A series financing transaction is a type of equity investment deal in which an investor injects cash into a business in exchange for preferred shares. The issuance of preferred shares is typically documented by a share subscription agreement between the investor and the company. A shareholders’ agreement (SHA) is also entered into between the investor and the company to govern the parties’ rights and responsibilities. The company’s memorandum of association and articles of association (M&AA) are amended and restated to incorporate relevant provisions of the SHA. This is to ensure that there are no inconsistencies between the agreement’s contractual provisions and the company’s constitution.

Cost-effective and quick to incorporate. The British Virgin Islands (BVI) and Cayman Islands companies are not expensive to incorporate and maintain. BVI companies are typically incorporated within one to two business days, while Cayman companies are incorporated within five to seven business days, or on a same-day express basis for an additional fee.

Corporate governance is efficient. Non-regulated entities may have a sole shareholder and a sole director, who may be the same person. There are no nationality and/or residency requirements for these roles.

Flexibility. There is flexibility in tailoring the M&AA of the company to accommodate the issuance of different classes of shares, and the rights and restrictions attached to them.

Tax neutrality. There is no corporation tax, capital gains tax, income tax, profits tax and/or share transfer tax under BVI and Cayman law.

Investor familiarity. Investors are familiar with the BVI and Cayman as jurisdictions that help facilitate investment decisions.

Secured creditor friendly. The BVI and Cayman are widely recognised as creditor-friendly jurisdictions, which help in facilitating debt financing that an early-stage company may require.

Basic corporate information, M&AA, directors and shareholders. For Cayman companies, access to date of incorporation, company name and registered address is publicly available. Access to constitutional documents and statutory registers is not public and can only be obtained with the company’s consent, authorising its registered office service provider to disclose them.

The M&AA of a BVI and a Cayman company may reveal important information, such as whether:

1. 1. Any third-party consents are required to implement a series financing, or whether certain conditions need to be met prior to its consummation;
   2. There is an existing SHA in relation to the company (which could impose certain consent requirements on the parties with respect to the series financing);
   3. A series financing falls within the scope of any existing board and/or shareholder reserved matters; and
   4. There are any most-favoured-nation provisions in favour of an existing investor.

Outstanding charges. The register of charges (if maintained) of a BVI company and the register of mortgages and charges of a Cayman company are matters of private record. The register of registered charges of a BVI company is publicly searchable.

Good standing. In the BVI, a company is in good standing if it is on the register of companies, has paid all fees, annual fees and penalties due, has filed a complete register of directors with the BVI registrar, and has filed its annual return.

A Cayman company, meanwhile, is deemed to be in good standing if all fees and penalties have been paid, and the registrar of companies has no knowledge that the company is in default.

Litigation. In the BVI, a search may be conducted to verify whether there are or have been any actions against a company in the courts. In the Cayman Islands, a search may be conducted to verify whether there are or have been any actions against a company in a Cayman court at the time of the search.

Certificate of incumbency. It is prudent to review an up-to-date certificate of incumbency issued by the company’s registered agent.

Books and records. Every BVI and Cayman company must maintain books and records showing that company’s transactions, assets and liabilities, and enable the financial position of the company to be determined with reasonable accuracy.

This article was first published in the Asia Business Law Journal https://law.asia/key-issues-series-financing-bvi-cayman-islands-law/

A series financing transaction is a type of equity investment deal where an investor injects cash into a business in exchange for preferred shares. Irrespective of whether the investor is a venture capitalist, an angel investor or a private equity house, the issuance of preferred shares to the investor by the relevant company is typically documented by a share subscription agreement between the investor and the company. A shareholders’ agreement (“SHA”) is also entered into among the investor(s) and the relevant company to govern the rights and responsibilities of the parties, and the memorandum of association and articles of association of that company (collectively, the “M&AA”) are typically amended and restated to incorporate relevant provisions of the SHA to ensure that there are no inconsistencies between the contractual provisions of the SHA and the constitution of the company.

A distinction is often drawn between different rounds of series financing transactions. For example, series A financing refers to the first round of venture capital funding for a startup which typically follows a company’s seed round. A series B financing usually follows thereafter if the company is successful. In general terms, while a series A investment usually provides a startup with sufficient capital to develop its products and team and to commence the execution of a go-to-market-strategy, a series B investment is designed to accelerate a company’s growth. Series C financing transactions and other “late-stage” investments generally occur at a subsequent stage to support an initial public offering (IPO) or in anticipation of an acquisition.

