Merger appraisal disputes are now a common feature of the litigation landscape in the Cayman Islands.
Upon a merger or consolidation of a Cayman company, Section 238 of the Companies Act provides a statutory mechanism for dissenting shareholders to seek a determination from the Grand Court as to the fair value of their shares.
The Section 238 mechanism was first introduced in 2009. Since the first Section 238 case reached trial in 2015, there has been a succession of decisions in which the Grand Court considered the mechanism and developed its jurisprudence in this fast-growing area. In particular, there has been an increasing number of take-private transactions in which Cayman companies operating in the People’s Republic of China have delisted from US stock exchanges via a merger or consolidation. Some of these transactions have resulted in Section 238 proceedings, as dissenting shareholders have challenged the agreed merger price and sought a determination as to the fair value of their shares.
This trend has continued into 2023.
A common battlefield in Section 238 cases relates to the extent of the documentary and other evidence to be given by the company, which is relevant to the assessment of fair value. Three notable decisions from the first half of 2023 address and expand the evidential burden on companies in this regard.
In the Matter of 58.com – Discovery and Privilege in Section 238 Proceedings
In 58.com, the Grand Court considered the extent to which the company could assert legal professional privilege as against dissenting shareholders, the effect of which would allow the company to avoid disclosing privileged material in the litigation.
In considering this issue, Kawaley J applied the seminal English case Woodhouse v Woodhouse [1914] TLR 559 (Woodhouse), which held that privilege cannot be asserted over a communication in circumstances where the parties to a relationship have a joint interest in the subject matter of that communication at the time it came into existence. Accordingly, where a shareholder can establish a joint interest with the company in legal advice obtained by it, the relevant advice is not privileged as between company and shareholder.
Kawaley J held the following.
- The rule in Woodhouse was not excluded by the statutory scheme in Section 238.
- Unless covered by litigation privilege, the company is not entitled to withhold from disclosure legal advice which is relevant to the appraisal of the fair value of the dissenters’ shares.
- To that extent, shareholders are entitled to be treated as successors in title to prior shareholders. Accordingly, the right to assert a joint interest in privileged material is not limited to legal advice received by the company during the period in which the shareholder asserting the claim was itself a shareholder.
- To assert litigation privilege, litigation must be actual, threatened or in contemplation; and the advice must have been obtained to enable the company to carry on with litigation and given in connection with the dispute. Litigation privilege does not therefore automatically attach to all advice received by the company from the date when litigation was first reasonably contemplated. The point at which litigation is reasonably in contemplation is not an abstract question, and will always involve a context-specific enquiry.
The decision in 58.com provides helpful confirmation of the breadth of discovery available to dissenting shareholders in Section 238 proceedings, which includes relevant legal advice obtained by the company on the merger unless specifically provided for the purpose of future proceedings under Section 238.
In the Matter of Trina Solar – Deal Process and the Evidential Burden Falling on the Company
In Trina Solar, the Cayman Islands Court of Appeal delivered a significant decision, allowing the dissenting shareholders’ appeal against the assessment at first instance that fair value was only slightly above the merger price.
“…the onus was squarely on the company to demonstrate a sufficiently robust sales process in order to rely on the merger price.”
The Court of Appeal undertook a detailed assessment as to the meaning of fair value and the weighting of different valuation methodologies in making that determination. The Court of Appeal revised the calculation of fair value at first instance to reflect a weighting of 30{92e447aa5ae4509d19f58c4a2ed7ec0dbb286610ae15b33d823e9409689b2d4a} market value and 70{92e447aa5ae4509d19f58c4a2ed7ec0dbb286610ae15b33d823e9409689b2d4a} discounted cash flow (DCF) valuation.
In reaching its decision, the Court of Appeal was critical of the gaps in the company’s discovery and of the witnesses put forward by it regarding the valuation issues. Coupled with deficiencies in the sales process and concerns regarding the management of conflicts of interest inherent in a transaction involving a management buy-out, this led the Court of Appeal to conclude that no reliance could be placed on the merger price.
The Court of Appeal was clear that the onus was squarely on the company to demonstrate a sufficiently robust sales process in order to rely on the merger price.
The Court of Appeal also addressed the issues of principle arising from the company’s approach to discovery and the lack of key evidence adduced regarding aspects of the sales process.
The Court of Appeal noted that the key information required by the court to assess fair value will primarily be in the hands of the company and its financial advisers, and that it was the duty of the company to provide the court with this information. This therefore required wide-ranging orders for discovery to be made in Section 238 proceedings, which the Court of Appeal stated the company must comply with. The company must also produce witnesses who can speak with knowledge about all matters relevant to the assessment of fair value.
The Court of Appeal therefore rejected the criticism directed at the dissenting shareholders at first instance, which had put the onus on dissenters to pursue applications for specific discovery to obtain such evidence. Rather, the Court of Appeal was clear and gave a stark warning that if a merging company does not fulfil its obligations in this regard, it may face not only adverse costs orders but also adverse inferences being drawn, where appropriate, as a result of any failures.
In the Matter of iKang Healthcare Group, Inc – Further Judicial Commentary on the Company’s Evidential Burden
In iKang, the Grand Court considered similar issues arising from the absence of discovery on key aspects of the sales process.
“…the absence of important documentary evidence from the financial adviser regarding the market check process significantly weakened the company’s case…”
On the facts, Segal J determined that the case for complete or very substantial reliance on a DCF valuation was very strong, holding that this was the most reliable methodology given that, on the facts, other valuation methodologies were subject to fundamental difficulties and much greater uncertainty. This led Segal J to hold that a 90{92e447aa5ae4509d19f58c4a2ed7ec0dbb286610ae15b33d823e9409689b2d4a} weighting should be given to the DCF valuation. Significantly, Segal J determined that no weight should be given to the market price or the merger price.
As in Trina Solar, the Grand Court had to contend with the absence of discovery of key documents, particularly the materials held by the financial adviser in respect of its work within the deal process and the market check process undertaken.
Segal J held that the absence of important documentary evidence from the financial adviser regarding the market check process significantly weakened the company’s case as to the robustness and completeness of the market check process undertaken. Segal J held that such would justify the court giving reduced weight to this, and in turn to the merger price.
Segal J gave another clear warning that in future cases companies in Section 238 proceedings should be prepared to make available a proper documentary record relating to the work of the appointed financial advisers and to the conduct of the market check and sales process undertaken. This included the need to properly justify why any missing documents had not been retained or were not available. Where the company places direct reliance on the merger price, Segal J considered it likely to be helpful and potentially necessary for evidence to also be adduced from the company’s financial adviser.
These recent decisions give a very clear indication as to the Cayman courts’ expectations in terms of the discovery and evidence to be adduced by the company in Section 238 proceedings. As such, they will only serve in encouraging aggrieved minority shareholders to have recourse to the Section 238 mechanism in response to take-private transactions involving Cayman companies.
This article was first published on www.chambers.com.
