Remedies for improper share dilution: The Cayman Islands Court of Appeal decision in China Shanshui
The recent Cayman Islands Court of Appeal decision in China Shanshui Cement Group Limited v Tianrui (International) Holding Company Limited has resolved inconsistency between earlier Grand Court decisions on the question of whether a shareholder has a personal claim where the company issues shares for the purpose of diluting the shareholder’s voting power.
China Shanshui is a part of a long running multijurisdictional legal saga for the control of one of the largest cement companies in China. In these proceedings, a significant shareholder brought a claim against the company challenging the validity of the company’s issuance of convertible bonds and subsequent issuance of shares. The company’s articles of association empowered the company’s board of directors to make such an issuance, and the conversion and issuance of shares have been approved by ordinary resolutions of the shareholders of the company. However the claimant shareholder alleged that the issuance was made for the improper purpose of diluting its shareholding to enable other shareholders to gain control of the company.
Company directors owe duties to act bona fide in the interests of their company and to act only for a proper purpose. These fiduciary duties are owed to the company, not the company’s shareholders. The company therefore applied to strike out the shareholder’s claim in China Shanshui on the basis that the breach of duty complained of by the claimant shareholder was actually of a duty owed to the company, and not the claimant shareholder.
Departing from earlier Grand Court authority in David Xiaoying Gao v China Biologic Holdings, the Judge at first instance relied on some English and Australian authorities to conclude that a shareholder has a personal claim in respect of diminished voting power where the company issues shares for the improper purpose of diluting the interest of the shareholder, and refused the company’s application to strike out the shareholder’s claim. You can read our blog post on that earlier decision here. The company then appealed to the Cayman Islands Court of Appeal.
The Court of Appeal distinguished or otherwise decided not to follow the authorities relied on by the first instance Judge. The Court of Appeal confirmed that there is no special exception for alleged share dilution to the uncontroversial rule that directors owe their fiduciary duties to the company and not the company’s shareholders. The claimant shareholder in China Shanshui therefore had no personal claim and its claim was struck out.
Importantly, the conclusion of the Court of Appeal does not mean that shareholders in the position of the claimant shareholder in China Shanshui are left without a remedy. A shareholder in that position may be able to pursue a just and equitable winding up of the company, bring a derivative action on behalf of the company against the directors for their breach of fiduciary duty, or perhaps bring a claim based on economic torts.