Although investors’ key commercial drivers will vary depending on circumstances and between different rounds of series financings, many of the local law issues that arise from a BVI and a Cayman Islands law perspective are materially the same with some nuances, however. For example, there may be differences, such as in relation to board and observer appointment rights, the payment of dividends and the rights in a winding-up, that BVI or Cayman Islands legal counsel (as appropriate) will be able to advise upon.

There are various features of BVI and Cayman Islands law which make these jurisdictions attractive to startups and other early-stage companies, such as:

1. 1. Cost-effective and quick to incorporate. BVI and Cayman Islands companies are inexpensive to incorporate and to maintain in comparison with companies in other premium offshore jurisdictions. BVI companies are typically incorporated within 1-2 business days of submitting an incorporation application and Cayman Islands companies may be incorporated within 3-5 business days or on a same day express basis for an additional fee.
   2. Corporate governance is efficient. Non-regulated entities may have a sole shareholder and a sole director (which may be the same person) and there are no nationality and/or residency requirements with respect to those roles. Corporate director(s) and/or corporate shareholder(s) may also be appointed. There is no requirement to appoint a company secretary and/or to prepare audited financial statements.
   3. Flexibility. There is significant flexibility in tailoring the M&AA of the relevant company to accommodate the issuance of different classes of shares and the rights and restrictions attaching to them, board and shareholder reserved matters and other provisions pertaining to corporate governance issues.
   4. Tax neutrality. There is no corporation tax, capital gains tax, income tax, profits tax and/or share transfer tax as a matter of BVI and Cayman Islands law. Additionally, there is no withholding tax from a local law perspective.
   5. Investor familiarity. Private equity houses and venture capital investors are familiar with the BVI and the Cayman Islands as jurisdictions which are helpful in facilitating investment decisions.
   6. Secured creditor friendly. The BVI and the Cayman Islands are widely recognized as creditor friendly jurisdictions, which are helpful in the context of facilitating any debt financing that an early-stage company may require. The BVI also has a straightforward system of publicly registering security interests which is attractive to secured creditors.

In our experience, most key investors opt to undertake local legal due diligence on a company into which an investment is proposed to be made or which otherwise forms part of the corporate structure.

From a BVI and a Cayman Islands law perspective, the due diligence exercise typically encompasses the following matters.

i.   Basic corporate information, M&AA, directors and shareholders

Whilst certain basic corporate information such as date of incorporation, company name and registered address, and the names of the current directors of a Cayman Islands company are a matter of public record, its constitutional documents and statutory registers are a matter of private record and can only be obtained with the consent of the relevant company authorizing its registered office service provider to disclose them. This consent will invariably be provided as it is market practice for an investor’s Cayman Islands legal counsel to review these documents.

In contrast, a broader range of corporate information is publicly available in relation to a BVI company. Its certificate of incorporation and M&AA may be obtained from a company search, its register of members is only publicly searchable if the company has opted to make it public and it has therefore filed it with the BVI Registrar of Corporate Affairs (the “BVI Registrar”). All of the other statutory registers of a BVI company (such as its register of directors, register of members (to the extent the company opted to keep it private) and private register of charges) are a matter of private record and can only be obtained with the consent of the relevant company authorizing its registered agent to disclose it. Similar to the Cayman Islands, this consent will invariably be provided as it is market practice for an investor’s BVI legal counsel to review these documents.

The M&AA of a BVI company and a Cayman Islands company may reveal important information in the context of a series financing transaction. For example, it could assist in determining whether:

1. 1. any third-party consents are required to implement a series financing, or whether certain conditions need to be complied with prior to its consummation;
   2. there is an existing SHA in relation to the company (which could impose certain consent requirements on the parties with respect to the series financing);
   3. a series financing falls within the scope of any existing board and/or shareholder reserved matters;
   4. there are any most-favored nation provisions in favour of an existing investor;
   5. there are certain procedures which ought to be followed before the issuance of preferred shares, such as with respect to pre-emption rights; and/or
   6. the directors of the company may resolve to refuse or delay the registration of an issuance of shares in the company at their discretion.

