What Is a Nomination Agreement?
A nomination agreement is a legally binding contract between a proposed donor and a proposed donee in which the donor states his/her intention to elect the donee as a director of the surrogate decision-making body for a plan or property. The nomination agreement sets out the circumstances that would trigger the appointment of the donee as the director of the surrogate decision-making body. The surrogate decision-making body directs the administration of a grant of property or the use and benefit of a plan and can consist of one or more persons. Where the donor retains the power to revoke or change the direction given under the nomination agreement, the agreement made by the donor is binding on the donee until the donor changes or revokes it. The directions given under a nomination agreement are not subject to amendment by the donee and are either followed as given or are not followed. A nomination agreement may be made jointly among other persons providing for joint surrogacy or separately enabling more than one donee to be appointed as a surrogate director of the surrogate decision-making body. A person may be a donor under a nomination agreement for more than one surrogate decision-making body and more than one donee may be appointed. A nomination agreement is commonly used in the following situations:
- Advance Care Planning through surrogate decision-making Most often , a patient who no longer has or has diminished capacity to make his or her own decisions regarding personal health care needs can, having capacity, designate a surrogate decision-maker who will be empowered to make health care decisions on behalf of the patient when the patient has lost capacity. If more than one surrogate is appointed, the surrogate decision-makers must agree on any proposed treatment that could be made by them jointly. If the surrogate decision-makers cannot decide whether or not to proceed with a treatment, a health practitioner can make the decision on the patient’s behalf in accordance with the Health Care and Consent Act (Canada) (HCCA).
- Estate Planning A donor may grant a power of attorney under the provincial legislation relating to powers of attorney to his or her attorney in order to deal with the donor’s financial affairs with such grant being effective when the donor ceases to have capacity. Under the HCCA a donor may give directions respecting the provision of some or all of his or her personal health care through the execution of a power of attorney for personal care to a person who has the donor’s permission.
- Bequest of Property A person may be appointed as a donee to take charge of a bequest of the property of a deceased donor becoming part of the estate of the deceased donor. The estate trustee is also a surrogate decision-maker for the donor in respect of the grant of property made to the surrogate decision-making body.
Legal Basis for Nomination Agreements
The legal framework governing nomination agreements will depend on the jurisdiction where the business is conducted or the real property which is the subject of the nomination agreement is located. The International Institute for the Unification of Private Law ("UNIDROIT") prepared a set of Principles for International Commercial Contracts ("UNIDROIT Principles"). The UNIDROIT Principles are designed to reflect prevailing international thought on contract law and are purely pragmatic in approach. As such, they do not purport to express the law or agreed best practice but are intended to be good practice and common sense.
Pursuant to Articles 1.1 and 1.2 of the UNIDROIT Principles, the parties are free to choose which law governs a given contract. Even if the choice of law is not expressly mentioned in the contract, the applicable law may be determined from the contract provisions, the commercial context, as well as the common practices of the parties. Article 6.1.4(1) of the UNIDROIT Principles provides that the parties are free to bind themselves by nominating a third party and, Article 6.1.4(2) provides that the party entitled to the benefit of the nomination agreement may not demand performance from the other party before the occurrence of a triggering event. However, it is important to keep in mind the law governing the real property which is the subject of the nomination agreement.
Typical Provisions and Clauses in Nomination Agreements
Nomination agreements typically contain the following standard terms and clauses:
Governing Law and Jurisdiction
Often, nomination agreements will contain a provision setting out the governing law applicable to the agreement and to any disputes under the agreement. In addition, the parties may agree to submit to the non-exclusive jurisdiction (that is, jurisdiction other parties can agree to) of the English courts in relation to any disputes arising under or in connection with the agreement. This is a standard clause, but parties and their professional representatives should be aware of the need to agree the governing law and jurisdiction of the agreement.
Variation
The parties may reserve the right to vary the terms of the agreement. Or they may agree that any variations of the agreement must be made in writing and signed by the parties. This is standard language for this type of clause, but parties and their professional representatives should be aware of the implications of this clause; a new agreement may need to be entered into for material variations to an agreement. For this reason, it is important to include the parties’ rights to revise the terms of an agreement for the most preferred scenarios.
