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Spotlight: Caymans Section 238 Litigation Support Investigations

Litigation support investigations are increasingly important in the specialized world of Section 238 litigation in the Grand Court of the Cayman Islands, particularly in disputes between Chinese companies and their minority shareholders over fair value of the companies. Recent rulings by the Grand Court on valuation approaches in Section 238 proceedings underscore the need for evidence to support a company valuation.


REVIEW OF SECTION 238


This is a brief review of Section 238 with special attention to companies operating in the People’s Republic of China (“China”) but offering shares of a related entity incorporated in the Cayman Islands that are listed/quoted on various international stock exchanges/markets.


Simply stated, Section 238 provides a statutory mechanism by which shareholders in Cayman Islands’ companies may dissent from mergers and consolidations, and they may simultaneously petition the Grand Court of the Cayman Islands (the “Grand Court”)[1] to determine the "fair value" of their shares. Sadly, but not surprisingly, Section 238 does not define, and it does not provide a valuation methodology to determine “fair value”. It is worthwhile noting the very nature of the legislation given the absence of “fair value” definition or valuation methodology, as applied to the dispute between the relevant company and the dissenting shareholder(s), will often encourage a negotiated settlement between the parties.


Although discussed briefly herein, we recommend readers have a quick look at Footnote 19, which identifies two ongoing litigation assistance areas of importance in Section 238 proceedings: valuation and disclosure obligations.


Section 238 - The Law [2]


Section 238 was initially enacted in May 2009 and, effectively, emulates Title 8, Section 262 of the General Corporation Law of Delaware, USA.[3] As noted by one commentator, among many, Section 238 litigation has rapidly increased in recent years due to issues related to “fair value” of China-related companies that are privatizing and delisting their shares.[4]


The relevant company, which has proceeded to seek a merger, consolidation and/or privatization/delisting, is usually represented by founding/majority shareholders, while dissenting shareholders are often large, global investment funds.


As should be readily evident and previously indicated, the primary issue at stake is “fair value”, which necessitates reviewing judicial decisions interpreting the same.


CAYMAN ISLANDS’ RECENT CHINA RELATED JUDICIAL DECISIONS


The Grand Court had issued three Section 238 final judgments as of 2020, one of which was an “…oil field services provider operating in the Russian market.”[5] Two other final judgments were related to China-related companies, and these are discussed, briefly, below.


In the matter of Shanda Games Limited (FSD 14 of 2016, 25 April 2017) [6]


Shanda Games Limited (“Shanda”) was founded by Chinese technology entrepreneurs, who, in 1999, “…introduced an online game with the ambition of connecting gamers in China using the Internet.”[7]


The dispute arose when the founding shareholders sought to privatize and delist Shanda, made an offer to acquire the equity interests of all shareholders and several large investment funds/shareholders challenged the offer price and valuation pursuant to Section 238. A concise overview of the more than 100-page final judgment was issued by a leading Cayman Islands law firm.[8]


The key takeaway from Shanda is the massively differing opinions of the valuation of the company based on the Discounted Cash Flow Approach (the “DCF Approach”), which was the methodology agreed upon by the experts, e.g., USD2.6 billion versus USD7.3 billion. The Grand Court “…determined that it would be up to Shanda and the Dissenting Shareholders to each establish on the balance of probabilities that the valuation their particular expert had presented on the issue in question was reasonable and reliable.”[9]


Shanda was further elaborated upon by the Cayman Islands Court of Appeal[10] and the United Kingdom Judicial Committee of the Privy Council. [11] [12] This largely focused on the holding of Shanda “…that the focus of attention in such cases should be on the value of the dissenters shares themselves, rather than on seeing the entitlement of the dissenting shareholders as being to a proportionate share in the value of the business as a going concern…the exercise is to value the shares as at the valuation date.”[13]


The use of the DCF Approach increases the utility of forensic investigations related to valuation and disclosure obligations within the defined time period, e.g., valuation date.


In the matter of Qunar Cayman Islands Limited (FSD 76 of 2017, 13 May 2019) [14]


Qunar Cayman Islands Limited (“Qunar”) was founded in May 2005 in China as an online travel agency.[15]


The dispute, yet again, arose when the majority shareholders sought to privatize and delist Qunar, made an offer to acquire the equity interests of all shareholders and several large investment funds/shareholders challenged the offer price and valuation pursuant to Section 238. A concise and well-written overview of the final judgment was issued by two leading Cayman Islands law firms.[16]


The key takeaway from Qunar is the Grand Court’s decision to use a “…50/50 blended methodology of DCF and an analysis of the Company's traded share price.”[17]


This more complicated “blended methodology” approach will only require enhanced efforts to obtain evidence to support a company valuation.

