The Court of Appeal of the Cayman Islands has delivered a landmark judgment which has provided clarification of and, arguably, amendments to, Section 238 of the Cayman Islands’ Companies Act (the “Act”).

The Court had to consider whether there was an error in or an omission from Section 238 of the Act and whether it was possible to interpret the law in a manner that gives effect to the original intention of the Cayman Islands’ Parliament.

For those who might not be familiar with this part of the Act, Section 238 affords important protection to minority shareholders who dissent to a merger or consolidation involving the Cayman company in which they are a shareholder. Section 238(1) of the Act states that a shareholder of a company is “entitled to payment of the fair value of that person’s shares upon dissenting from a merger or consolidation” and the remainder of Section 238 sets out the steps by which such ‘fair value’ is achieved. The process begins with the dissenting shareholders serving notice of their objection on the relevant company¹ and in the absence of agreement on ‘fair value’, culminates in an application being made to the Court for ‘fair value’ to be determined there.²

Crucially, section 238 of the Act is drafted on the assumption that the shareholders of the relevant company will be able to vote on the proposed merger or consolidation. However, such a vote is not always required. If the proposed merger or consolidation is between a parent company and a subsidiary company both of which are incorporated in the Cayman Islands, the requirement for such a vote can be dispensed with provided that a copy of the plan of merger is provided to all shareholders.³

As a matter of terminology, mergers or consolidations where a vote is required are known as ‘long-form mergers’ and those where no vote is required are known as ‘short-form mergers’.

The question to be answered by the Court in this case was therefore whether minority shareholders in a subsidiary company (which it was proposed would merge with a parent company by way of a short-form merger) could benefit from the protection provided by Section 238 of the Act.

Section 238(1) of the Act establishes the “fair value” principle for the benefit of dissenting shareholders and it reads as follows:

“(1) A member of a constituent company incorporated under this Act shall be entitled to payment of the fair value of that person’s shares upon dissenting from a merger or consolidation.”

Section 238 of the Act therefore does not, on its face, distinguish between long-form mergers or short-form mergers. The same cannot be said of the remaining sub-sections, however, and the Court noted that “it is plain that subsections (2) to (16) of section 238 apply only to long-form mergers. This is evident from the fact that the opportunity to object and the opportunity to dissent depend upon the existence of a shareholder vote, and the timing of the matters set out in subsequent subsections depends upon the existence of such a vote.”⁴

The Court held that subsection (1) of Section 238 is a ‘free-standing provision’ and so is capable of applying to both long-form mergers and short-form mergers whilst noting that the remainder of Section 238 of the Act is “not apt to apply to short-form mergers”.⁵

The Court considered further that “this is not what the legislature intended”⁶ with the Judge observing that “the sensible and commercially justifiable decision to dispense with a shareholder vote in a short-form merger has had the unintended and hitherto unrecognised effect of depriving minority shareholders in a short-form merger of appraisal rights which the legislature intended them to have.”⁷

Regardless of the Court’s view that Section 238 of the Act had been incorrectly drafted, the Judge did not consider it to be within the Court’s powers to interpret Section 238 so as to give effect to Parliament’s original intentions by using ordinary means of construction. The reason for this was because there was no ambiguity in the drafting of Section 238 as it clearly excluded short-form mergers from its ambit because so many of the subsections were predicated on the requirement for a vote of shareholders on the proposed merger or consolidation in every such case.

The Court therefore gave consideration to the principles of construction mandated by the Constitution of the Cayman Islands to see if they produced a different result. In particular, the Court considered section 15 of the Bill of Rights of the Cayman Islands which affords the right of peaceful enjoyment of property with protection against dispossession of such property, save in certain limited circumstances prescribed by law.

