The Companies Act (As Revised) (the “Act”) provides that “[e]very conveyance or transfer of property, or charge thereon, and every payment obligation and judicial proceeding, made, incurred, taken or suffered by any company in favour of any creditor at a time when the company is unable to pay its debts within the meaning of section 93 with a view to giving such creditor a preference over the other creditors shall be voidable upon the application of the company’s liquidator if made, incurred, taken or suffered within six months immediately preceding the commencement of a liquidation.”

It is important to note that a payment to a “related party” of the Cayman company shall be deemed to have been made with a view to giving a creditor a preference and therefore would be voidable upon the application of the company’s liquidator if made, incurred, taken or suffered within six (6) months immediately preceding the commencement of a liquidation.

A creditor shall be treated as a “related party” if it has the ability to control the Cayman company or exercises significant influence over the company in making financial and operating decisions.

When is a company unable to pay its debts?

A Cayman company is deemed to be unable to pay its debts if:

• it fails to comply with a statutory demand;
• the company fails to satisfy a judgment debt; or
• it is proven to the satisfaction of the Court that the company is unable to pay its debts.

Commencement of a liquidation

Under Cayman Islands law, the compulsory winding up of a company is deemed to commence at the time of the presentation of the petition for the winding up or, in the case of a voluntary liquidation, at the time of the resolution or expiry of the relevant period, or occurrence of an event provided by the company’s Articles of Association upon which the company is to be wound up, or in the case where a restructuring officer has been appointed pursuant to section 91B or 91C of the Act and the order appointing the restructuring officer has not been discharged, at the time on the date of the presentation of the petition to appoint a restructuring officer pursuant to section 91B of the Act.

Every disposition of property made at an undervalue by or on behalf of a company with intent to defraud its creditors shall be voidable at the instance of its official liquidator (i.e. the liquidator of a Cayman company which is being wound up by order of the court or under the supervision of the court and includes a provisional liquidator). The official liquidator bears the burden of establishing an “intent to defraud” (i.e. the official liquidator must establish that there was an intention to wilfully defeat an obligation owed to a creditor). The intention to defeat a creditor needs only be “a” purpose and not the sole or dominant purpose. No legal proceedings may be brought by the official liquidator under after six years following the date of the relevant disposition or transaction.

The term “undervalue” in relation to a disposition of a company’s property means (i) the provision of no consideration for the disposition; or (ii) a consideration for the disposition the value of which in money or monies worth is significantly less than the value of the property which is the subject of the disposition.

However, the rights of the transferee are subject to some protection. In the event that any disposition is set aside and the Court is subsequently satisfied that the transferee has not acted in bad faith: (i) the transferee shall have a first and paramount charge over the property which is the subject of the disposition, of an amount equal to the entire costs properly incurred by the transferee in the defence of the action or proceedings; and (ii) the relevant disposition shall be set aside subject to the proper fees, costs, pre-existing rights, claims and interests of the transferee (and of any predecessor transferee who has not acted in bad faith).

 If in the course of the winding up of a Cayman company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the liquidator (i.e. official liquidator or voluntary liquidator) may apply to the Court for a declaration that any persons who were knowingly parties to the carrying on of the business with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose are liable to make such contributions, if any, to the company’s assets as the Court thinks proper. Directors of a Cayman company are potentially liable when managing a company’s business if that business is carried on fraudulently. There is no applicable limitation period for fraudulent trading.

In addition to Cayman companies, Cayman Islands law as stated above may also apply to limited liability companies (LLCs) and exempted limited partnerships (ELPs). Accordingly, the Directors of a Cayman company, the General Partner of an ELP and the Manager of an LLC should exercise caution and seek legal advice from Cayman legal counsel where there is any uncertainty about the solvency (on a cashflow basis) of the applicable Cayman entity which they are managing. These situations might, for example, arise within the context of an investment fund with severe liquidity issues.  Directors should consider carefully the point at which creditors’ interests take priority over shareholders’ interests and how those interests are best served (e.g. appointment of a liquidator or a restructuring officer). Failure to seek urgent advice on their duties could increase the Directors’ exposure to risk of personal liability.

