Take private transactions - a quick glance into the Cayman Islands mergers & acquisitions regimes

Special Committee Considerations

Although not statutorily required, it is common for the target company in a take private transaction, particularly where the buyer consortium includes members of the board of directors of the target, to establish a special committee to evaluate the take-private proposal and make a recommendation to the board on whether or not to accept the proposal.  The remit of the special committee is to act independently and fairly taking into account the interests of the target company and its shareholders, in particular if there is a chance that the management of the target company may have a conflict with the interests of the shareholders of the target company. (e.g., in the case where the management join the buyer consortium or roll over some or all of their equity interests into the new private company upon closing of the take-private transaction).   The special committee usually consists of members of the board of directors who are independent and disinterested (i.e. they are not buyer consortium members).

As directors of the target company, members of the special committee are governed by the same set of statutory and fiduciary duties applicable to other directors, and they are expected to discharge the same level and degree of skill, care and diligence when exercising their judgment in the decision making process.  One of the main requirements of special committee members is to maintain their independence and hence avoid any influence from potentially interested parties. 

Pros and Cons of the statutory merger regime

As noted above, the Cayman Islands statutory merger regime provides a straightforward and well-tested merger mechanism, with a relatively low approval threshold.  It does not require any Court approval which reduces costs and shortens the deal implementation timetable.  The major downside is that shareholders retain a statutory right to petition the Cayman Islands Courts for the payment of ‘fair value’ for their shares.  This can lead to uncertainty at the tail-end of deals and needs to be carefully managed.

(2) Schemes of Arrangement

The Cayman Islands Companies Act provides for a scheme of arrangement (Scheme) regime, based on the English common law equivalent, which is an alternative to the statutory merger regime.  Although a Scheme is suitable for taking Cayman Islands companies private, they have historically been used for complicated restructurings, involving, for example, a capital reduction.  A Scheme is a court sanctioned compromise or arrangement between a company and its creditors, or between a company and its shareholders, or any class of them. The statute does not restrict the nature of the arrangement that may be agreed between the company and its members/creditors.   For the purpose of this article, we will focus on members' Schemes, which are more relevant in the context of M&A.  In addition to the power to compromise with creditors and members, the Companies Act includes broad provisions facilitating reconstruction and amalgamation of companies, including where a scheme or contract involves the transfer of shares or any class of shares to another company, and provides for the power to acquire shares of dissentient shareholders.  

A Scheme usually begins with setting out the proposals in detail in a set of shareholders' communication documents (such as, public announcements, circulars, notice of court meeting, notice of shareholders' meeting, etc.).  The Company then applies to the Court to obtain permission to proceed with the Scheme. Once the Court provides its green light to proceed, the company may convene a meeting with its shareholders according to the directions given by the Court at the first direction hearing for approving the Scheme (the Shareholders Meeting).  Pursuant to the Companies Act, a scheme of arrangement must be approved by at least a majority in number, representing at least 75% in value, of the shareholders or class of shareholders who are present and voting either in person or by proxy at the shareholders' meeting, i.e., the 'headcount test' and the 'value test'.   Once the requisite shareholders' approval thresholds for approving the Scheme have been obtained, there will be another Court hearing for the purpose of sanctioning the Scheme.  All shareholders are entitled to attend the sanction hearing and express their objections if they want to.   Once the Court is satisfied that all the prescribed conditions under the Companies Act are fulfilled (which include, shareholders being well informed of the scheme proposal, all meetings properly convened and held, and such other conditions which may be imposed by the Court), the Court will sanction the Scheme.   