Third Party Rights
This proposal grants no right to a third party under the Contracts (Rights of Third Parties) Act 1999. Contracts (Rights of Third Parties) Act 1999, or C(RTP)A, outlines rights third parties have concerning claims for damages in tort, interest in a trust, or breach of contract. In certain circumstances, third-party individuals associated with a contract can make a claim against the parties directly to that contract. However, section 1(3) states that a third party cannot enforce a term of a contract unless there is evidence in the contract that the named third party may do so. Parties may wish to include this clause to prevent any third party from having the right to enforce the terms of the agreement, although it is also possible for a third party to have some rights and claim damages from a contracting party in contract, tort, and trust breach.
No Assignment
The agreement may state that no party can transfer any of its rights and/or obligations under the agreement without the prior written consent of the parties. In a long-term contract between the parties, it can be required to gain approval from contracting parties before the rights and obligations are transferred to a third party.
Pros and Cons of Nomination Agreements
Nomination agreements are a common tool in cross-border and multi-jurisdictional restructurings involving multiple classes of creditors and creditors from different jurisdictions. It can be especially helpful where there is an intercreditor agreement that requires the approval of a majority or supermajority of creditors from one or more classes of creditors before any party can take, permit or enforce any action against any other party to the agreement. As such, a participant in the restructuring process who may be blocked from taking an action that it considers vital to its recovery through the use of a blocking position can use a nomination to circumvent the express terms of an intercreditor agreement. A further advantage of a nomination agreement is that the affected party may not need full approval from the entire class of creditors to obtain its desired result as the required "percentage approval" threshold can normally be a lower than that required to amend or terminate an intercreditor agreement.
A nomination agreement is, however, a tool that is often used without careful thought as to its risks and consequences. Such risks and consequences include the following: To mitigate these risks, interested parties should carefully consider the terms and conditions of each nomination agreement and take the following steps: Aside from careful drafting, parties should not use a nomination agreement as a substitute for negotiating the terms of a decision-making process with other interested parties. Any party to a restructuring process is subject to the risk that they will be overruled by a higher "percentage approval" threshold, and should conduct a thorough analysis of its risk in taking on a blocking position in a restructuring process. As discussed above, the relative costs of voting in favour of a restructuring plan on an ad hoc basis may be less than what would be required of a party who adopts a blocking position in a restructuring process.
Drafting and Negotiating Nomination Agreements
A key aspect of drafting a nomination agreement is ensuring that the parties clearly understand their respective rights and obligations, and that those are fairly balanced. To this end, the deed should:
- Define the scope of the exclusive mandate clearly, as well as the composition of the relevant legally constituted authority or authorities;
- Set out the minimum threshold in terms of the number of votes or percentage of votes required to appoint the independent fiduciary, bearing in mind the later step in the proxy process where shareholders must also endorse the vote made by the independent fiduciary; and
- Ensure that the independent fiduciary is fully apprised of any applicable company law issues regarding the appointment of directors, and provisions of the company’s MOI and shareholder agreements that may have an impact on the power of the independent fiduciary.
Although both parties should reasonably expect each other to engage with one another on the one or two contentious issues regarding scope that are most practically significant to each of them, it is possible that the initial points of contention will be identified by both at the outset, and that they can move to negotiating and drafting a position which suits them both.
Instead of an independent fiduciary being appointed through an exclusive mandate, parties can make use of a joint proxy, and this is more frequently being used for smaller companies. In this scenario, the parties make a mutual agreement that they will vote for one another’s nominated directors, without instituting an exclusive mandate.
Whilst this method may be convenient, it has a number of downsides, the most significant of which is that the directors are not appointed by the legally constituted authority as provided for in the MOI. This leaves the validity of the directors’ appointments open to question because the applicable company law provisions require the company to appoint directors. Although the directors may be considered de facto directors and therefore valid until set aside by either the existing board or shareholders, if a director terminates office for any reason (other than by being suspended or removed from office) or ceases to hold office, on the expiry of the 60-day notice period that triggers a casual vacancy, the remaining directors must fill the casual vacancy by appointment , or the appointment lapses.