ii.   Outstanding charges

Although the register of charges (if maintained) of a BVI company and the register of mortgages and charges of a Cayman Islands company are matters of private record, the register of registered charges of a BVI company is publicly searchable. The primary purpose of filing particulars of a charge in a BVI company’s register of registered charges is to protect the priority of the underlying security interests and to put third parties on constructive notice of them. An investor’s offshore legal counsel will invariably review the register of registered charges of a BVI company and request a copy of the register of charges or register of mortgages and charges (as applicable) to be provided to ascertain whether a company’s assets are subject to existing security interests.

iii.   Good standing

In the BVI, “good standing” means that the relevant company is on the Register of Companies, has paid all fees, annual fees and penalties due and payable, has filed with the BVI Registrar a copy of its register of directors which is complete, and has filed its annual return in accordance with the BVI Business Companies Act (As Revised). Any BVI law firm can order a certificate of good standing from the BVI Registrar with respect to a BVI company which confirms that the relevant company is in good standing as a matter of BVI law.

A Cayman Islands company is deemed to be in good standing if all fees and penalties under the Cayman Companies Act (As Revised) (the “Cayman Act”) have been paid and the Registrar of Companies of the Cayman Islands has no knowledge that the company is in default under the Cayman Act. Only the registered office service provider of a Cayman Islands company can order a certificate of good standing from the Cayman Registrar which confirms that the relevant company is in good standing as a matter of Cayman Islands law.

An offshore law firm that is conducting due diligence on a BVI company or a Cayman Islands company will order or request to be provided (as applicable) a certificate of good standing to ascertain whether the relevant company is in good standing.

iv.   Litigation

In the BVI, a search may be conducted to verify whether there are or have been in the past any actions or petitions against a company in the Eastern Caribbean Supreme Court, the Court of Appeal (Virgin Islands) and the High Court (Civil and Commercial Divisions) at the time of the search.

In the Cayman Islands, a search may be conducted to verify whether there are or have been in the past any actions or petitions against a company in the Grand Court of the Cayman Islands at the time of the search.

These searches will invariably be completed by an investor’s offshore legal counsel.

v.  Certificate of incumbency

An investor’s offshore legal counsel will usually review an up-to-date certificate of incumbency issued by the registered office service provider or registered agent (as applicable) of the relevant company. Most certificates of incumbency typically confirm that the applicable company is in good standing, as well as its name and company number, registered office address, the identities of the director(s) and shareholder(s) and share capital (if applicable). It is usually also possible to request a confirmation from the registered office service provider or the registered agent (as applicable) that it is not aware of any proceedings which are pending or which have been threatened against the relevant company, and that, to its knowledge, no receiver has been appointed over the assets of the company.

vi.  Books and records

Every Cayman Islands company must maintain, or cause to be maintained, proper books of account including information (including contracts and invoices with respect to, assets and liabilities) as are necessary to give a true and fair view of the state of the company’s affairs and to explain its transactions.

Every BVI company must maintain, or cause to be maintained, records and underlying documentation of the company in such form as (i) are sufficient to show and explain the company’s transactions; and (ii) will, at any time, enable the financial position of the company to be determined with reasonable accuracy. This includes keeping copies of invoices, contracts and similar documents. A BVI and a Cayman Islands company must also keep copies of all resolutions of its directors and shareholders and minutes of any meetings.

Whether a review of a BVI or a Cayman Islands company’s books and records is necessary will depend on a variety of factors, including the risk appetite of the investor and the activities of the relevant BVI or the Cayman Islands company. To the extent that any commercial agreements have been entered into by the company, an investor may request these to be reviewed to identify any consent requirements in relation to a proposed series financing and any change of control and/or termination provisions which could be triggered by an issuance of preferred shares. We have generally seen an increase in these types of requests which is reflective of a more cautious approach that is currently being adopted by many investors.

The following is an indicative list of local law issues that we frequently encounter in series financing transactions.

i.  Inconsistencies between the SHA and the M&AA

As noted above, it is important to ensure that there are no inconsistencies between the contractual provisions of the SHA and the M&AA of a BVI or a Cayman Islands company. Although there is no prescriptive approach as to the incorporation process as a matter of BVI and Cayman Islands law, certain types of provisions in the SHA will invariably be included in the M&AA for legal, commercial and other reasons. Examples of such provisions include rights and restrictions with respect to the shares (such as provisions with respect to pre-emption, drag-along and tag-along rights), matters which are reserved to the board of directors and/or the shareholders, distribution rights, share transfer restrictions and other matters that impact the corporate governance of the company (such as provisions with respect to board and shareholder meetings). While the approach that is taken will vary as between BVI and Cayman Islands companies because, as noted above, the M&AA of a BVI company is a matter of public record, whereas the M&AA of a Cayman Islands company is a matter of private record, there may be advantages of incorporating commercially important provisions into the M&AA for the following reasons:

1. 1. new shareholders are automatically bound by the M&AA, whereas only shareholders that execute the SHA or a deed of adherence to it are bound by the SHA;
   2. there are statutory remedies available for a breach of the M&AA, whereas only contractual remedies will be available for a breach of the SHA; and
   3. an amendment to the SHA typically requires the consent of all of the parties, whereas the M&AA of a BVI company may usually be amended by a majority of the directors or shareholders (depending on the nature of the amendment) and the M&AA of a Cayman Islands company may be amended by a special resolution (which ordinarily requires at least two thirds of the votes cast by shareholders).

To address any potential conflict between the provisions of the SHA and the M&AA of a company, the SHA typically provides that its provisions will prevail in the event there is any conflict with the M&AA. This provision is potentially unenforceable against a BVI or a Cayman Islands company which, in the first hand, is bound by its constitutional document, the M&AA. For that reason, the conflicts provision in the SHA should be amended to limit its application to the shareholders and to impose a covenant upon them to amend the M&AA to resolve any such conflict(s). In practice, the circumstances of the conflict and the interpretation of the documents may determine which document takes precedence over the other. For example, in Dear and another v Jackson¹ , where an SHA obliged the parties to ensure that a shareholder would be periodically re-appointed as a director but the M&AA permitted the other directors to remove him, the Court of Appeal of England and Wales ruled that there was no conflict: the SHA was to be read as if it did not purport to affect the removal provisions in the M&AA, especially because some of the directors had no knowledge of the terms of the SHA and were entitled to take the M&AA at face value and to assume that the removal article would work. This underscores the importance of appointing local law counsel in a series financing transaction to ensure that any agreed commercial terms are duly incorporated into each of the SHA and the M&AA.

ii.   Covenants with respect to group companies

Given that BVI and Cayman Islands companies typically serve as holding vehicles, it is relatively usual to see covenants imposed upon them in the SHA with respect to the activities and conduct of their operating subsidiaries. Such covenants usually prescribe that the relevant BVI or Cayman Islands company must procure that its subsidiaries do not take specified corporate actions without meeting the same consent requirements that are applicable to the company. Whether the relevant company is in a position to comply with such procurement obligations is ultimately a matter of fact that will depend on case-specific circumstances, but in practice the company may be unable to do so with respect to any indirect subsidiaries over which it does not exercise direct control. There are different approaches to drafting which may be taken in the SHA to address this issue that local law counsel can advise upon.

iii  Directors that are appointed by key investors

It is relatively common for key investors to be given the right to appoint directors to the board of the relevant company. An SHA typically states that such directors need to comply with the instructions that are given by the appointing shareholder(s).

Under BVI and Cayman Islands law, the directors of a company generally owe their common law and fiduciary duties to the company and not to other parties, such as any individual appointing shareholder(s).² There are certain exceptions to this. For example, where a company is insolvent or potentially insolvent, the duties of a company’s directors may extend to the company’s creditors.³ A BVI company that is carrying out a joint venture may also act in a manner which is in the best interests of a shareholder or shareholders, even if it is not in the best interests of the company, so long as this is expressly permitted by that company’s M&AA.⁴

Absent any exceptions of the above nature, any provisions which seek to curtail the discretion of the directors should be carefully reviewed as they may render the directors unable to comply with their fiduciary duties and may therefore be unenforceable as a matter of local law. Depending on the circumstances, it may be possible to include drafting in the relevant M&AA and SHA to clarify that the directors shall only comply with instructions provided by the appointing shareholder(s) to the extent that they are compatible with BVI or Cayman Islands law (as applicable), including the fiduciary duties of the directors.

iv.   Statutory fetters

A statutory fetter is a restriction that is imposed on the ability of a company or its shareholder(s) to exercise certain rights or powers granted under statute. This is relevant in the context of a series financing transaction because it is relatively common for an SHA and, in turn, the M&AA, to prescribe a list of matters in relation to the company that are reserved to the directors and/or the shareholders. Typical examples of such matters include the alteration of a company’s share capital, the issuance of shares, a change to the name of the company, and amendments to the M&AA. While shareholders may enter into such contractual agreements in the SHA among themselves as they please, any provisions which constitute a statutory fetter that purport to bind the company will be potentially invalid and unenforceable. Offshore legal advice should be sought to identify the most effective solutions with respect to these types of issues.

