Section 238: Emerging Patterns In Cayman Islands Merger Appraisal Litigation

• Published date: 25 June 2021
• Subject Matter: Corporate/Commercial Law, M&A/Private Equity, Corporate and Company Law, Shareholders
• Law Firm: Collas Crill
• Author: Mr Rocco Cecere

Introduction

Pursuant to section 238 of the Cayman Companies Act ("Section 238"), upon a merger or consolidation, a dissenting shareholder is entitled to a determination by the Grand Court of the "fair value" of its shares, along with a fair rate of interest. A long-form merger or consolidation under Part XVI of the Companies Act is authorised by a two-thirds majority in voting power of the company's members¹ . Upon giving notice of dissent, all of the dissenting shareholder's rights are replaced by an entitlement "to be paid the fair value of that person's shares"².

Section 238 has given rise to a large number of petitions in recent years, most of them involving Cayman Islands companies listed on United States stock exchanges with substantial business operations in the People's Republic of China.

In the majority of cases, the merger is initiated by the company's founder as a mechanism to take the company private by acquiring the shares of minority shareholders.

To date, comparatively few Section 238 petitions have gone to trial³ . In light of international developments,⁴ COVID-related market disruptions which depressed share prices and, more recently, confirmation of a dissenter's entitlement to a fair value determination irrespective of the form of merger (see further below), the number of Section 238 petitions has continued to increase.

Section 238 is a comparatively recent addition to the Companies Act. Since its introduction, the Grand Court has sought to grapple with what "fair value" means in this context and which valuation methodology, or combination of methodologies, it can rely on when determining fair value. In the recently decided cases, the battle lines between dissenting shareholders and petitioning companies⁵ have followed a similar pattern. On the company-side, the tendency has been to rely on certain market indicators as proxies for fair value, namely:

(a) the adjusted share price (i.e., the price at which the company's shares would have been bought and sold on the relevant exchange as at the valuation date, in the absence of any proposed merger); and/or

(b) the merger price of the transaction which the dissenters have dissented from. On the dissenter-side, reliance has more frequently been placed on a discounted cash flow analysis ("DCF") with a view to establishing the intrinsic value of the dissenters' shares. From a commercial perspective, market-based approaches almost invariably produce a fair value determination equal to or only marginally better than the merger price.

As a result, the expert valuation evidence being adduced in Section 238 proceedings is increasingly sophisticated (and voluminous), addressing a broad spectrum of issues. These include:

(a) as regards the adjusted share price, the 'efficiency' of the market for the company's shares, as well as the existence or not of 'material non-public information' (or 'MNPI');

(b) as regards the merger price, the robustness of the deal process which led to the transaction, the conduct of the special committee appointed to negotiate the transaction on the seller-side, and any structural factors which may have prevented or inhibited competing bids from emerging; and

(c) as regards the DCF, evidence going to the different components making up the valuation model including the reliability of the company's projections and forecasts. Further, in a recent case, the parties were given permission to adduce expert evidence from 'industry experts', as well as experts of Delaware law, in circumstances where Delaware's appraisal regime served as one of the models for Section 238 when it was enacted (see further below).

This article considers the most recent developments in this space, particularly the first instance judgments in Re Trina Solar Limited ("Trina") and Re Nord Anglia Inc. ("Nord") which have shed further light on the Grand Court's approach to determining "fair value" in the Section 238 context. From a procedural standpoint, there have also been some significant clarifications on the ambit of dissenter discovery, as well as confirmation of dissenters' entitlement to a fair value determination in the context of a short-form merger. These developments are also considered below.

The Delaware connection

Section 238 was enacted as recently as May 2009. In contrast, statutory merger regimes have been long-standing fixtures of the corporate codes of certain...