Therefore the parties should consider their positions carefully before deciding to use a voting right. The ideal vehicle would be to implement the exclusive mandate coupled with a no-change period before the appointment of an independent fiduciary in order to ensure the mandate lasts long enough for the independent fiduciary to take up his or her position and cast the vote for the shareholders.
It is important to ensure that each party to the agreement understands the process involved in the holder of the exclusive mandate. In this regard, the independent fiduciary should be advised of the procedure required for obtaining the approval or dissenting vote of shareholders. An example of such a procedure, as implemented by Apple South Africa (Proprietary) Limited under its Sowetan Nomination Agreement, is set out below:
- The exclusive mandate is given to the independent fiduciary over the relevant class of shares.
- The independent fiduciary notifies the shareholders listed as shareholders of the particular class of shares of the resolution that is subject to the exclusive mandate and of the date by which shareholders must respond.
- The shareholders cast their votes in favour or dissenting of the resolution; it should be noted that the vote of the independent fiduciary can only be cast in accordance with the exclusive mandate, i.e. the independent fiduciary may not consult the affected shareholder.
- Where the resolution is supported by the shareholders, the independent fiduciary must vote in accordance with the exclusive mandate in favour of the resolution.
- In the event that the resolution is not supported by the shareholders, the independent fiduciary must provide his detailed reasons to the mandator for voting against the resolution and may not create a tie in respect of the resolution to prevent it from passing.
- If the independent fiduciary is unable to vote on any resolution in accordance with the exclusive mandate, he must provide his detailed reasons to the mandator for the failure to execute the mandate and, unless otherwise agreed, the exclusive mandate will be suspended pending the agreement of the independent fiduciary and the mandator.
Unfortunately, too often neither party position themselves to accommodate an urgent need for implementation of an exclusive mandate, preferring to go through a ‘cooling off’ period. This often leads to significant concentration of shareholders through an exclusive mandate into a period of high tension and ill will. Therefore it will be better to work early on an exclusive mandate solution by addressing points of contention early in order to prepare the parties for dealing with the relevant points later when the need arises.
Use Cases for Nomination Agreements
To illustrate how nomination agreements, or more specifically, their absence, can have significant implications, consider an investment company that seeks to issue stock options as a form of incentive for its key employees. For tax and corporate law purposes, it will be necessary for this company to adopt an option plan. Assuming the option plan contemplates the issuance of shares of common stock, then depending on the number of shares actually reserved for the option plan, the option plan may be subject to shareholder approval requirements under applicable stock exchange rules (such as the Nasdaq Stock Market Corporate Governance Rules or NYSE Listed Company Manual). Failure to obtain the necessary stockholder approval for the option plan would result in any option grants pursuant to that plan being rendered ineffective. In this case, an option agreement would not constitute a "written agreement" in accordance with Section 409A because Section 409A(d)(1) expressly excludes from the definition of "coverage" any arrangement to the extent the arrangement is "not currently effective." As a result of such bad planning, instead of being taxed at the taxpayer’s effective federal income tax rate at grant, the related income tax could be treated as failing to satisfy the non-deferral and specified employee requirements resulting in a steep penalty tax, including a federal additional tax equal to up to 20 percent of the amount of the income tax that is imposed on the individual with respect to the deferred compensation and interest (up to one and one half times the applicable federal underpayment rate) on the amount of the income tax that is imposed on the individual with respect to the deferred compensation. Accordingly, planning with nomination agreements in mind at the outset of any deferred compensation arrangement is critical.