At the Shareholders' Meeting, the voting thresholds apply to each class of shares. i.e., shareholders holding different classes of shares will vote as separate classes, which is also a key challenge in the context of implementing a scheme of arrangement.  Attention must be paid to the relevant listing rules and regulations which the company is subject to when interpreting the 'headcount test' and the 'value test' in the context of voting at the Shareholders' Meeting.  The 'headcount test' is one of the best examples to show how these tests are open for interpretation.  Most shares in a HKEx listed company are held by a nominee company such as the HKSCC Nominee Limited in Hong Kong SAR.  Similarly, shares in US-listed Chinese companies that issue ADRs will be held by a central depositary. The question would be on the calculation of the number of 'heads' in respect of those shares held by the nominee company at the Shareholders' Meeting.  The company may apply to the Court for a direction to 'look' through the nominee to determine the 'genuine' headcount.

Once the Scheme is sanctioned by the Court at the second hearing, all shareholders are bound including those shareholders who did fail to vote or voted against the Scheme in the meeting. No appraisal right is available.  The latest notable transaction in the market by way of a Scheme is the filing of a petition by Luckin Coffee Inc. with the Court in September 2021 in connection with the restructuring of its US$460 million 0.75% convertible senior notes due 2025 proposed by Luckin Coffee and its joint provisional liquidators.

 Pros and cons of the Scheme of Arrangement approach

As a Cayman Islands scheme of arrangement requires two court hearings, the implementation of these types of transactions is generally longer than a typical merger transaction, and in addition significantly more expensive. However, a major advantage of the scheme of arrangement mechanism is that once the Scheme has been sanctioned at the second Court hearing, it will become binding on all shareholders, and there is no route to dissent or petition for fair value as is the case with the merger regime.

 (3) Takeover Offer or Squeeze-Out

The statutory squeeze-out, or a takeover, under the Companies Act refers to an acquisition where an offeror which has acquired at least 90% of the issued share capital in a target company may compel the acquisition of the shares of the remaining minority shareholders.  Once the squeeze-out offer is effective, the offeror can require the transfer of minority shareholders' shares to it, to become the sole shareholder of the target company.     

The process begins with the offeror sending the offer details to the shareholders of the target company.   In case the target is a public company, a set of takeover documents will be distributed to the shareholders of the target company including public announcements, circulars, etc., which will also be required to be filed with the relevant stock exchange.  If the offer is accepted and the offeror has acquired 90% or more in value of the shares in the target company, the offeror may proceed with exercising the squeeze-out provision without the need to obtain separate shareholders' consent.   The offer is a lengthy process.  The offeror can only exercise its squeeze-out under the Companies Act after the expiry of 4 months from the date the offer is made.  Dissenting shareholders have limited rights to object to the acquisition; they shall have one month from the date they receive notice of the offer to apply to Court if they object to the acquisition, although in practice it is unlikely that the Court will intervene unless the parties to the offer are in breach of any statutory requirements under the Companies Act.

Once the above mentioned requirements under the Companies Act have been complied with, and provided that no order to the contrary has been made by the Court, the parties will proceed with the completion logistics to register the offeror as the sole shareholder of the target company and to pay the shareholders of the target company the consideration sum. 

Since the commencement of the Cayman Islands statutory merger regime, the use of the “short-form” merger has emerged as an alternative last step to the squeeze-out process.  When the 90% acceptance threshold is met, the squeeze-out can be implemented by way of a "short-form" merger pursuant to the Companies Act, which allows the offeror holding 90% or more of the voting rights in the target company to undertake a merger with the target company; no shareholders' approval is required but appraisal rights will apply. 

Pros and cons of the Takeover Offer or Squeeze-Out approach

The squeeze-out approach to acquiring a Cayman Islands company is generally seen as a cheaper alternative to the merger or scheme of arrangement approaches discussed above, as there are no shareholder meetings nor Court hearings involved.  However, the statutory timetable, if strictly followed, can mean these transactions can take 6 months or more to fully implement.

