Bermuda: Share Transfers & AML/ATF Concerns – Real Or Contrived

Last Updated: 26 October 2016
Article by Nick Miles, Mark Chudleigh and Alex Potts

The judgment of the Supreme Court of Bermuda in Capital Partners Securities Co. Ltd. v Sturgeon Central Asia Balanced Fund Ltd ([2016] SC (Bda) 68 Com (27 June 2016)), handed down in July 2016, resolves important questions about restrictions on share transfers in the bye-laws of Bermuda companies, particularly with reference to companies carrying on business as funds. It also gives helpful guidance for companies faced with 'non-routine' transfer requests regarding how they should exercise rights of refusal.

The case is illustrative of the increasingly onerous customer due diligence requirements for Bermuda companies, following statutory amendments taking effect at the start of 2016. Complying with these requirements is, in some circumstances, liable to slow down the process of determining whether to admit new members or beneficial owners. However, the need to comply can also provide a pretext for strategic delay where the company or Board of Directors (Board) objects to a proposed new member for reasons unrelated to genuine compliance issues.

CPS v Sturgeon happens to be the third case within the last 12 months to result in a reported decision on the Bermuda Court's jurisdiction to rectify the register of members of a company.

Facts

The plaintiff was the beneficial owner of participating shares in the defendant, a Bermuda exempted company, and was the purported transferee of shares in the defendant pursuant to an instrument of transfer. It sought rectification of the register of members of the defendant to reflect the transfer pursuant to section 67 of the Companies Act 1981, which provides that:

'(1) If—

  1. the name of any person is, without sufficient cause, entered in or omitted from the register of members of a company; or
  2. default is made or unnecessary delay takes place in entering on the register the fact of any person having ceased to be a member,
  3. the person aggrieved, or any member of the company, may apply to the court for rectification of the register'.

The plaintiff had lodged the instrument of transfer with the defendant on or about 6 January 2016. The transferor was the nominee of the plaintiff and a large number of other beneficial owners. The result of the transfer, if perfected by entry in the register of members, would be that the plaintiff would hold some shares as nominee for beneficial owners and others for its own account. The transfer therefore involved no change in beneficial ownership.

The Board of the defendant were allegedly concerned about adverse effects on the secondary market in the shares that would flow from the plaintiff holding a number of participating shares for its own benefit, and concerns about the need for anti-money laundering/ anti-terrorist financing (AML/ATF) due diligence on the underlying beneficial owners of a number of other participating shares to be held by the plaintiff as nominee.

The plaintiff had in fact declined the defendant's requests to provide customer due diligence regarding the underlying beneficial owners and had instead invited the defendant to rely upon the plaintiff's due diligence exercise in lieu of carrying out its own, which the defendant considered it was prevented from doing.

However, the Board were well aware that the plaintiff's goal, in seeking entry on the register of members was to acquire, in due course, standing to present a contributory's petition for the winding up of the defendant, and there were grounds to suspect that this motivated the Board's failure to approve the transfer.

The hearing of the Originating Summons took place approximately five months after the instrument of transfer had been lodged. By the time of the hearing, the defendant claimed that it still needed time to consider whether registration should be refused on the basis of regulatory concerns allegedly arising in the course of the defendant's compliance procedures.

Can a Company's Right to Refuse to Register a Transfer of its Shares be Lost by Effluxion of Time and If So When?

The plaintiff's primary case was that the defendant's right to refuse to register, as set out in the bye-laws of the defendant (and cited in relevant part further below), had lapsed upon expiry of the three-month statutory period for notification of refusal prescribed by Section 50 of the Bermuda Companies Act 1981 which provides as follows:

'Notice of refusal to register transfer

50. (1) If a company refuses to register a transfer of any shares or debentures, the company shall, within three months after the date on which the transfer was lodged with the company, send to the transferor and transferee notice of the refusal.

(2) If default is made in complying with this section, the company and every officer of the company who is in default shall be liable to a default fine'.

The defendant argued that the defendant retained the right until expiry of a reasonable period of time, which might be three months but might be longer, and a reasonable period was continuing.