The Court found that section 15 of the Bill of Rights is precise as to the provision that must be made by applicable law in circumstances where personal property is interfered with. Such provision must require the “prompt payment of adequate compensation and for securing a right of access to the Grand Court for the determination of the amount of any compensation”.⁸

As the Court had concluded that there were no other remedies available to protect the interests of minority shareholders in cases of short-form mergers, the Court considered it to be necessary to consider how that would affect its interpretation of Section 238 of the Act. It was noted as part of this consideration that section 25 of the Bill of Rights required all legislation to be interpreted in a manner that is compatible with the Bill of Rights.

In light of this, the Court concluded that “the effect of section 25 of the Bill of Rights is to give the court a greater degree of interpretative latitude than is available under the ordinary rules of construction”.⁹

Section 238 ‘as amended’ by the Court’s judgment

In exercising such ‘interpretative latitude’, the Court set out in paragraph 79 of the judgment a mark-up of Section 238 of the Act to more visually demonstrate its interpretation of that section for the benefit of dissenting shareholders in short-form mergers. It is as follows (with amendments shown in red by us):

Section 238

(1) A member of a constituent company incorporated under this Act shall be entitled to payment of the fair value of that person’s shares upon dissenting from a merger or consolidation.

(2) A member who desires to exercise that person’s entitlement under subsection (1) shall give to the constituent company, before the vote on the merger or consolidation (if any such vote is to be held) or (if no such vote is to be held) immediately after the date on which the plan of merger is given to the member pursuant to section 233(7), written objection to the action.

(3) An objection under subsection (2) shall include a statement that the member proposes to demand payment for that person’s shares if the merger or consolidation is authorised or approved.

(4) Within twenty days immediately following the date on which the vote of members giving authorisation for the merger or consolidation is made, or (if no such vote is to be held) within twenty days immediately following the date on which the plan of merger or consolidation is filed with the Registrar pursuant to section 233(9), the constituent company shall give written notice of the authorisation or filing to each member who made a written objection.

(5) A member who elects to dissent shall, within twenty days immediately following the date on which the notice referred to in subsection (4) is given, give to the constituent company a written notice of that person’s decision to dissent, stating-

(a) that person’s name and address;
(b) the number and classes of shares in respect of which that person dissents; and
(c) a demand for payment of the fair value of that person’s share.

Conclusion

Mergers and consolidations can be contentious and highly emotive processes, especially for minority shareholders who consider that the initial price they are being offered for their shares is below ‘fair value’. Whilst shareholder dissent from such processes is already a well-trodden path in the Cayman Islands, the conclusions reached by the Court in this case are surely correct whilst the clarification that has been provided in the context of short-form mergers is very much welcome. However, what will undoubtedly raise a few eyebrows is the willingness of the Court to essentially re-write statutory provisions.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on value dissenting merger/take-private in Cayman Islands, please contact your usual Loeb Smith attorney or:

Robert Farrell

E: robert.farrell@loebsmith.com

T: +1 345 749 7499

[1] Section 238(2) of the Act.

[2] Section 238(9) of the Act.

[3] Section 233(7) of the Act.

[4] CICA (Civil) Appeal 6 of 2021 – In the matter of Changyou.Com Limited – Judgment (FSD 120 of 202) (ASCJ)) at para. 44.

[5] Ibid.

[6] Op cit. at para. 44.

[7] Op cit. at para. 52.

[8] Op cit. at para. 65.

[9] Op cit. at para. 78

The Alternative Investment Fund Managers Directive1 (“AIFMD”), which came into effect on 21 July 20112, as a policy response to the 2008 global financial crisis, aimed to provide a harmonized, stringent and more transparent regulatory and supervisory framework for both EU alternative investment managers (“EU Fund Managers”) and non-EU Fund Managers.

Further rules and regulations from the European Parliament and the Council of the European Union in relation to the cross-border distribution of funds were published on 2 August 20213 (“Rules”), which amend the AIFMD. The Rules were implemented in order to address the divergences in the different pre-marketing conditions between EU Member States and create a harmonized definition of “pre-marketing” and the conditions under which an EU Fund Manager can engage in pre-marketing.