RECENT OUTCOMES (2022)


It is worthwhile noting a plethora of Section 238 interlocutory decisions related to various matters, including Procedural Matters, Interim Payments, Company Disclosure Obligations, Dissenter Disclosure Obligations, Management meetings and admissibility of evidence, Expert evidence, Minority Discount, Valuation Methodology and Costs, prior to final judgments are ongoing in the Cayman Islands.[18]


Recent outcomes (2022) continue to develop the many facets of “fair value”.[19] Suffice it to say, many of these rulings have involved the founding/majority shareholder of China-related companies privatizing and delisting Cayman Islands’ entities and large, investment funds/shareholders dissenting about the prices offered to them to buy out their equity interests.


Simply stated, I-OnAsia can play key roles in all these matters.


ABOUT I-ONASIA


I-OnAsia is a global investigations and security consulting company. Established in 2001, the company's clients include Hong Kong and Mainland China headquartered companies, US based investors, and their respective capital markets advisors and litigation counsel. I-OnAsia has completed ~18,000 due diligence, litigation support and security consulting assignments on their behalf.


I-OnAsia is ranked by Chambers and Partners for litigation support in Asia. The company employs ~50 full time subject matter experts, including in Greater China and the Americas. Reports prepared by I-OnAsia have been submitted to regulators and law enforcement authorities in China, the United States and elsewhere, and have been used in a variety of litigation proceedings.


