Legal Insight - Minority Shareholder Rights under Cayman Islands Law

Introduction

In general, the rights of shareholders of Cayman Islands domiciled companies are governed by the provisions of the Companies Law (2018 Revision) as amended (the “Companies Law”) and the provisions contained in the Memorandum of Association (“Memorandum”) and Articles of Association (“Articles”) of the company. Section 25(3) of the Companies Law states that, when registered, the Articles bind the company and its members to the same extent as if each member had subscribed his name and affixed his seal thereto, and there were in such Articles contained a covenant on the part of himself, his heirs, executors and administrators to conform to all the regulations contained in such Articles subject to the Companies Law. The Articles therefore creates a statutory contract between the members and the company. Each shareholder by agreeing to be a member of the company agrees to be bound by the voting provisions set out in the Articles and subject to the decisions of the majority or special majorities required under the Companies Law and the Articles

The provisions of the Companies Law which govern minority shareholder protection are to a large extent derived from the equivalent provisions in English law. However there are some differences.

Unfair Prejudice

Unlike under English law, there is no ability for a shareholder of a Cayman Islands company to bring a petition before the Cayman Islands Grand Court (the “Court”) on the basis of “unfair prejudice”. However under section 95(3) of the Companies Law, the Court hearing a just and equitable winding-up petition has the discretion to grant alternative remedies to a winding-up, which are the same as the remedies which an English court can grant on an “unfair prejudice” petition, including the following:

  • an order regulating the conduct of the company’s affairs in the future;
  • an order requiring the company to refrain from doing or continuing an act complained of by the petitioner or to do an act which the petitioner has complained it has omitted to do, or
  • an order authorising civil proceedings to be brought in the name and on behalf of the company by the petitioner on such terms as the Court may direct; or
  • an order providing for the purchase of the shares of any members of the company by other members or by the company itself and, in the case of a purchase by the company itself, a reduction of the company’s share capital accordingly).

Right to Information

A shareholder of a Cayman Islands company has no right by virtue of his position as shareholder to be provided with information regarding the company, including the company’s accounts unless such a right is specifically stated in the Articles, or has been agreed by contract (e.g. in a shareholders agreement) which is binding on the company. A search request can be submitted to the Cayman Islands Companies Registry in respect of the company but the only information a search will reveal is the company’s name, number, formation date, type, registered office and status.

Under section 64(b) of the Companies Law, the Court may appoint one or more competent inspectors to examine into the affairs of a company and to report thereon to the Court in such manner as the Court may direct on the application of the holders of not less than one-fifth (1/5) of a company’s issued and outstanding shares. Section 65 of the Companies Law states that it is the duty of all officers and agents of the company to produce for examination by an inspector all books and documents in their custody or power; any inspector may examine upon oath the officers and agents of the company in relation to its business, and may administer such oath accordingly; and any officer or agent who refuses or neglects to produce any book or document directed to be produced, or to answer any question relating to the affairs of the company, shall incur a penalty in respect of each such offence.

Right to bring Personal Action

A shareholder in a company may be able to bring an action directly against the company’s directors if the shareholder can show that the directors have breached a duty owed to the shareholder personally (instead of a duty owed to the company). However actions against directors for breach of their duties, are typically brought to enforce a right belonging to the company rather than to one or more shareholders and accordingly such actions brought to enforce a right belonging to the company, as a general rule of law, have to brought by the company itself (i.e. the right will lie with the Board of Directors of the company for and on behalf of the company).

Derivative Actions

As stated above, the general principle is that an action seeking to enforce a right belonging to a company has to be brought by the company itself. This rule derives from the English common law case of Foss v. Harbottle [1843] 2 Hare 461. The Cayman Islands Court of Appeal has affirmed this principle in two cases: Schultz v Reynolds [1992-93] CILR 59; and Svanstrom v Jonasson [1997] CLLR 192.

Since the right to bring an action to enforce a right belonging to the company belongs to the company, the litigation has to be brought by the company itself. Normally, a company’s Articles will state that the right to commence litigation will lie with the company’s Board of Directors. The shareholder(s) will therefore need to persuade the directors to bring an action on behalf of the company. If the directors decline to take this action, the shareholder(s) would then typically want to consider whether they can replace the directors with a newly constituted Board, who can then initiate the action against the former directors. The procedure for removal and replacement of directors will be set out in the Articles.

There will be instances when a shareholder, who is in the minority on a vote at a general meeting, will wish to object to the result. Generally speaking, a shareholder will object to the result of a vote in circumstances where (X) in the shareholder’s view, harm will result to the company (and consequently the value of the shareholder’s shareholding), or (Y) the shareholder’s personal rights as shareholder have been infringed.

The English common law case of Foss v. Harbottle mentioned above, has also been extended to cover the principle that "an individual shareholder cannot bring an action in the courts to complain of an irregularity (as distinct from an illegality) in the conduct of the Company's internal affairs if the irregularity is one which can be cured by a vote of the Company in general meeting" (Prudential Assurance Co. Ltd. v Newman Industries (No. 2) [1982] Ch. 204, C. A,). This is often referred to as the second limb of the rule in Foss v Harbottle. The reason behind what is known as the second limb of the rule in Foss v Harbottle was the courts desire to avoid futile litigation. If the thing complained of was an action which in substance was something the majority of the company’s shareholders were entitled to do, or if something has been done irregularly which the majority of the company’s shareholders are entitled to do regularly, there was no point in having litigation about it as the ultimate result of the litigation would be that a general meeting of the company’s shareholders has to be called and ultimately the majority gets its way (per Mellish LJ in MacDougall v. Gardiner).