However, despite the objective of the Rules, there is still much uncertainty as to the impact of the pre-marketing rules on reverse solicitation (i.e. where a prospective investor approaches an investment fund or its manager, by the investor’s own exclusive initiative) in each Member State, in particular in relation to non-EU Fund Managers.

The pre-marketing provisions in the Rules apply directly to EU Fund Managers. The Rules are silent on the application to non-EU Fund Managers.

Pursuant to the Rules, pre-marketing is addressed to a potential professional investor and concerns an investment idea or investment strategy in order to test an investor’s interest in an alternative investment fund (“Fund”). The definition of pre-marketing is broad enough (i) to encompass fundraising roadshows, a due diligence questionnaire requested by potential investors, a teaser document and any other materials which refer to the investment strategies of a Fund, and (ii) to capture a Fund which has not even been incorporated at the time of such activity.

(a) Documents circulate to investors

During the course of pre-marketing, an EU Fund Manager is not permitted to distribute subscription forms (including in draft form) and facilitate a subscription into the Fund. If an offering document is issued to a potential professional investor during pre-marketing, this should not contain sufficient information to allow an investor to take an investment decision and must include certain disclosures which emphasize that the offering document does not constitute an offer or invitation to subscribe and is subject to change.

(b) Duration of pre-marketing

Any subscription by professional investors within 18 months of the EU Fund Manager starting pre-marketing of a Fund is automatically considered as a result of the marketing and is subject to notification procedures in the EU, as set out under paragraph (c) below.

(c) Notification procedure

An EU Fund Manager is required within two weeks of commencing pre-marketing in an EU Member State to send an informal letter to the competent authorities of its home Member State specifying (i) the Member States in which it is or has engaged in pre-marketing, (ii) the periods during which pre-marketing is taking place or has taken place, and (iii) details of the Fund. It then becomes the responsibility of the competent authorities of the home Member State of the EU Fund Manager to promptly inform the competent authorities in the EU Member State in which the EU Fund Manager is or has pre-marketed a Fund.

The Rules restrict the ability of EU Fund Managers to appoint non-EU distributors or placement agents to conduct pre-marketing on behalf of a Fund. EU Fund Managers are only permitted to appoint certain types of authorised EU financial institutions to engage in pre-marketing activities (“Third Party AIFM”).

The Rules apply to EU Fund Managers and are not intended to apply to non-EU Fund Managers (e.g. fund managers from the Cayman Islands, U.K., U.S., and the British Virgin Islands) that pre-market their funds into Member States using (i) the relevant National Private Placement Regime of each Member State, or (ii) a Third Party AIFM.

However, a non-EU Fund Manager that has established a Fund managed by a Third Party AIFM that wishes to market the Fund to investors in Member States will be affected by the Rules indirectly, as the Third Party AIFM will need to comply with the Rules.

It is also important to note that it is up to each Member State to pass implementing legislation to confirm whether the Rules (including the pre-marketing provisions) apply to non-EU Fund Managers. For example, Germany, The Netherlands and Luxembourg have passed laws to confirm that the Rules will apply to non-EU Fund Managers. In such a case, as a non-EU Fund Manager will not have a home Member State regulator, a pre-marketing notification will be made to the regulator of the Member State where the non-EU Fund Manager is applying to market to investors.

Following the Rules, the European Commission wrote a letter to request for further guidance on reverse solicitation from The European Securities and Markets Authority (“ESMA”) on 24 September 2021 (“EC Letter”), in order to submit a report of the European Parliament and the Council. The EC Letter requested input from the national competent authority of each Member State (together, the “NCAs”), in particular in relation to data from asset managers on the use of reverse solicitation.