Recent Trends in Cayman Islands Appraisal Litigation

In recent years, the Cayman Islands courts have become the battlefield for dissenters petitioning under the statutory merger regime in relation to their appraisal rights pursuant to the Companies Act.  The argument is always around the question of "fair value" of the dissenter's shares in the target company.  “Fair value” here is a legal rather than an economic construct, without a defined valuation methodology or prescriptive formula.  The Cayman Islands Court of Appeal summarised the position in Shanda Games: “s.238 requires fair value to be attributed to what the dissentient shareholder possesses. If what he possesses is a minority shareholding, it is to be valued as such. If he holds shares to which particular rights or liabilities attach, the shares are to be valued as subject to those rights or liabilities." [4] This is in contrast to the “fair value” in Delaware, where “the shares of dissenters are regarded as proportionate shares in the value of the business itself as a going concern"[5]. Given the complex construction of the concept, it was commented by the Court that the assessment of fair value is “more of an art than a science”, that "it is more than imply the application of mathematical formulae or economic principles." [6]

The Privy Council's judgement was followed and interpreted in more detail by the Court in Trina Solar. In Trina Solar, Segal J emphasised that the Privy Council had explained that a minority discount could be applied in an appropriate case, but did not rule out the possibility that there might be a case where such a discount was inappropriate. Faced with these often entrenched positions, the Court has in recent cases proceeded to “blend” valuation approaches in reaching its final determination of fair value, applying different weightings to market approaches as well as to the traditional income (discounted cashflow) approach. In both Trina Solar and Nord (as well as Qunar before them), the Grand Court determined fair value by blending different valuation methodologies.

Only five cases have gone to trial to date: Re Integra Group [2016 (1) CILR 192], Re Shanda Games (judgments in the Grand Court, Court of Appeal and the Privy Council), Re Qunar Cayman Islands Ltd. [2019 (1) CILR 611], Re Nord Anglia Inc (Unreported, Grand Court, 17 March 2020) and most recently, Re Trina Solar (Unreported, Grand Court, 23 September 2020).  Trina Solar is the first judgement in which fair value was determined to be below the merger price.  The Company’s valuation expert used a blended approach to valuation, ascribing 40 per cent weighting to the merger price, 40 per cent to the unaffected trading price and 20 per cent to a discounted cash flow valuation, reaching a valuation that was below the merger price.

Another recent trend in the appraisal cases relates to the scope of dissenter discovery. Although dissenter discovery was ordered in many previous cases, a number of recent Court decisions demonstrated a trend to limit the scope of dissenters' discovery.

In Re eHi Car Services Limited, the Grand Court rejected the company's attempts to extend categories of disclosure to be provided by dissenting shareholders. The Court opined that these extensions are disproportionate, as it had done in prior cases. Subsequently, in Re FGL Holdings the Court once again rejected an attempt which sought to impose an obligation on the dissenters to the effect of giving general discovery.

Outlook

Despite the constantly changing economic landscape, and the challenges brought by the highly volatile market conditions, we are optimistic about the growth in the level of global M&A activity in 2022.  To remain competitive, companies will continue to explore strategic opportunities through mergers and acquisitions as a gateway to maximising the valuation of their business and returns.  US-listed Chinese companies delisting from US securities exchange, and the need for existing SPACs to complete de-SPAC mergers will both contribute strongly to global and regional M&A activity for the foreseeable future.

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[1]  Global M&A volumes hit new record in 2021, overtaking last year's haul | Reuters

[2]  EY study: Global mergers and acquisitions activity in the first six months of the year reaches a historic high

[3]  The authors note that this article provides an overview of the Cayman Islands legal requirements to acquire Cayman Islands companies. In addition to these requirements, listed Cayman Islands companies will also need to comply with the securities laws and stock exchange rules applicable to the jurisdiction in which they are listed.

[4]  Re Shanda Games (Court of Appeal) at para. 50

[5]  Re Qunar Cayman Islands Ltd at para. 40

[6]  Re Qunar Cayman Islands Ltd at para. 70

An original version of this article was first published by Asian Legal Business, November 2021.

© Carey Olsen 2021.