[1]“Apart from when it sits as an appellate court from the lower courts or other tribunals (usually statutory, quasi-judicial), this court is a Superior Court of Record of First Instance, having unlimited jurisdiction in both criminal and civil matters.” https://www.judicial.ky/courts/grand-court. [2] “Rights of dissenters 238. (1) A member of a constituent company incorporated under this Law shall be entitled to payment of the fair value of that person’s shares upon dissenting from a merger or consolidation. (2) A member who desires to exercise that person’s entitlement under subsection (1) shall give to the constituent company, before the vote on the merger or consolidation, written objection to the action. (3) An objection under subsection (2) shall include a statement that the member proposes to demand payment for that person’s shares if the merger or consolidation is authorised by the vote. (4) Within twenty days immediately following the date on which the vote of members giving authorisation for the merger or consolidation is made, the constituent company shall give written notice of the authorisation to each member who made a written objection. (5) A member who elects to dissent shall, within twenty days immediately following the date on which the notice referred to in subsection (4) is given, give to the constituent company a written notice of that person’s decision to dissent, stating — (a) his name and address; (b) the number and classes of shares in respect of which that person dissents; and (c) a demand for payment of the fair value of that person’s shares. (6) A member who dissents shall do so in respect of all shares that that person holds in the constituent company. (7) Upon the giving of a notice of dissent under subsection (5), the member to whom the notice relates shall cease to have any of the rights of a member except the right to be paid the fair value of that person’s shares and the rights referred to in subsections (12) and (16). (8) Within seven days immediately following the date of the expiration of the period specified in subsection (5), or within seven days immediately following the date on which the plan of merger or consolidation is filed, whichever is later, the constituent company, the surviving company or the consolidated company shall make a written offer to each dissenting member to purchase that person’s shares at a specified price that the company determines to be their fair value; and if, within thirty days immediately following the date on which the offer is made, the company making the offer and the dissenting member agree upon the price to be paid for that person’s shares, the company shall pay to the member the amount in money forthwith. (9) If the company and a dissenting member fail, within the period specified in subsection (8), to agree on the price to be paid for the shares owned by the member, within twenty days immediately following the date on which the period expires — (a) the company shall (and any dissenting member may) file a petition with the Court for a determination of the fair value of the shares of all dissenting members; and (b) the petition by the company shall be accompanied by a verified list containing the names and addresses of all members who have filed a notice under subsection (5) and with whom agreements as to the fair value of their shares have not been reached by the company. (10) A copy of any petition filed under subsection (9)(a) shall be served on the other party; and where a dissenting member has so filed, the company shall within ten days after such service file the verified list referred to in subsection (9)(b). (11) At the hearing of a petition, the Court shall determine the fair value of the shares of such dissenting members as it finds are involved, together with a fair rate of interest, if any, to be paid by the company upon the amount determined to be the fair value. (12) Any member whose name appears on the list filed by the company under subsection (9)(b) or (10) and who the Court finds are involved may participate fully in all proceedings until the determination of fair value is reached. (13) The order of the Court resulting from proceeding on the petition shall be enforceable in such manner as other orders of the Court are enforced, whether the company is incorporated under the laws of the Islands or not. (14) The costs of the proceeding may be determined by the Court and taxed upon the parties as the Court deems equitable in the circumstances; and upon application of a member, the Court may order all or a portion of the expenses incurred by any member in connection with the proceeding, including reasonable attorney’s fees and the fees and expenses of experts, to be charged pro rata against the value of all the shares which are the subject of the proceeding. (15) Shares acquired by the company pursuant to this section shall be cancelled and, if they are shares of a surviving company, they shall be available for re-issue. (16) The enforcement by a member of that person’s entitlement under this section shall exclude the enforcement by the member of any right to which that person might otherwise be entitled by virtue of that person holding shares, except that this section shall not exclude the right of the member to institute proceedings to obtain relief on the ground that the merger or consolidation is void or unlawful.” https://www.cima.ky/upimages/lawsregulations/CompaniesLaw2020Revision_1579811065_1599479694.pdf. [3] Any stockholder of a corporation of this State who holds shares of stock on the date of the making of a demand pursuant to subsection (d) of this section with respect to such shares, who continuously holds such shares through the effective date of the merger, consolidation, or conversion, who has otherwise complied with subsection (d) of this section and who has neither voted in favor of the merger, consolidation or conversion nor consented thereto in writing pursuant to § 228 of this title shall be entitled to an appraisal by the Court of Chancery of the fair value of the stockholder’s shares of stock under the circumstances described in subsections (b) and (c) of this section. https://delcode.delaware.gov/title8/c001/sc09/index.html. [4] “In particular, there has been a trend of Cayman Islands incorporated companies operating in the People's Republic of China being taken private, delisting from the US stock exchange, and then relisting on alternative stock exchanges, sometimes at a much higher value shortly thereafter.” https://www.ogier.com/publications/appraising-section-238-fair-value-proceedings-in-the-cayman-islands-an-overview?_gl=1*jmnd3b*_up*MQ..*_ga*MTAyNzI1ODk0Mi4xNjcwMzAzOTYy*_ga_PNXNNXG9H5*MTY3MDMwMzk2Mi4xLjAuMTY3MDMwMzk2Mi4wLjAuMA... [5] In the Matter of Integra Group, https://cilr.judicial.ky/Judgments/Cayman-Islands-Law-Reports/Cases/CILR2016/CILR161192.aspx. [6] https://ky.vlex.com/vid/re-shanda-games-ltd-793259965. [7] https://www.shanda.com/shanda-games/. [8] https://www.conyers.com/wp-content/uploads/2017/04/Rebranded-2017-04-CAY-Article-Dissenting-Shareholders-Fair-Value-Petitions-and-Statutory-Appraisals-New-Guidance-from-the-Cayman-Islands.pdf. [9] Page 2, Ibid. [10]Appeals from the Grand Court go to the Court of Appeal.” https://www.judicial.ky/courts/court-of-appeal. [11] “Until recently, the Privy Council remained the final appellate court for most Commonwealth countries. Today it still presides in that capacity only for certain final appeals from within…The British Overseas Territories, including the Cayman Islands and a few Commonwealth countries, including the Bahamas.” https://www.judicial.ky/courts/judicial-committee-of-the-privy-council. [12] “In Shanda Games the uplift was 134.9%, plus 4.3% interest. This uplift was subsequently reduced to 81% (plus interest) by the Cayman Islands Court of Appeal to take account of a "minority discount", or discount for lack of control, in valuing the dissenters' shareholdings, which was recently upheld by the Judicial Committee of the Privy Counci.” https://www.ogier.com/publications/appraising-section-238-fair-value-proceedings-in-the-cayman-islands-an-overview?_gl=1*jmnd3b*_up*MQ..*_ga*MTAyNzI1ODk0Mi4xNjcwMzAzOTYy*_ga_PNXNNXG9H5*MTY3MDMwMzk2Mi4xLjAuMTY3MDMwMzk2Mi4wLjAuMA... [13] https://www.conyers.com/publications/view/qunar-cayman-islands-limited-10-may-2019-qunar/. [14] https://www.wilberforce.co.uk/wp-content/uploads/2019/05/Qunar-Judgment-Amended-13-May-2019.pdf. [15] https://www.qunar.com/. [16] https://www.conyers.com/wp-content/uploads/2019/05/2019-05-CAY-Offshore-Case-Qunar-Cayman-Islands-Limited-10-May-2019-%E2%80%9CQunar%E2%80%9D.pdf and https://www.harneys.com/our-blogs/offshore-litigation/qunar-company-victory-in-landmark-s-238-ruling/. [17] https://www.harneys.com/our-blogs/offshore-litigation/qunar-company-victory-in-landmark-s-238-ruling/. [18] FSD Users Sub-committee – Section 238 Proceedings, https://judicial.ky/wp-content/uploads/publications/reports/FSDUsersSubSection238CaseSummariesJune2021.pdf. [19] https://www.ogier.com/publications/reappraising-section-238-fair-value-proceedings-an-update-on-recent-developments#.

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