The fiduciary duty of directors is to act in good faith in the interests of a Cayman company. The interests of the company have until recent times been treated as being the interests of its members as a whole. However in the UK Supreme Court’s decision given on 5 October 2022 in BTI 2014 LLC (Appellant) v Sequana SA and others (Respondents), which is persuasive authority in the Cayman Islands, it was re-affirmed that directors of financially distressed companies are required to consider, as one of the relevant factors, the interests of creditors. The Supreme Court concluded that the weight to be given to the interests of creditors will increase as the company’s financial difficulties become increasingly serious. Creditors’ interests will take precedence over the interests of the company’s shareholders at the point where insolvent liquidation or administration is inevitable.

Official liquidation

When a winding up order has been made, any disposition of the company’s property and any transfer of shares or alteration in the status of the company’s members made after the commencement of the winding up is, unless the Court otherwise orders, void.

The commencement of a winding-up is the date a petition is presented to the Court (or, if the company was first placed into voluntary liquidation, the passing of that resolution) rather than the date when the Court grants a winding-up order. Accordingly, any transaction during the period between the presentation of a winding-up petition and its resolution before the Court, will be avoided if a winding-up order is ultimately granted, unless the Court validates the transaction.

The presentation of a winding-up petition can have a material adverse effect on a company’s business, due to the uncertainty during the period between the presentation of a winding-up petition and its resolution before the Court. A validation order takes away that uncertainty and enables companies to continue to operate in the ordinary course of their business prior to the hearing of the petition.

Voluntary liquidation

Any transfer of shares, not being a transfer with the sanction of the liquidator, and any alteration in the status of the company’s members made after the commencement of a voluntary winding up is void. Unlike a compulsory liquidation, a transfer of the company’s property is not automatically void. There is not normally the same uncertainty with voluntary liquidations because upon the appointment of a voluntary liquidator, all of the powers of the directors cease and are displaced by the voluntary liquidator (except so far as the company in a general meeting or the voluntary liquidator sanctions their continuance). Accordingly, the transfer of property is not automatically void but any transfer of property effected by the company after the appointment of a voluntary liquidator should be authorized by the liquidator.

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: 

E: gary.smith@loebsmith.com

E: robert.farrell@loebsmith.com

E: elizabeth.kenny@loebsmith.com

E: vanisha.harjani@loebsmith.com

E: edmond.fung@loebsmith.com

E: vivian.huang@loebsmith.com

E: faye.huang@loebsmith.com

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.

The Privy Council (the last court of appeal for Cayman Islands legal proceedings) was asked to determine:

Whether Tianrui could bring a derivative action: Tianrui needed to show that the alleged misconduct amounted to a “fraud on the minority” and that China Shanshui itself was unable to act because the Board was complicit in the alleged wrongdoing.

Fiduciary Duties of Directors: The case scrutinised the Board’s duties to China Shanshui, particularly their obligation to act in its best interests and their duty to avoid conflicts of interest.

Corporate Governance Principles: The Privy Council had to balance shareholder remedies with the fundamental principle of corporate autonomy, which dictates that companies should generally control their own business and affairs without interference.
Against the above matters, the Privy Council had to consider many decades of prior jurisprudence on derivative actions. Whilst some of the cited cases provided that a perceived improper dilution of a shareholder’s interest could form the basis of a derivative action, the established case law was either vague, contradictory or silent on the legal basis of a claim being brought by a shareholder directly.

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.

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

The scope of the AML Regulations is still defined by reference to “relevant financial business”. Persons undertaking “relevant financial business” in the Cayman Islands must comply with the requirements of the AML Regulations. The definition of “relevant financial business” that was included in previous versions of the anti-money laundering regulations has been removed from the AML Regulations and has instead been placed in Section 2 of the PCL. The definition continues to cover (emphasis added) “mutual fund administration or the business of a regulated mutual fund within the meaning of the Mutual Funds Law (2015 Revision)” which covers all funds registered with and regulated by CIMA. The definition had also covered and continues to cover investment managers licensed by or registered with CIMA (e.g. those who have applied for and obtained a SIBL Exemption). However, Section 2 and Schedule 6 of the PCL now extends the meaning of “relevant financial business” to cover activities which are “otherwise investing, administering or managing funds or money on behalf of other persons.”