A frequent area where financial and estate planning and tax planning, respectively, can result in highly inefficient or sub-optimal results is where the two intersect involving the cross-ownership of businesses. In this situation, carefully crafted nomination (and other PBWI) agreements can achieve maximum benefit, whereas poorly designed or omitted nomination arrangements can result in millions of dollars of unnecessary income, estate, generation-skipping and other transfer taxes being incurred. For example, a family owned business is owned 70% by one sibling and 30% by another sibling. If the siblings wish to pass the business to their children (who are also business owners) through a series of irrevocable gifts or through a sale to the separate family trusts of the children, the sibling who owns a minority interest in the business (30%) would have no control or economic interest in the business at the time that he or she gifted the shares of the business to his or her children. A nomination agreement coupled with sprinters rights can alleviate this risk by effectively treating the shares gifted to the nominated children as a separate business with the other parent of the children having the ability to control the stock of the business and receive economic distributions until the earlier of a death or the value of the business dropping to zero. No other family member would have the right to vote the stock holding company shares. Basically, through the use of nomination agreements in this situation, the children of the business owners can be given full rights to own the business without effectively taking care of the business for the parents. This transaction which would have been highly susceptible to being challenged as a "sham" business transaction can be structured without the risk of a challenge by the IRS and family members.
Ideally, any nominee arrangement adopted should be documented and executed as quickly as possible after the creation or funding of accounts, funds, policies, trusts and other assets to avoid the possible assertion by creditors of claims of resulting trusts (or an equivalent classification under state law) and jeopardizing the domestic asset protection planning.
In the event that prior to the use of nomination agreements, a trust contract designates the wrong type of trustee under the terms of the instrument or if the wrong (or no) trustee was named under a PBWI arrangement, the use of nomination agreements can be used to correct these mistakes.
In application, nomination agreements can be used in any situation where the owner of property wishes to create a legally enforceable ownership interest with respect to an asset by someone else in the future. For this reason, nomination agreements tend to used in connection with investment management, insurance and estate planning arrangements of all types.
Frequently Asked Questions about Nomination Agreements
The following are expected questions from the various stakeholders involved in a nomination.
Q: Do all OFS appointments have a Nomination Agreement?
A: No. Not all OFS appointments have a Nomination Agreement. Some appointments do not require one if the work being performed can be done under an appointment letter or other agreement. This particularly applies to permanent appointment holders, as long as they remain in an appointment holding position. Other appointments, such as seconded or associated appointments, require a Nomination Agreement if employees are to be paid as quasi-employees. In these cases, the Nomination Agreement is the contractual arrangement between them and their substantive employer to allow for the employer’s remuneration to be used to "pay" the appointees, and the Taxation Office lawfully provides these arrangements with a quasi-employee status.
Q: If I do not want to sign a Nomination Agreement because I am happy with the arrangement as it stands with my employer, do I have a choice?
A: There is no requirement for an employee to sign a Nomination Agreement; however, if the nominated employee does not sign the agreement, then the nominated employee cannot or should not be paid as an appointee. This could leave the nominated employee without pay or certain entitlements, or potentially lead to unintended taxation ramifications. In addition, the nominated employee is not covered by the ordinary terms and conditions of employment or the Code of Conduct. The nominated employee’s substantive employer may also be reluctant to approve the appointment if the nominated employee is not covered in that manner.
If the nominated employee has reservations about signing the NAA , then the nominated employee should contact their HR contact or the service area applying the nomination. If the nominated employee chooses not to sign the nomination agreement, the nominated employee should understand the potential consequences.
Q: What is the liability of the employee for early termination of a seconded appointment?
A: The nominated employee is not liable for early termination unless they have agreed to cover any costs of reinstatement. The additional clauses which may be included in the Nomination Agreement include reimbursement of fees for services incurred by the substantive employer, or returning the appointee to their substantive role at the substantive employer.
The nominated employee must notify the Chief Executive or delegate prior to accepting another appointment, so that any outstanding secondary liability can be addressed.
Q: Can employees nominate themselves?
A: Employees may nominate themselves for an appointment, but it is subject to the Chief Executive or delegate approving the appointment. In the Nomination, employees may request restrictions be placed on their appointment to particular duties.
Q: Who pays for the relocation costs?
A: If the nominated employee is travelling to a different location, then the Chief Executive or delegate can approve compensation to cover travel costs. Often the nominated employee will be required to cover their own travel costs.