v.  Definitions and concepts that are incompatible with BVI and Cayman Islands law

As most SHAs are based on precedents that are governed by English or Hong Kong law, it is important to remain alert to any drafting that is incompatible with BVI and Cayman Islands law. Common examples include:

1. 1. share issuance and transfer provisions which purport to pass title to the shares upon delivery of share certificates, as opposed to when the register of members of the relevant company is updated;
   2. conditions precedent and/or conditions subsequent to closing that include items which are not necessary from a local law perspective (such as bought and sold notes) and/or which have no particular meaning from a BVI or Cayman Islands point of view (such as endorsing share certificates);
   3. references to “share capital” with respect to BVI companies, despite the fact that this concept is no longer applicable to most BVI companies; and
   4. definitions that do not meet the minimum requirements of BVI or Cayman Islands law (such as in relation to the thresholds for passing resolutions at a meeting or in writing, or the declaration of a dividend).

These types of issues highlight the importance of seeking local law advice in series financing transactions.

The following items are typically provided to a key investor at closing from a BVI and a Cayman Islands law perspective in connection with a series financing transaction:

1. 1. a copy of the constitutional documents and statutory registers of the relevant company;
   2. an up-to-date certificate of good standing of the relevant company;
   3. an up-to-date certificate of incumbency of the relevant company;
   4. duly executed resolutions of the board of directors and shareholders of the relevant company approving, as applicable and among other customary matters, the issuance of the preferred shares, the updates to the company’s register of members, the issuance of share certificates (to the extent that share certificates are to be issued), the appointment of any new director(s), any updates to the company’s register of directors or register of directors and officers (as applicable), and the amendments to the company’s M&AA;
   5. a certified, updated copy of the relevant company’s register of members showing the investor as the holder of the applicable preferred shares;
   6. a certified, updated copy of the relevant company’s register of directors or register of directors and officers (as applicable) showing the appointment of any new director(s) by the investor;
   7. new share certificates (to the extent that share certificates are to be issued); and
   8. a stamped copy of the amended and restated M&AA in relation to a BVI company (noting that delivery of a stamped copy of the amended and restated M&AA in relation to a Cayman Islands company is usually a post-closing obligation).

Additional documentation may also be necessary if the parties undertake to complete other key actions as part of the closing process, such as changing the registered office service provider or registered agent (as applicable) of the relevant company. Furthermore, to the extent that the relevant company’s M&AA (or any agreements to which the relevant company is a party) impose additional requirements in relation to an issuance of shares, additional deliverables may need to be provided to the relevant investor.

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¹    [2013] EWCA Civ 89
²   Percival v Wright [1902] 2 Ch421
³   Walker v Wimborne (1976) 50 ALJR 446 (High Court of Australia)
⁴   Section 120(4) of the BVI Business Companies Act, 2004 (As Amended)

This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us. We would be delighted to assist.

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Answer: The key features are:

• A Cayman Islands Limited Liability Company (“LLC”) is a corporate entity with separate legal personality to its members.
• The LLC is formed under the Limited Liabilities Companies Act (as Revised) (the “LLC Act”) and is similar in structure to the Delaware LLC as the LLC Act is broadly based on the Limited Liability Company Act in the State of Delaware, U.S.A. However, the LLC Act has also preserved the broad legal principles applicable to Cayman Islands companies and the rules of equity and common law.
• Formation of an LLC is straightforward. It requires the filing of a registration statement with the Companies Registry and payment of the requisite Government fee.
• An LLC must have at least one member. It can be member managed (by some or all of its members) or the LLC agreement can provide for the appointment of persons (who need not be members) to manage and operate the LLC.
• The LLC must have a written LLC agreement or operating agreement of the member/members of the LLC which sets out the internal governing terms for dealing with the affairs of the LLC. The LLC agreement is not required to be filed with the Companies Registry.
• The liability of an LLC’s members is limited. This means that each member’s liability is limited to the amount that the member has agreed to contribute to the assets of the LLC, whether in the LLC agreement or otherwise, and such other liabilities and/or obligations that is set out in the LLC agreement.
• Members can have capital accounts and can agree amongst themselves (in the LLC agreement) how the profits and losses of the LLC are to be allocated and how and when distributions are to be made (similar to a Cayman Islands exempted limited partnership).
• An LLC may be formed for any lawful business, purpose or activity and it has full power to carry on its business or affairs unless its LLC agreement provides otherwise.
• The following statutory registers are required to be maintained for an LLC but, similarly to the requirement for a Cayman Islands exempted company, only an LLC’s register of managers is required to be filed with the Companies Registry:

1. 1. a register of members;
   2. a register of managers; and
   3. a register of mortgages and charges.