After considering an English authority on the then UK equivalent of Section 50, which held that a company's discretion to refuse to register a transfer lapsed upon expiry of a reasonable period of time in which to decide to refusal to register, the judge expressed dissatisfaction with the 'nebulous' concept of unreasonableness. His primary concern was the interplay between subsections (1) and (2) of Section 50. Section (2) imposes a penalty on the company and its officers in the event of late notice. The existence of a right to refuse to register and the liability to pay a penalty had to mutually exclude one another, in the judge's view, so that the company could not at once notify a refusal in accordance with extant contractual rights yet be liable to pay a fine under Section 50(2).

This meant that the length of time for notification had to be certain, and the judge was unable to accept that whether or not the company and its officers were liable to pay a default fine was subject to the vagaries of what facts the regulatory authorities may or may not view as constituting a reasonable excuse in any particular case.

The judge found as a matter of law that a company may not ordinarily refuse to register a transfer after the statutory time for notice has expired. This is not an inflexible rule, but exceptional circumstances broadly corresponding to the grounds on which liability for a default fine could be challenged, are required to justify departing from it. As to what counts as exceptional circumstances, the judge held that these are to be ascertained by reference to the grounds specified in Section 280(1) of the Companies Act, which provides relief from statutory penalties where the individual in default is not knowingly guilty of the default and has not knowingly and wilfully authorized or permitted the default. Exceptional circumstances included circumstances where:

  1. the directors had no actual knowledge of the transfer request;
  2. the refusal occurred within the required time-frame but due to an administrative oversight was not timely given; and
  3. for exceptional logistical reason it was impossible to convene the board to make the refusal decision in time.

How to Respond to 'Non-Routine' Transfer Requests

The judge then made various findings about how a company with the benefit of a right of refusal should proceed when in receipt of a request to reflect a transfer in its register of members. Anyone concerned with the decision of Bermuda companies whether or not to approve registration of a transfer, including corporate service providers, will find these of interest.

  • Share transfers should ordinarily be given effect to in a prompt manner because any delays interfere with the shareholder's fundamental right to enjoy and freely dispose of his property.
  • Routine transfers must be registered within the time period mandated and save in exceptional circumstances the company will lose the right to refuse to register the transfer if it does not do so within the statutory period.
  • A shareholder can seek rectification if neither registration nor refusal occurs within the three months' period.
  • The position should in principle be no different in 'non-routine' cases where, as in this case, the company is unwilling to register a transfer because it has regulatory concerns. Either those concerns are resolved within the statutory period and the transfer is registered or the concerns are not resolved. If concerns are not resolved within the minimum statutory period the company can simply serve notice of refusal.

Did Exceptional Circumstances Apply?

Having found that the right to refuse could survive expiry of the statutory period where there were exceptional circumstances in this case, the judge considered whether exceptional circumstances applied.

As noted above, the intention of the plaintiff's registration request was that the plaintiff would acquire standing to present a contributory's winding-up petition.

The judge considered that there were strong grounds for suspicion that the defendant's delay in considering the registration request will have been motivated by its litigation strategy. Additionally, there was no evidence that the Board was impeded from meeting and refusing to register the transfer on an interim basis before the three months' time limit expired.

Interestingly the court found that once the defendant decided that it was unwilling to process the change of legal ownership as a 'routine' administrative matter, a refusal decision was then required to enable to the plaintiff to effectively access the court's rectification jurisdiction under Section 67.

In the circumstances, the court found that the defendant should have convened a meeting of the Board when expiry of the three month period was approaching, and made an 'interim' refusal, rather than simply ignoring the statutory time limit. The consequence of defendant's failure to comply with the mandatory provisions of Section 50 was that it lost the right to refuse to register the transfer.

Alternative Finding – Had the defendant Notified a Refusal in a Timely Manner, Would the Refusal have been a Valid Exercise of Rights Under the Bye-laws?

Although the foregoing finding disposed of the matter, the judge also made an alternative finding, in the event that he was wrong that the right to refuse had been lost, as to whether the plaintiff's application would succeed in the event that a timely refusal decision which was prima facie valid had in fact made.