The net effect of expanding the meaning of relevant financial business to include activities of “otherwise investing, administering or managing funds or money on behalf of other persons,” is that now all unregulated investment entities (as well as regulated investment entities) are covered and will need to maintain AML procedures in accordance with the AML Regulations.

Going forward all Cayman unregulated investment entities (as well as regulated investment entities) will be required to have the following AML procedures in place:

• identification and verification (KYC) procedures for its investors/clients;
• adoption of a risk-based approach to monitor financial activities;
• record-keeping procedures ;
• procedures to screen employees to ensure high standards when hiring;
• adequate systems to identify risk in relation to persons, countries and activities which shall include checks against all applicable sanctions lists;
• adoption of risk-management procedures concerning the conditions under which a customer may utilise the business relationship prior to verification;
• observance of the list of countries, published by any competent authority, which are non-compliant, or do not sufficiently comply with the recommendations of the Financial Action Task Force;
• internal reporting procedures (i.e. appointment of a money laundering reporting officer and deputy money laundering reporting officer);
• and such other procedures of internal control, including an appropriate effective risk- based independent audit function and communication as may be appropriate for the ongoing monitoring of business relationships or one-off transactions for the purpose of forestalling and preventing money laundering and terrorist financing.

In order to allow unregulated investment entities not previously subject to the AML/ CFT regime to implement appropriate procedures (or delegation arrangements) to comply, the AML Regulations have been amended to provide a grace period until 31 May 2018 within which to assess their existing AML/CTF procedures and to implement policies and procedures which are in compliance with the AML Regulations.

The Monetary Authority (Amendment) Law, 2016 (the Amendment Law) which came into force on 15th December 2017 gives CIMA the power to impose administrative fines for non- compliance on entities and individuals who are subject to Cayman Islands regulatory laws and/or the AML Regulations.

For a breach prescribed as minor fine would be CI$5,000 (approximately US$6,000). For a breach prescribed as minor the Authority also has the power to impose one or more continuing fines of CI$5,000 each for a fine already imposed for the breach (the “initial fine”) at intervals it decides, until the earliest of the following to happen:

1. the breach stops or is remedied;
2. payment of the initial fine and all continuing fines imposed for the breach; or
3. the total of the initial fine and all continuing fines for the breach reaches CI$20,000 (approximately US$24,000).

For a breach prescribed as serious, the fine is a single fine not exceeding: (a) CI$50,000 (approximately US$61,000) for an individual; or (b) $100,000 (approximately US$122,000) for a body corporate. For a breach prescribed as very serious, the fine is a single fine of not exceeding: (a) CI$100,000 (US$122,000) for an individual; or (b) CI$1,000,000 (US$1,220,000) for a body corporate.

The Monetary Authority (Administrative Fines) Regulations, 2017, which came into force immediately after the Amendment Law came into force sets out, among other things, rules and guidance regarding the amount of fines, different categories of breaches, the criteria for exercising fine discretions, including procedures of imposing fines, appeals, payment and enforcement.

The AML Regulations are intended to more closely align Cayman Islands’ AML regime to the Financial Action Task Force 2012 recommendations which are intended to set the standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. The changes introduced by the AML Regulations enhances the Cayman Islands’ AML regimes adherence to such international standards and its reputation as one of the premier offshore financial centres.

Fund managers should check (i) whether the AML regime being applied in respect of their Fund is the Cayman AML regime or the regime of jurisdiction recognised as having an equivalent AML regime, (ii) if it is the latter whether or not the relevant delegate is actually subject to the AML regime of that jurisdiction, and (iii) whether or not the delegate has the requisite personnel (in terms of numbers, training and experience) to maintain the AML / CFT procedures on the Fund’s behalf.

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