• The register of managers and register of mortgages and charges are required to be maintained in a manner similar to the register of directors and register of mortgages and charges for a Cayman Islands exempted company.
• Subject to any express provisions of an LLC agreement to the contrary, a manager of the LLC will not owe any duty (fiduciary or otherwise) to the LLC or any member or other person in respect of the LLC other than a duty to act in good faith in respect of the rights, authorities or obligations which are exercised or performed or to which such manager is subject in connection with the management of the LLC provided that such duty of good faith may be expanded or restricted by the express provisions of the LLC agreement.

Answer: LLCs are being used as private equity funds and venture capital funds because they have the combined features of separate corporate personality (like an exempted company) with the ability to deal with the allocation of profits and losses in manner similar to a partnership.

They are also being used as (i) general partner vehicles in GP/LP investment fund structures, (ii) joint venture companies, (iii) investment vehicles in private equity transactions, and (iv) operating vehicles in certain digital asset transactions.

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

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E: yun.sheng@loebsmith.com

The dispute in the case arose between Tianrui (International) Holding Company Ltd (“Tianrui”), a minority shareholder in China Shanshui Cement Group Ltd (“China Shanshui”), a company incorporated in the Cayman Islands and listed in Hong Kong. Tianrui alleged that the board of directors of China Shanshui (the “Board”) engaged in misconduct, including breaches of fiduciary duties and self-dealing. Tianrui sought to bring proceedings to address the alleged misconduct.

The history of the case involved a “prolonged battle” for ultimate control of China Shanshui whose core business was the production, distribution and supply of cement and other construction materials throughout The People’s Republic of China. Following the allotment of shares to the holders of certain convertible bonds in China Shanshui, Tianrui alleged that the recipients of those allotments were connected to other shareholders who were competing with it for ultimate control of China Shanshui. The allotment of shares in question resulted in Tianrui’s shareholding being materially diluted (following the dilution, Tianrui was no longer able to block the passing of a special resolution as its shareholding dropped below 25%) and Tianrui therefore argued that this amounted to an improper exercise of the Board’s power to issue shares.

China Shanshui’s counter argument was that Tianrui was not entitled to bring its claim directly, on the basis that any claim should be brought as a derivative claim on behalf of China Shanshui against the Board. Under Cayman Islands law, derivative actions are an exception to the general rule that only a company itself can sue to remedy wrongs done to it – often referred to as the rule in Foss v Harbottle.

Derivative actions are a unique aspect of corporate law designed to protect shareholders in exceptional circumstances. To succeed in bringing such an action, a claimant must satisfy the following strict criteria:

1. Fraud on the Minority: The claimant must prove that the directors of the company in question engaged in fraudulent or oppressive conduct, harming the company and its shareholders.
2. Control of Wrongdoers: The claimant must show that the wrongdoers in question have effective control of the company, leaving it unable to bring the action itself.

The Court must also consider the overarching principle of corporate personality, ensuring these actions do not undermine the company’s governance structure and fundamental autonomy as a body corporate in its own right.

Tianrui argued that the Board misused their powers for personal gain and failed to act in China Shanshui’s best interests. Specifically, Tianrui alleged that certain decisions taken by the Board unfairly diluted its shareholding (as described above) and improperly favored other shareholders in China Shanshui.

In resisting Tianrui’s submissions, the Board contended that their actions were lawful and had been made in good faith to safeguard China Shanshui’s stability and prospects. The Board further argued that the derivative action that Tianrui was attempting to bring was an inappropriate means for Tianrui to challenge decisions taken by the Board.

