by becoming shadow directors or bringing the vehicle onshore to the jurisdiction of the principals.

Shadow Directors

Under English law the term "shadow director" is defined as "any person in accordance with whose directions or instructions directors of a company are accustomed to act". There is judicial authority that unless the whole of the Board, or at least a governing majority of it, are accustomed to act upon the directions of an outsider, such a person could not be a shadow director. Reformers repeatedly suggest that if any one director is accustomed to act on the instructions of a third party, that third party ought to be deemed a shadow director, but for the time being the directors as a whole need to act in accordance with the directions or instructions of the shadow director. Interestingly, the expression "shadow director" is not confined to an individual – a body corporate may be so characterised. The classic sort of person who might be caught by the shadow director's rules would be a controlling shareholder who instructs the directors how to act or appoints a nominee director whose wishes tend always to be followed by the Board, or an employee of an arranger or other intermediary who "advises" the Board but whose advice is never properly considered and always blindly followed.

Management and Control

The true test of the residence of a company is not where it is incorporated or where its registered office is located. The company is resident where the central management and control of its business abides. Residence will be where the Board habitually meets and decides matters of fundamental policy. The test of corporate residence must, therefore, be distinguished from questions as to the control of the company itself. Shareholders control the company, directors exercise central management and control over the business of the company. In the case of a limited liability company owned by shareholders, they will collectively have the power to ensure that the affairs of the company are conducted in accordance with their wishes, exercising that power through general meetings of the company, but they do not exercise central management and control of the business of company. Equally, corporate residence can be distinguished from where the business of the company is carried on or where the profits are earned.

Getting it wrong

The tax cases of R v Dimsey and R v Allen are instructive examples of what not to do. Dermot Jeremy Dimsey and Brian Roger Allen were convicted of the common law offence of conspiracy to cheat the public revenue. Worse still, from a lawyer's point of view, Dimsey's solicitor, a Mr De Costa from a firm in Gerrards Cross, was also found guilty of conspiracy and sentenced to 12 months' imprisonment. An examination of the facts of the case reveals many object lessons in how not to respect the integrity of an offshore vehicle. Dimsey was resident in Jersey and owned a company which provided various financial services including the formation and administration of such companies. Mr Allen was a client of Dimsey. The prosecution sought to prove that Allen himself managed and controlled the companies in the United Kingdom. When his home address was searched there were found numerous detailed cash statements and lists in respect of the offshore companies, cheque books in respect of the companies with blank cheques signed by the authorised signatories and bank statements of the companies annotated by Allen. One company had provided £80,000 worth of Premium Bonds to the Allen family. The companies provided Allen family members with credit cards used to pay household and personal bills and the properties in which he and his family lived were all in the names of offshore companies. One company paid for the school fees of four of Allen's children and the family's holidays. All of this had been brought about by Allen's manipulation of the offshore companies.

Admittedly, it is unusual in the context of international finance transactions to see such egregious disrespect for the integrity of SPVs, but there are a number of common sense lessons to be drawn from these cases. In this post Enron era it will be increasingly important to learn these lessons and put them into practice if arrangers are to be able to demonstrate to the satisfaction of their regulators that offshore vehicles really are independent entities.

Don't incorporate overnight

In the real world it is unlikely that a company could be formed on a Monday and on Tuesday, acting independently and of its own accord, sign up contracts to issue several hundred million dollars worth of debt and appoint an investment manager to invest the proceeds in a carefully balanced basket of assets on its behalf. It is difficult to sustain the argument that the directors carefully considered a six inch high pile of documentation and decided that its entry was in the best corporate interests of the company if they were only given 8 hours to peruse it. Sometimes it is unavoidable – in the real world people do have to move quickly to seize fleeting opportunities - but in general it is far preferable for the company to be incorporated well in advance and for the directors to resolve to enter into discussions with the arranger with a view to completing the proposed transaction. At a subsequent meeting, the directors can review drafts and authorise one of their number to approve final versions and execute them on behalf of the company.

Keep your directors in the loop

It is not unheard of for the parent company of a financing subsidiary to help themselves to a dividend from the subsidiary's profits without even informing the Board, far less consulting it or obtaining its approval. This does not help to boost the argument that the company is an independent entity with its own separate personality.

Use credible directors

As the saying goes, if you pay peanuts you get monkeys. It is worth going to a service provider who will supply properly qualified and experienced directors who have a legitimate contribution to make to the conduct of the company's business. The use of directors who are such in name only damages the credibility of the company's integrity and independent existence.

Don’t be mean

It is extraordinary the lengths to which investment banks will go to avoid surrendering the last thousand dollars of capital in a company. There must be some corporate benefit to the company in entering into the transaction and the prospect of having change out of a thousand dollars at the end of a transaction to distribute to its shareholders is not much, but it is enough. In any event, since the shareholder is holding the shares on trust for charitable purposes, any dividend will go to charity (often the International Red Cross) and very few of us involved in these transactions couldn't use the good karma associated with the occasional charitable donation.

Don't be afraid to ask questions

It not only makes good sense to ask where is the money coming from, where is it going and why, but most lawyers and bankers are now under an obligation to report suspicious transactions they observe in practice, often without alerting the clients. Compliance specialists confirm that often one's own gut feeling that there is something not quite right about a transaction is as good a test as any – not being able to put your finger on quite what is wrong may be the strongest indication that there is a problem.

Getting it right

To get it right, you need to picture yourself in the following scene, and know you will be able to acquit yourself with dignity. You are in the box at the High Court, or before some gruesomely named sub-committee of the US Senate. A highly paid lawyer asks you the following questions about Veritas, the repackaging vehicle set up by your institution, Megabank.

  • Does Megabank directly or indirectly own Veritas and, if it doesn't, who does?
  • Does Megabank own the charitable trust and, if not, who does?
  • Who are the directors of Veritas?
  • Why were they appointed and what are their qualifications?
  • Does Megabank pay them? Then who does?
  • If Megabank comes up with a deal for Veritas, how does it know that Veritas will do it if Megabank doesn't control Veritas?
  • How many deals does Veritas refuse?
  • Who negotiates the deals for Veritas?

There are perfectly good and legitimate answers to all those questions, but you won't find yourself able to give them unless you respect the fundamental integrity of the vehicle throughout its establishment and subsequent operation, and are prepared to structure Veritas properly.


The exigencies of commercial life have moved on from the days of purveyors of hand made footwear to the gentry, but even in the world of multi billion dollar oil companies, the fundamentals remain the same: the limited liability incorporation is a legitimate tool with tremendous benefits for both the entrepreneur and the putter-together of complex structures. But to take advantage of those benefits, one must be careful to respect the integrity and independent existence of the beast, or run the risk of that independence being challenged in court.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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