A fair share?: s.238 shareholder disputes in Caymans' privatised companies

Disputes amongst shareholders, and the litigation that follows, are commonplace in financial centres such as the Cayman Islands. To put this into context, and while estimates range, there are believed to be in excess of 100,000 companies worldwide incorporated in the Cayman Islands. This is not surprising, given that it is a sophisticated jurisdiction with a well-developed legal system, which has produced a rich line of jurisprudence regarding shareholder disputes. In particular, many of these disputes involve complaints brought by minority shareholders to the effect that their rights are being infringed or their shares are being expropriated.

Comparative considerations

In England, there are broadly two statutory regimes that provide a mechanism or ability to acquire shares of a dissenting minority upon a takeover or merger, namely: the scheme of arrangement and ’squeeze out’ tools. In the Cayman Islands, the Companies Act similarly includes a scheme of arrangement and squeeze out tools – but there is also an additional statutory option available. Pursuant to s.238 of the Cayman Islands’ Companies Act, on a merger or takeover, those shareholders that did not vote in favour of the transaction are entitled to ’air value’ of their shares, as determined by the Grand Court of the Cayman Islands (the Grand Court). In general terms, we are speaking of share appraisal litigation normally synonymous with share appraisal disputes litigated in Delaware. This article focuses on the rise of such share appraisal litigation in the Cayman Islands in recent years.

How does this work?

Take-private transactions are often, but not always, instigated by a non-binding proposal by a company’s controlling shareholder(s) and/or management. They are usually structured under the Cayman Islands statutory merger regime, whereby, provided the merger is approved by shareholders at a general meeting, the company ends up merging with a corporate vehicle that is 100 per cent owned by the buyer group’s holding company. As part of the merger regime and once the merger is approved at a general meeting, those shareholders who do not consider the price offered by the buyer group for their shares to be fair, have the right to dissent from the merger. Given that the merger is already approved, their rights do not entitle them to frustrate the deal, but it does entitle them to payment of the ‘fair value’ of their shares. What constitutes “’air value’ – a term that has no statutory definition under Cayman Islands law – can be a highly contentious issue, given the sums of money at stake. It has spawned a growing body of jurisprudence in the Cayman Islands, where dissenting shareholders seek to persuade the court that ‘fair value’ exceeds the deal price. In short, the dissenting shareholders argue that the price offered, known as the merger price, is too low – whereas the subject company will ordinarily argue in favour of the merger price, or less, depending on various factors.

What is the court’s approach?

To date, there have been over 26 petitions filed in the Cayman Islands seeking the court’s determination of fair value. 7 have proceeded to trial, 2 settled during the course of, or following, trial, and 5 trial judgments have been handed down. 

The Grand Court, like the courts in Delaware, have a number of valuation methodologies available to them when determining the fair value of shares under their respective statutory appraisal regimes. To date, however, there are only three valuation methods that have been applied: (1) the discounted cash flow method (DCF), which is developed based on the company’s projected cash flows; (2) the unaffected market price of the shares, the reliance on which will heavily depend on the efficiency of the market at the relevant time; and (3) the merger or ‘deal’ price, which is likely to be considered where it can be shown that the transaction was conducted at arm's length and with a robust sale process.

While the approach to valuation is unconfined in the Cayman Islands, the Grand Court has, in the most recent cases, shown a preference for the ‘blended approach’. While the Delaware courts have moved away from the income-based methodologies, i.e. DCF, the Grand Court continues to rely on DCF as an indicia of fair value – and this is arguably a distinguishing feature of the approach in the Cayman Islands. The DCF methodology was given considerable weight by the Grand Court in Nord Anglia Education, Inc (In the matter of Nord Anglia Education, Inc, Grand Court of the Cayman Islands (Financial Services Divisions) Cause No. FSD 235 of 2017 (IKJ) (unreported, 17 March 2020) and it was held that this is a correct approach, provided the DCF analysis does not generate a value which is significantly different to the market price, when viewed together with the deal price. This suggests that the DCF method should be used as a form of ‘sense-check’ on the market-based indicators, and if it produces an amount which is greatly in excess or below the market price and/or deal price, then it may be considered unreliable, or, alternatively, show that the deal price is unreliable.

How does this apply in the real world?

In Nord Anglia Education, Inc, the Court gave a 60 per cent weighting to the transaction price and a 40 per cent weighting to a DCF valuation, resulting in a fair value determination 1.16 times the merger price. It was expressly noted by the court that there is no precedent in the Cayman Islands for placing primary or sole reliance on the market price. In the most recent judgment, in Trina Solar Limited (In the matter of Trina Solar Limited, Grand Court of the Cayman Islands (Financial Services Division) Cause No. FSD 92 of 2017 (NSJ) (unreported, 23 September 2020), the Court determined fair value by applying a blended approach of adjusted market price at 30 per cent, merger price at 45 per cent, and DCF at 25 per cent.

With only 5 reported judgments so far, share appraisal litigation is still very much in the development stage in the Cayman Islands. However, the jurisdiction is widely seen as the new ‘hotbed’ for appraisal litigation. This is primarily driven by the presence of Chinese operating companies that are incorporated in the Cayman Islands. There are approximately 200 US-listed, Cayman-incorporated companies that operate mainly in the PRC. There is an estimated market capitalisation of PRC companies listed on the US-based exchanges at approximately US$1.8tn. The increased scrutiny of Chinese-owned companies that are listed on US exchanges is not in dispute. Recent examples are the passing of the Holding Foreign Companies Accountable Act by US legislators – thereby ensuring that such companies are subject to much greater audit reviews and the increased scrutiny of foreign owned companies by the listing exchanges. These changes are likely to have the effect of increasing the number of PRC-operating companies seeking to de-list from the US exchanges, and seeking to go private. With the increasing attention and interest of hedge funds and arbitrage investors as shareholders in these companies, it is likely that we will see more of these cases before the Grand Court.

Paul Madden is a Partner with Harneys. Paula Kay is a Partner with Harneys: harneys.com