Privy Council Judgment Clarifies Protections for Shareholders in the Cayman Islands

On 14 November 2024, the Judicial Committee of the Privy Council handed down a landmark decision in Tianrui (International) Holding Company Ltd v China Shanshui Cement Group Ltd (Cayman Islands) [2024] UKPC 36. This ruling overruled the Grand Court of the Cayman Islands’ decision in Gao v China Biologic Products Holdings, Inc 2018 (2) CILR 591, in which the court had struck out an action filed by a minority shareholder. The action challenged the board of directors’ exercise of their power to allot and issue shares, with the plaintiff claiming a breach of fiduciary duty. However, the Grand Court had held that the fiduciary duty in question was owed to the company, not to individual shareholders, meaning the shareholder lacked standing to pursue the claim.

The Privy Council’s decision set a precedent in the Cayman Islands, allowing shareholders whose holdings are diluted by an improper allotment of shares to bring a personal claim against the company. This development represents a significant shift in the legal landscape for minority shareholders and clarifies their rights in such circumstances. HSM Associate, Alex Davies, explores this case.

Background to the Appeal

The Respondent was a cement production company based in China but registered in the Cayman Islands. The Appellant was one of four major shareholders in the company, alongside Asia Cement Corporation (ACC), China National Building Materials (CNBM), and China Investment Company Limited.

There had been an ongoing dispute over control of the Respondent. The Appellant claims that bonds and shares were issued to parties connected to ACC and CNBM, with the improper aim of diluting the Appellant’s shareholding and gaining control of the company.

When the Appellant sought a court declaration that the issuance of shares was improper, the Respondent attempted to have the case dismissed. The Grand Court of the Cayman Islands ruled in favour of the Appellant, but the Cayman Islands Court of Appeal overturned this decision, striking out the case. The Appellant then appealed to the Judicial Committee of the Privy Council (the “Board”) to reinstate the case.

Judgment and Reasons

The Board allowed the appeal, ruling that a shareholder can bring a personal claim against a company if the company’s directors issue shares for an improper purpose that negatively impacts the shareholder. Therefore, the writ filed by the Appellant should not have been struck out and should be reinstated. Lord Hodge and Lord Briggs delivered the judgment.

A company’s relationship with its shareholders is governed by the company’s articles of association. However, these terms can be changed by a special resolution passed by a 75% majority of shareholders. [paragraph 31]

The courts have long recognized that shareholders can enforce certain rights directly against the company, such as the right to vote at a general meeting, through a personal claim, rather than through a derivative action on behalf of the company. [40]

While not all shareholder rights are explicitly outlined in the company’s articles, directors are fiduciaries with special duties, including the duty to use their powers only for proper purposes. Directors may, however, act in a way that appears to be within their powers under the articles but is done for an improper purpose, making the action invalid. Shareholders adversely affected by such actions may then have grounds for a claim against the company. [41]

In this case, the Cayman Islands Court of Appeal mistakenly ruled that no such claim existed. The Board corrected this, ruling that a shareholder whose stake has been diluted by an improper issuance of shares can bring a personal claim against the company. However, in some cases (not applicable here), such claims may be blocked if a majority of shareholders ratify the improper allotment at a general meeting, excluding the newly issued shares. [66]

When a person becomes a shareholder, they acquire a bundle of rights, including the right for directors to issue shares. This power is a fiduciary one and must be exercised for a proper purpose. [67]

It is an implied term of the contract between the company and its shareholders that when directors issue new shares, they must do so in accordance with their fiduciary duties, in good faith, and for the benefit of the company as a whole. If the issuance is aimed at benefiting one group of shareholders at the expense of others, the issuance is invalid. [69-71]

Although directors owe their duties to the company and not directly to individual shareholders, an improper exercise of power (acting as the company’s agents) breaches the corporate contract between the company and its shareholders, providing a basis for the shareholder’s claim. [72-75]

Finally, while a majority of shareholders could theoretically ratify an invalid allotment of shares, such ratification must actually occur and cannot override protections against the oppression of minority shareholders. [80-81, 84]

Fiduciary Duty and the Power to Allot Shares

In its judgment, the Privy Council emphasised that the power to allot and issue shares is conferred upon directors by the company’s articles of association, and that this power must be exercised as a fiduciary duty. The decision underscores the directors’ obligation to act in the best interests of the company when making such decisions. The Privy Council explicitly stated that the power to allot shares must not be used for improper purposes, such as altering the balance of power between shareholders.

While it is common for an allotment of shares to affect the relative power of shareholders, the ruling clarified that this should only occur where the allotment is made in good faith and for a legitimate business purpose, such as raising capital.

Improper Purpose

The Privy Council’s judgment further considered the nebulous issue of improper purpose, including whether directors’ decisions are tainted by improper motives. This question has been the subject of some debate in previous cases, including the landmark Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas Plc. [2015] UKSC 71 in which the Supreme Court was divided on the issue. In that case, the Court considered whether a decision with both legitimate and illegitimate reasons should be set aside. The Supreme Court found on the facts of that case they should, and that in that case the proper purpose rule was pervasive, an obligation to consider the purpose in addition to acting in the best interests of the company. Lord Sumption and Lord Hodge stated that courts should focus on the improper purpose and whether the decision would have been made without it. If the decision would not have been made without the improper motive, it would be considered improper. Conversely, if the legitimate reasons for the decision were sufficient to warrant the action, even without the improper motive, the action may stand.

In Stobart Group Ltd v Tinkler [2019] EWHC 258 (Comm), the court suggested test should be whether the improper purpose was the “substantial or primary purpose” behind the decision.

Remedies

If an allotment of shares is successfully challenged on the grounds of improper purpose, shareholders have several potential remedies. The primary remedies are:

1. Damages: Shareholders may be entitled to compensation if they can demonstrate that they suffered financial loss as a result of the improper allotment.
2. Rescission (Unwinding): Shareholders may seek to have the decision rescinded, effectively undoing the allotment and returning the company to its previous shareholding structure. This remedy may redress inequality if a share allotment was made to alter shareholder control for improper purposes, but must be promptly sought or such remedy is unlikely to be endorsed by the court.

Conclusion

The Tianrui decision marks a significant shift in Cayman Islands law regarding the rights of minority shareholders and the fiduciary duties of directors. Shareholders who face dilution of their holdings due to an improper allotment of shares now have a clearer path to seek redress. However, the legal questions surrounding improper purpose and the appropriate remedies remain complex and nuanced, and future cases will likely continue to refine the application of these principles.