Monthly Archives: December 2010

Why the Foreign Business Act is Fundamentally Flawed

The Foreign Business Act (FBA) is flawed because of its extraordinary breadth.  The FBA covers about 50 types of businesses ranging from the production of military armaments and the extraction of natural resources to the simple provision of services and the operation of restaurants.  It covers business activities where there are arguably good policy reasons to restrict foreign ownership to business activities where the rationale for restricting foreign ownership is transparently protectionist and counter-productive.

The same definition of what constitutes an “alien” business applies to every business covered by the FBA irrespective of whether it is a carrier of sensitive military communications or delivering pizzas.  The same factors that determine if a business is employing an illegal nominee shareholding structure to circumvent the FBA applies to both businesses that (arguably) affect national security and those that run Italian restaurants.

The FBA and its predecessor have always defined an “alien” business without any reference to foreign control.  When a business is simply making and delivering pizzas, does anyone really care?  We doubt it.  But when a business is acting in areas that relate to national security, it’s no surprise that there is a tremendous press from some quarters to change the law to make the law actually restrict foreign participation.

This flaw was present at the law’s inception.  Because it was unrealistically restrictive in its breadth, the thin definition of what constitutes an alien business in terms of simple shareholding was required to maintain Thailand’s international competitiveness.   But over time, as other economies in the region have become more open and security concerns more important, the flaws of this law have become more apparent.

On the one hand, it undermines the government’s ability to effectively regulate foreign control and ownership of businesses where many – in a country where the military has always held tremendous power – honestly believe that such regulation is not only appropriate, but also absolutely necessary.  On the other hand, it creates unnecessary red tape and risk to foreigners operating in straightforward commercial activities that make the economy dynamically more competitive, employ, directly and indirectly, millions of Thais, provide all Thais with more choices and improve the quality of life here.

Because the law is ludicrous (and that word is justified for this law), it undermines respect for the rule of law generally in Thailand.  It doesn’t achieve any of its stated policy objectives, and it has been a PR nightmare for investment and business in Thailand. It’s a bad law, and we don’t see it going away in the near future


Self Evident Illegal Nominee Shareholding under the FBA

Examples do exist.  Imagine a document entitled a “Deed of Nominee Shareholding” executed by the majority Thai shareholders.  The deed says the Thai shareholders are not the “beneficial” owners of the shares but are simply holding them on the behalf of foreign shareholders to “comply with local law restrictions on foreign shareholding.”  The Thai nominee shareholders expressly disclaim any rights they would otherwise have as genuine holders of the shares, including rights to dividends or the right to vote. They will do as told by the foreign shareholders when voting their shares.  If they do receive any dividends from the shares they hold “as nominees”, they will immediately hand them over to the  “real” foreign shareholders.

They don’t sound like genuine investors, do they?  Indeed, the use of the word nominee says it all.  When read in the context of the FBA Section 36’s prohibition on nominee shareholder, these documents often read like a confession statements where the Thai shareholding is admitting a violation of the FBA: “Yes, I admit it, I am holding shares as an illegal nominee.”

Who prepares these documents?   Well a one-stop shop didn’t like one of my prior blogs.  (This is how in large part I intend to respond to those comments since I intended to get around to these issues anyway.)  And to be fair, I haven’t seen one from a one-stop shop.   Instead, the origin is generally a lawyer seated outside of Thailand – invariably Singapore or Hong Kong, but generally the former – who has heard about the FBA, but doesn’t seem to quite get it.

What about email traffic essentially saying the Thai shares are really only held by nominees or something akin to nominees?  Depends upon on what they say, but they typically talk about a payment of a fee to hold the shares, provided the Thai shareholder turns over dividends to the foreign shareholder and votes as instructed to do so.  Again, a problem.

Because these problems are contained in internal company documents and personal files that the Ministry of Commerce (MOC) may never see, we have only seem them develop into problems when someone brings these documents to the attention of the MOC or during a due diligence by a prospective buyer.  With the MOC, the source is typically a disgruntled former employee who has seen and kept a copy of email traffic about shareholding arrangements or the deed of nominee shareholding.   It’s not an everyday occurrence, but it happens and it’s not surprising that it does happen.

