From Delaware to the Cayman Islands: the new frontier for fair value share appraisal opportunities
Fund managers wishing to invest in appraisal opportunities have a new jurisdiction to consider. Cayman Islands share appraisal litigation is on an upward trajectory, where the statutory regime is similar to Delaware, yet in many ways more favourable to dissenters; where discounted cash flow (DCF) or other income-based company valuation methodologies still prevail, and where fair value has been determined to exceed merger price.
The 2017 decisions of the Delaware Supreme Court in DFC Global  and Dell  may, according to some market participants, have all but sounded the death knell for Delaware share appraisal arbitrage.
At a recent corporate law conference in New Orleans, one panel member proclaimed this would be the final year that share appraisal litigation would feature as a topic. The statement was met with by applause from some in the room, if not the fund managers, valuation experts and litigators.
An analysis of DFC Global and Dell is beyond the scope of this article. The key point is that following those decisions, the general position in Delaware appears to be that merger price will generally be afforded significant, if not dispositive, weight in appraisal actions to determine the fair value of shares held in a public company which have been expropriated from minority shareholders following a robust, arms-length sales process.
This is unwelcome news for would-be arbitrage investors.
It should therefore come as no surprise that the number of appraisal actions coming before the Delaware courts in recent years mirrors our perceptive panellist’s forecast. In 2016, a total of 85 appraisal cases were determined by the Delaware Courts. In 2017, that number fell to 62. In 2018, it fell again to 26. Last year, there were just 11. Whilst there may of course be additional policy and/or legal considerations informing the reasons behind this trend, the trend itself is clear.
Unlike Delaware, Cayman Islands law generally adopts a “loser pays” regime on costs. Further, dissenters can seek payment of a ‘baseline’ interim sum at the commencement of the litigation.
Fair Value in the Cayman Islands
The Cayman Islands is a procedurally attractive, user-friendly and sophisticated jurisdiction that is becoming increasingly well-versed in heavily contested appraisal litigation.
The Cayman Islands equivalent to Section 262 of the Delaware General Corporation Law can be found in Section 238 of the Companies Law, which provides that “a member of a constituent company incorporated under this Law shall be entitled to payment of the fair value of his shares upon dissenting from a merger or consolidation”.
By way of overview, the principles governing the meaning of fair value in the Cayman Islands can broadly be stated as follows: Fair value is intended as a form of compensation, reflecting an economic exchange of the rights and obligations attaching to the shares, for cash; fair value applies both to the dissenters and to the company; excluded from the assessment of fair value are the benefits and burdens of the merger transaction itself; “fair” adds the concepts of just and equitable treatment, and flexibility, to “value”; minority shareholdings are to be valued as such (although that does not necessarily mean that a discount must always be applied); and it is the shares themselves that are to be valued, not a pro rata share of the going concern (although, as will be seen, the methodology used to value the shares has, to date, always centered around an analysis of the value of the going concern).
Fair value determinations: the picture so far
As the Grand Court expressly noted in Nord Anglia, so far there is no precedent in the Cayman Islands for placing primary or sole reliance on the market price in any of them. Instead, the methodology adopted by the Court has always taken into account valuation conclusions arrived at by reference to the value of the relevant going concern.
Four recent decisions are of note. In the first decision, DCF was afforded a 75% weighting (with market price afforded 25%). In the second, DCF was afforded a 100% weighting (as agreed by the parties). In the third, DCF was afforded a 50% weighting (with market price afforded 50%). In the fourth, DCF was afforded a 40% weighting (with merger price afforded 60%).
There are additional advantages for investors engaged in Cayman Islands share appraisal litigation. The three most obvious examples are the costs regime, the interim payments regime, and the rate of interest to be paid to the dissenters upon the determination of fair value.
Unlike in the US, where the parties are responsible for their own legal fees irrespective of the outcome of the proceedings, the starting point in the Cayman Islands is that the losing party pays the costs of the prevailing party.
While there some nuances, broadly speaking the successful dissenters will in the ordinary course be able to recover their reasonable legal and expert fees.
It is now settled that the Cayman courts have jurisdiction to award interim payments within the context of Section 238 proceedings. This means that dissenters are entitled to receive advance payment on account of the fair value sum that is ultimately determined by the Court to be payable to them.
Unlike in Delaware, therefore, dissenters need not be kept out of the money whilst the fair value proceedings run their course, creating a “war chest” in effect. This is obviously advantageous from a cash flow perspective. Taken together with a costs regime, payment of a ‘baseline’ fair value sum in advance of judgment significantly de-risks the investment from the outset.
Under Section 238, dissenting shareholders are to be paid a fair rate of interest. To date, the approach taken by the Cayman Islands courts in ascertaining a fair rate of interest is consistent with the practice in Delaware. This is reflected by the Grand Court’s decision, affirmed by the Court of Appeal in Shanda, in which the Judge adopted a midway point between the rate of interest representing the return that a prudent investor could have made on unpaid appraisal monies, and the rate of interest that the company would have had to pay in order to borrow the equivalent sum.
It Is likely that share appraisal proceedings will be featuring more prominently in the Cayman Islands. This is perhaps unsurprising given that this complex area of law is, at least compared with the Delaware jurisprudence, still in its infancy. Further, determinations of fair value will always be highly fact sensitive.
While there is undoubted overlap between the jurisdictions, there are also significant differences and this is never more evident than the types of Cayman Islands incorporated companies availing themselves of the Cayman Islands merger regime. To date, the vast majority of these companies have been listed in the US, but have their centre of operations in the People’s Republic of China. Cayman Islands appraisal litigation has seen arguments deployed, and in certain instances accepted by the Cayman Islands courts, regarding the US market’s perception of such companies. In any event, given the Grand Court’s continued application of the DFC valuation methodology, the landscape for share appraisal litigation remains wide open.
DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017)
Dell, Inc. v Magnetar Global Event Driven Master Fund Limited 177 A.3d 1 (2017) (Del. 2017)
In re Qunar (Unreported, 20 June 2018; CICA No 23 of 2017, on appeal from FSD 76 of 2017 (RPJ))
In re Shanda Games (Unreported, 25 April 2017; FSD 14 of 2016 (NSJ))