Cayman Court issues landmark decision in Fair Value Section 238 merger/dissenting equity case in Re Changyou.com Limited

Introduction

The Cayman Islands Court of Appeal issued a landmark judgment that provided clarification and, arguably, amendments to Section 238 of the Cayman Islands Companies Act (the “Law”).

The Court had to consider whether there was an error or omission in Section 238 of the Act and whether it was possible to interpret the Act in a way that gives effect to the original intention of the Cayman Islands Parliament. .

Legislative background

For those who may be unfamiliar with this part of the law, Section 238 offers significant protection to minority shareholders who object to a merger or consolidation involving the Caymanian company of which they are shareholders. Section 238(1) of the Act provides that a shareholder of a company is “entitled to payment of the fair value of such person’s shares upon dissent from a merger or consolidation” and the remainder of Section 238 sets out the steps by which these ‘just value’ is accomplished. The process begins with the notification by the dissenting shareholders of their opposition to the company concerned¹ and, in the absence of an agreement on the “fair value”, results in a request to the Court for the “fair value” to be determined there.²

Basically, Section 238 of the Act is drafted on the assumption that the shareholders of the relevant company will be able to vote on the proposed merger or consolidation. However, such a vote is not always required. If the proposed merger or consolidation is between a parent company and a subsidiary company both incorporated in the Cayman Islands, the requirement for such a vote may be waived provided that a copy of the proposed merger is provided to all shareholders .³

In terms of terminology, mergers or consolidations where a vote is required are called “long mergers” and those where no vote is required are called “simplified mergers”.

The question which the Court had to answer in this case was therefore whether the minority shareholders of a subsidiary (which it was proposed to merge with a parent company by means of a simplified merger) could benefit from the protection provided by the article 238 of the act.

Is the wording of Article 238 “wrong”?

Section 238(1) of the Act establishes the principle of “fair value” for the benefit of dissenting shareholders and reads as follows:

“(1) A member of a constituent company incorporated under this Act is entitled to payment of the fair value of the shares of such person in the event of dissent in respect of a merger or amalgamation.”

Section 238 of the Act therefore does not, on its face, distinguish between detailed mergers and simplified mergers. However, the same cannot be said of the remaining subsections, and the Court noted that “it is clear that subsections (2) to (16) of section 238 apply only to detailed mergers. This is evident from the fact that the ability to oppose and the ability to dissent depend on the existence of a shareholder vote, and the timing of the matters set out in the following subsections depend on the existence of such vote. »⁴

The Court held that subsection (1) of Section 238 is a “stand-alone provision” and therefore can apply to both detailed mergers and short-form mergers, while noting that the rest of the article 238 of the law is “not suitable to apply to simplified mergers”.⁵

The Court further held that “this is not what the legislator wanted”⁶ with the judge observing that “the sensible and commercially justifiable decision to dispense with the vote of shareholders in a simplified merger has had the unintended and heretofore unrecognized effect of depriving minority shareholders in a simplified merger of the rights of expertise that the legislator intended for them .”^seven

Is a different interpretation of article 238 of the law possible?

Regardless of the Court’s opinion that section 238 of the Act was poorly drafted, the judge did not find that it was within the jurisdiction of the Court to interpret section 238 so as to give effect Parliament’s original intentions using ordinary means of interpretation. The reason for this was that there was no ambiguity in the wording of section 238, as it clearly excluded simplified mergers from its scope, since so many subsections were based on the requiring a shareholder vote on the proposed merger or consolidation in each such case.

The Court therefore examined the principles of interpretation mandated by the Cayman Islands Constitution to see if they produced a different result. In particular, the Court considered Section 15 of the Cayman Islands Bill of Rights which grants the right to the peaceful enjoyment of property with protection from dispossession of that property, except in certain limited circumstances provided by law.

The Court concluded that section 15 of the Bill of Rights is specific as to the provision that must be made by applicable law in cases where personal property is interfered with. Such a provision should require the “the prompt payment of adequate compensation and the obtaining of a right of access to the Grand Court for the determination of the amount of any compensation”.⁸

As the Court had concluded that there were no other remedies available to protect the interests of minority shareholders in simplified merger cases, the Court felt it necessary to consider how this would affect its interpretation of section 238 of the law. It was noted in the course of this review that Section 25 of the Bill of Rights requires that all laws be interpreted in a manner consistent with the Bill of Rights.

In light of this, the Court concluded that “the effect of section 25 of the Bill of Rights is to give the court a greater latitude of interpretation than is afforded by the ordinary rules of interpretation”.⁹

Article 238 “as amended” by the judgment of the Court

In exercising this “interpretative latitude”, the Court set out in paragraph 79 of the judgment an increase in Article 238 of the law to demonstrate more visually its interpretation of this article for the benefit of dissenting shareholders in simplified mergers. It is as follows (with the modifications indicated in red by us):

Section 238

(1) A member of a constituent company incorporated under this Act is entitled to payment of the fair value of the shares of that person if he objects to a merger or consolidation.

(2) A member who wishes to exercise that person’s right under subsection (1) must give the constituent society, before the vote on the merger or consolidation (if such a vote is to be taken) or (if no such vote shall be held) immediately after the date on which the draft amalgamation is delivered to the member in accordance with section 233(7), a written objection to the action.

(3) An objection under subsection (2) must include a statement that the member proposes to demand payment for that person’s shares if the merger or consolidation is voted on or approved.

(4) Within twenty days immediately following the date on which the vote of the partners authorizing the amalgamation or consolidation is taken, or (if no such vote is taken) within twenty days immediately following the date on which the draft of amalgamation or consolidation is filed with the Registrar pursuant to section 233(9), the Constituent Society shall give written notice of the authorization or filing to each member who has made a written objection.

(5) A member who chooses to dissent must, within twenty days immediately after the date on which the notice referred to in subsection (4) is given, give the constituent society written notice of that person’s decision to express his dissent, stating:

(a) the name and address of that person;

(b) the number and classes of shares in respect of which that person is dissenting; and

(c) a demand for payment of fair value from that person.

Conclusion

Mergers and consolidations can be contentious and highly emotional processes, especially for minority shareholders who consider the initial price offered to them for their shares to be less than “fair value”. While shareholder dissent from such processes is already a well-trodden path in the Cayman Islands, the findings reached by the Court in this case are certainly correct, while the clarification that has been made in the context of mergers simplified is welcome. However, what will undoubtedly raise some eyebrows is the Court’s willingness to essentially rewrite the statutory provisions.