How about an ad on the Internet or in the paper that says a local business can provide you with Thai shareholders so that your company will be Thai?  Depends.  It’s not a good start, but it depends upon what the rest of the ad says.  If the rest of the ad explains that you, the foreigner, will not really have a full control over the company, that you are going to have to give it up some of the benefits that come up with real ownership or better yet, that you really won’t own the copmany, that should help.  But it really depends, and we have also seen these create serious problems.  This also should not be surprise.

Why?  To put it bluntly, because they are so public.  This isn’t as clear-cut as the first example or often the second, but it’s not a good start.  And it’s all out there for the world to see.

Best to stay clear of all of these arrangements.  It’s an invitation for trouble that you don’t want to make.

What is Illegal Nominee Shareholding under the FBA?

There is no simple and clean answer.  To start, even though news reports, journals and blogs (including this one) use the term “nominee”, that word does not appear anywhere in the Foreign Business Act (FBA), let alone the relevant provision of the FBA, Section 36. FBA Section 36 refers to Thais “aiding and abetting…by holding shares on behalf of foreigners…in order for foreigners to operate a business in violation of the [FBA]…”

The word “nominee” is shorthand for the much more complicated language of Section 36, and it is useful shorthand in many ways because it does help capture parts of this provision of the FBA.  But it is also misleading in some ways because it implies certain concepts (such as trusts) that don’t work well in Thai law (more about that later).

Whenever there is a reference to “aiding and abetting”, you know that intent matters.  Here, you not only need to look at the intent of the shareholders, but also the intent and precise language of the law itself.  This is a criminal provision, and criminal provisions should be and are construed narrowly.  This means you look at the actual language of Section 36, not the “spirit” of Section 36.  You don’t commit crimes by violating the “spirit” of a law (assuming there is such a thing); you commit crimes by intentionally violating the express provisions of a law.

When you look at the history of this law (previously summarized on this blog), its apparent there was no intent for the FBA to provide that a nominee relationship exists simply because foreigners hold shares with greater voting rights or control a company.  The word “alien” is precisely defined so as to exclude any reference to voting rights.  If the FBA was intended to cover voting rights and control, it should have said so expressly.  It didn’t and still doesn’t.

References to voting rights and control are conspicuous by their absence.

Efforts to amend the law so as to include a reference to voting rights have been rejected several times now by several Thai parliaments.  The Ministry of Commerce is on record as saying that a company is not employing a nominee structure simply because foreigners hold shares with superior voting rights or can somehow exercise control over a company.

What matters is whether the Thai shareholders are “genuine investors”.  When the Ministry of Commerce vets company registrations for nominee shareholding, it asks for evidence of the shareholders ability to pay for the shares and, sometimes, evidence that they paid for their shares with their own money.

This makes sense when you look at commercial investments generally.  Individuals make genuine investments all of the time into companies and funds they don’t control.  That doesn’t make the investments any less genuine.  Investors in companies, Thai or otherwise, make all sorts of arrangements about who is responsible for what and who has control over this and that.  A party is not a nominee simply because they lack control over a company.  There are bona fide commercial reasons why parties agree to such arrangements, and a blanket rule saying that certain types of arrangements are illegal per se would do serious damage to the Thai economy.   It would also unreasonably limit the ability of individual Thais to make investments as they see fit.

Changing the FBA to add references to control would constitute a compulsory divestiture or a “taking” from foreign investors.  This would, and did in 2007, raise create major headaches for Thailand.  The EU claimed this sort of change would violate Thailand’s obligations under WTO.  Are they right?  I honestly don’t know.  But what is clear that the efforts to redefine nominee relationships in terms of foreign control were a PR nightmare for investment in Thailand and did absolutely nothing to clarify Section 36 of the FBA.

Looking at control alone is therefore not the answer.  And because a nominee relationship does not arise out of control alone, the mere fact that foreigners hold shares with superior voting rights does not mean that an unlawful shareholding structure is being employed.

So what is an illegal nominee relationship?  In the next post on this subject I will try to give some self-evident examples of a nominee relationship.