The result of these combined principles is that a minority shareholder can seldom bring an action in his own name against those in control of the company where the action is in respect of a wrong done to the company. The minority shareholder will simply not have locus standii to do so. Furthermore, it will be difficult for a minority shareholder to use the name of the company to bring an action (i.e. a derivative action).

However, based upon established English case law authorities, if the shareholder can bring himself within one of the exceptions to the rule in Foss v Harbottle, the shareholder may be able to bring a derivative action, whereby he or she may bring an action in his or her own name but on behalf of the company. The exceptions are as follows:

  • where the alleged wrong is ultra vires (i.e. beyond the capacity of) the company or illegal;
  • where the action complained of is an irregularity in the passing of a resolution which could only have been validly done or sanctioned by a special resolution or special majority of shareholders (i.e. a majority which is more than a simple majority of over 50%);
  • where what has been done amounts to a “fraud on the minority” and the wrongdoers are themselves in control of the company, so that they will not cause the company to bring an action; and
  • where the act complained of infringes a personal right of the shareholder seeking to bring the action.

Where the Acts amount to a Fraud on the Minority and the Wrongdoers are themselves in control of the Company

The reason for this exception is that if minority shareholders were denied the right to bring an action on behalf of themselves and all others in such circumstances, their grievance would never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue. In order for this exception to apply, first it must be shown that there has been a fraud within the meaning of that word in the English case law authorities on this area and second, it must be shown that the wrongdoers are in control so that the minority shareholder is being improperly prevented from bringing a legal action in the name of the company. In this context, fraud is thought to comprise "fraud in the wider equitable sense of that term, as in the equitable concept of a fraud on a power". Fraud does not include pure negligence, however gross. The traditional approach that appears to have been followed by English courts in the circumstances is to examine the nature of the act complained of to determine whether it is ratifiable by the majority and if it is not, then it will amount to a fraud on the minority. Based on English case law authorities (which are persuasive authority in the Cayman Islands), the following points can be made:

The misappropriation of the company's property or assets by the majority for their benefit, at the expense of the minority, is an act which can be interfered with by the Court at the suit of the minority, since it is not ratifiable by the majority.

Many breaches of directors' duties are ratifiable by the majority shareholders in general meeting, and in these circumstances the minority will have no remedy. Therefore, for example, in the case of Pavlides v. Jensen where it was alleged that the directors were grossly negligent, but not fraudulent, in selling property of the company at an under-value, this was ratifiable by the majority.

There may be circumstances in which the majority shareholders do not exercise their powers bona fide for the benefit of the company as a whole which could amount to a fraud on the minority.

As stated above, an individual shareholder will only be permitted to bring an action in respect of a fraud on the minority if he shows that the company is controlled by the wrongdoers. The meaning of control in this context is not clear although it covers voting control, even where shares are held by nominees.

The question of whether or not there has been a fraud in the sense discussed above and whether or not the wrongdoers are in control of the company must be determined before the minority shareholder's action is allowed to proceed.

Just and Equitable Winding Up

An alternative remedy to taking a derivative action for an aggrieved shareholder would be to petition the Cayman Islands court on the basis that it is just and equitable that the company should be wound up under Section 92(e) of the Companies Law. If a winding-up order is made, liquidators will be appointed who can then investigate the company’s affairs and pursue claims against the former directors (and any others who have caused loss to the company).

As stated above, under section 95(3) of the Companies Law, the Cayman Islands courts hearing a just and equitable winding-up petition has the discretion to grant alternative remedies to a winding up of the company (see Unfair Prejudice above).

Schemes of Arrangement

Sections 86 to 88 of the Companies Law set out provisions regarding schemes of arrangement that may be entered in relation to the company pursuant to which a minority shareholder may be bound by the actions of the majority specified in such provision. We would draw your attention to the provisions of Section 88 which set out the powers to acquire the shares of dissenting shareholders.

Dissenting Rights under the Cayman Merger Law Regime

Section 238 of the Companies Law, provides a shareholder of a Cayman Islands company, involved in a merger or consolidation under the merger regime set out in Part XVI of the Companies Law with the entitlement to be paid the fair value of his or her shares upon dissenting from the merger or consolidation.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice, please contact your usual Loeb Smith attorney or any of:

[email protected] [email protected] [email protected] [email protected]loebsmith.com [email protected]

(per McGarry V-C in Estmanco (Kilner House) Ltd. v. GLC [1982] 1 All ER 437).

(Pavlides v. Jensen [1956] 2 All ER 518).

(Menier v. Hooper's Telegraph Works [1874] LR 9 CH APP 350), (Cook v. Deeks [1916] 1 AC 544).

(Estmanco (Kilner House) Ltd. v. GLC).

(Russell v. Wakefield Waterworks Co. [1875] LR 20 EQ 474).

(Pavlides v. Jensen [1956] 2 All ER 518).

(Prudential Assurance Co. Ltd. v. Newman Industries Ltd. (No. 2) [1980] 2 All ER).

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