In its judgment, the Privy Council sought to strike an appropriate balance between the fundamental and long-established legal principles and more practical matters, and found as follows:

1. Directors to act properly: on the basis that the memorandum and articles of association of a company are a statutory contract between the company in question and its shareholders, it follows that the directors of the company must exercise the powers that are given to them (including the power to issue shares) under those memorandum and articles of association for proper purposes.
2. Fraud and Wrongdoing: The Court agreed that derivative actions require evidence of serious misconduct. The Privy Council held that Tianrui had successfully demonstrated that the alleged conduct could qualify as a “fraud on the minority”, if proven. In particular, it was noted that the dilution of shareholders, particularly where the effect of that dilution removes practical rights from minority shareholders (such as the ability to block a special resolution from being passed), can be an improper exercise of the directors’ ability to issue shares.
3. Control by Wrongdoers: The Privy Council acknowledged that derivative claims are a vital tool which is available to protect shareholders where the alleged wrongdoers dominate the company’s decision-making processes. Tianrui established that those who were allegedly responsible for the misconduct in question retained effective control of China Shansui, thus effectively blocking any other remedy that might be available.
4. Fiduciary Duties: Directors have a duty to act in good faith and to prioritise the company’s best interests over their personal interests or those of their affiliates. The Privy Council emphasised that breaches of this duty are central to shareholder protection. It follows that the ability to bring such a claim is not just the preserve of minority shareholders; if the criteria for bringing such a claim are met, any shareholder (including majority shareholders) could bring a claim.
5. Corporate Governance: The judgment highlighted the need to balance minority shareholder protections with the principle of corporate autonomy. While derivative actions are an essential remedy, the court stressed their use should remain limited to prevent interference with legitimate board decision-making.

The Privy Council ultimately ruled in favor of Tianrui, thus allowing the derivative action that was sought by Tianrui to proceed. It confirmed that the allegations, if proven, would constitute serious breaches of fiduciary duty by the Board and would justify the intervention of the Court.

This decision underscores that derivative actions are not to be taken lightly. The claimant must present clear evidence of wrongdoing and demonstrate that the company itself cannot pursue the claim.

This case offers valuable lessons for shareholders, and directors:

1. For Shareholders: Minority shareholders who are seeking such a remedy must be prepared to meet the high bar that is set in order for such an action to proceed. Those who suspect wrongdoing should carefully and accurately document evidence of alleged wrongdoing contemporaneously in a way that proves both misconduct and the company’s inability to act. Meeting only one of these standards alone will be insufficient to enable such an action to proceed.
2. For Directors: Directors should be mindful of their fiduciary duties, exercise their powers only for a proper purpose and should ensure that their decisions withstand objective, and possibly judicial, scrutiny. Transparent and well-documented decision-making processes can mitigate the risk of challenges to decisions made and/or help to defend against these challenges. Directors of companies would therefore be well advised to do the following.

1. 1. Ensure that full and accurate minutes are kept of all important decision-making processes. Such minutes should be sufficiently detailed and should contain a full and accurate consideration by the directors of the pros and cons of the proposed actions and should outline why the directors consider them to be appropriate and to be in the company’s best interests. Any finding by a Court as to whether there has been wrongdoing and whether a claim can be brought are, necessarily, subjective in each case. In the event of any challenge, these records will be valuable evidence and could ultimately be determinative.
   2. Fully and properly disclose any personal interest(s) in matters which are to be considered by them in the course of their role as director. Whilst this is both a necessary and fundamental principle of good corporate governance and required (usually) by the articles of association of the company, this can also go some way to demonstrating that the directors in question are acting in good faith. Directors should therefore familiarise themselves with the provisions of the articles of association relating to the disclosure of their interests and whether they are permitted to continue to form part of the applicable quorum and/or to vote on the matter, irrespective of such interest. They should also consider that where they are so interested, the fact that they are permitted to count in the quorum and vote on the matter, does not mean that they should do so.

The Privy Council’s judgment in Tianrui v China Shanshui serves as a significant clarification of derivative action principles in the Cayman Islands. By allowing the case to proceed, the Privy Council reinforced the importance of holding directors accountable while ensuring that shareholder remedies do not disrupt proper corporate governance.

This decision also highlights the Cayman Islands’ commitment to maintaining a robust legal framework for resolving corporate disputes, preserving its reputation as a leading jurisdiction for global businesses. Minority shareholders can take comfort in the availability of effective remedies where the require threshold is met, whilst directors are reminded of their fiduciary duties and their obligation to consider the interests of all shareholders when taking decisions.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us. We would be delighted to assist.

E: robert.farrell@loebsmith.com