The judge was required therefore to ascertain whether such refusal would have been in accordance with the specific restrictions imposed by the bye-laws, in the following form, which will be familiar to those working in or advising the Bermuda funds industry:

'16 Subject to the Act, to any applicable restrictions in these bye-laws and with the prior consent of the Board, any shareholder may transfer all or any of his shares by an instrument of transfer in the usual common form or in any other form which the Board may approve. Any transferee of such shares is required to furnish the same information and execute similar documentation to that which would be required of a direct subscription of the shares in order for a transfer application to be considered by the Board. No such instrument shall be required on the redemption or repurchase of a share by the Company.'

RESTRICTIONS ON TRANSFER

'18.1 The Board may refuse to register the transfer of a share where the proposed transferee is a non-qualified person. The Board shall refuse to register any transfer unless all applicable consents, authorisations and permissions of any governmental agency or body in Bermuda have been obtained.'

'18.2 No transfer of Participating Shares may be made if:

18.2.1 As a result of such transfer either the transferor or the transferee of such participating shares would hold less than the minimum number of participating shares as the Board may from time to time specify; or

18.2.2 Such transfer would in the opinion of the Board result in a breach of any restrictions imposed by the Board under these bye-laws or would, or is likely to, cause a pecuniary, tax, legal, regulatory or material administrative disadvantage to the company or its shareholders as a whole...' [emphasis added by the judge]

The judge noted that the right to transfer shares is expressed in broad terms while the right of the Board to refuse to register a transfer is expressed in narrow, restrictive terms. This the judge found to be consistent with the status of the defendant as what he characterised as more a 'quasi-public company' than a 'quasi-partnership private company'.

The judge considered that 18.2.2 required a causal connection between the legal and regulatory concerns and the decision to refuse registration of the plaintiff as a member.

The evidence on behalf of the defendant was that the Board was concerned about adverse effects on the secondary market in the shares in the defendant that would flow from the plaintiff holding a number of participating shares for its own benefit, and concerns about the need for AML/ATF due diligence on the underlying beneficial owners of a number of other participating shares to be held by the plaintiff as nominee.

The concerns about effects on the secondary market were found to have been sufficiently allayed by the plaintiff's offer to undertake not to sell the shares which it beneficially owned.

That left the AML/ATF concerns.

The judge was prepared to find on a provisional basis that the defendant was in fact entitled and required to seek customer due diligence on the underlying beneficial owners.

Nevertheless, although this meant (provisionally) that the plaintiff had failed to provide documents necessary to allow the defendant to complete its compliance review, the judge found that these matters were not relevant to the identity of the nominee, which was the only change involved.

The judge held that the plaintiff's refusal to comply with the defendant's customer due diligence information request was not grounds for refusing to register the share transfers pursuant to bye-law 18.2.

  • There was no or insufficient evidence of a causal connection between the legal and regulatory concerns and registration of the plaintiff as a shareholder.
  • Bye-law 18 had to be construed in a way which gives due deference to the prima facie rights of transferors and transferees to have share transfers registered.
  • There were no grounds for believing that the plaintiff if registered would not comply with the defendant's information requests in the light of the court's provisional finding that it is required to do so.
  • The plaintiff would in any event have to disclose the identity of the beneficial owners in any winding up application made on the petition of the plaintiff.

The judge also expressed the view that Section 67(3) of the Act gave the court jurisdiction to provide ancillary relief compelling the plaintiff to comply with the defendant's reasonable requests for customer information.

Conclusion

The case is of particular interest for confirming:

  • As a matter of Bermuda law, a company loses its right to refuse to register a transfer upon expiry of the statutory period in Section 50(1) subject to exceptional circumstances; and
  • Exceptional circumstances involve matters that would also entitle the company or officers to relief under Section 280(1) for inadvertent non-wilful default, and/ or inability to convene a meeting of the Board;

and for its obiter observations that:

  • A restrictive approach to interpreting rights of refusal is appropriate;
  • Where a right of refusal arises where the company is of the opinion that a transfer would give rise to compliance breaches, there must be sufficient evidence that the company is of that opinion and that such opinion motivates the refusal; and
  • That a company faced with a non-routine transfer is duty bound to consent or refuse within the statutory period, failing which the aggrieved party is entitled to seek rectification.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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