ESMA responded to the EC Letter on 17 December 2021, in a response which stated that almost all NCAs have no readily available information on the use of reverse solicitation from asset managers and investor associations. However, the absence of figures on reverse solicitation was noted to be explained by the fact that under EU law, asset managers are not subject to any obligation to report any information on subscriptions from reverse solicitation to the applicable NCA.

ESMA has hinted at the possibility of introducing new reporting requirements in order to facilitate the collection of information on reverse solicitation across the EU.

The European Commission published a proposal on 25 November 2021 to further amend AIFMD (“AIFMD II”). However, AIFMD II does not provide for further measures to clarify and harmonize the application of the reverse solicitation regime under AIFMD (as amended by the Rules).

AIFMD II includes a condition that non-EU Fund Managers and non-EU Funds must not be established in jurisdictions identified as high risk under the EU’s anti-money laundering rules.

The Rules mean that each EU Fund Manager and non-EU Fund Manager will need to carefully select the EU jurisdictions in which it intends to pre-market to investors and to obtain advice in respect of the specific local laws.

It is advisable for an EU Fund Manager and any non-EU Fund Manager that is caught by the implementing legislation of a Member’s State, as set out in paragraph 5 above to (i) seek appropriate advice in order to comply with the applicable local law, (ii) conduct due diligence on any Third Party AIFM used (i.e. to check it has the appropriate regulatory license), and (iii) make sure that any pre-marketing is adequately documented.

Part IIIA (EU Connected Funds) of the Cayman Islands’ Mutual Funds Act (As Revised) (“MFA”) and certain amendments to the Cayman Islands’ Securities Investment Business Act (As Revised), which came into force on 1 January 2019 (“Amendment Laws”), were implemented in order to ensure consistency with the AIFMD.

The key changes brought into effect by the Amendment Laws include (i) the creation of a framework for Cayman Islands Funds and managers to voluntarily “opt-in” and be licensed by the Cayman Islands Monetary Authority (“CIMA”), via a passport regime, to the AIFMD system in order to manage or market funds to investors in the EU, and (ii) the introduction of a definition of “EU Connected Fund”.

An EU Connected Fund is:

a company, unit trust or partnership carrying on business in or from within the Cayman Islands, which issues shares, units or partnership interests that carry an entitlement to participate in the profits or gains of the fund (whether open or closed-ended) the purpose of which is the pooling of investor funds; and

is either (i) managed by a person whose registered office is in an EU Member State (being either a member of the EU or a part of the EEA in which the AIFMD has been implemented) and whose regular business is managing one or more alternative investment funds, or (ii) marketed to investors or potential investors in an EU Member State.

If a Cayman Islands Fund meets the definition of an “EU Connected Fund”, it is required to notify CIMA within 21 days of the commencement of marketing in a country or territory within the EEA, that it is marketing in a country or territory within the EEA.

Furthermore, as an EU Connected Fund, the Fund is required to comply with the following on-going notification obligations (i) notify CIMA of any changes to the particulars previously submitted to CIMA, (ii) notify CIMA when it has ceased marketing in all Member States of the EEA, and (iii) provide written confirmation to CIMA on an annual basis that there has been no change to the particulars previously submitted to CIMA.

The MFA also introduced a formal procedure for EU Connected Funds to request attestations or confirmations of status from CIMA (where required to be submitted to regulators of particular Member States in which it is proposed to market the EU Connected Fund) upon the submission of certain details and payment of a fee to CIMA.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on Pre-Marketing and Reverse Solicitation in the EU, please contact your usual Loeb Smith attorney or:

Elizabeth Kenny

E: elizabeth.kenny@loebsmith.com

T: +1 345 749 7594

1. Directive 2011/61/EU of The European Parliament and of The Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010
2. EU Member States given until 22 July 2013 to implement its requirements
3. Rules (EU) 2019/1160 and Regulation (EU) 2019/1156 of the European Parliament and of the Council of 20 June 2019 amending Rules 2009/65/EC and 2011/61/EU