In recent years, number of cases under section 238 of the Act have grown substantially as there are an increasing number of take-private transactions involving US listed Chinese companies.
The statutory merger process pursuant to part 16 of the Companies Act must be authorised by a special resolution of the Company’s members, which requires the consent of a two-thirds majority of the shareholders (referred to as a “long-form merger”). A member who wishes to dissent from a long-form merger must file a notice of objection in writing prior to the vote in the extraordinary general meeting (“EGM“), and a formal notice of dissent after the company gives notice that the merger was authorised at the EGM.
Section 233(7) of the Act provides for an exception to the special resolution requirement, such that shareholder votes and the requisite notices are not required. For this to apply, a parent company should hold at least 90 per cent voting power in the general meetings of the subsidiary (referred to as a “short-form merger”).
Section 238 dissenter rights loophole?
Before the Cayman Islands Court of Appeal upheld the Grand Court’s decision in Changyou.com[1], for a long time, many were of the view that the short-form merger process provided a loophole for companies which were able to meet the 90 per cent threshold to enable them to avoid the section 238 dissenter rights regime as no shareholder votes are needed.
The Changyou.com decision confirmed a specific but significant point that minority shareholders are entitled to dissent from and be paid fair value for their shares in relation to a short-form merger, meaning that appraisal rights are available to minority shareholders in both long and short form mergers.
Changyou.com Limited case
In Changyou.com, Changyou.com Limited (“Changyou”) was a Cayman Islands incorporated company principally engaged in developing and operating online and mobile games in China. Changyou subsequently proceeded with a short-form merger to merge with its parent company under s.233(7) of the Act, and effectively forced out the independent minority shareholders. Certain minority shareholders attempted to dissent from the merger. However, Changyou argued that the appraisal rights were only available in long-form mergers (where a shareholder vote is required to approve the merger), and that in short-form mergers, as the shareholders are not required to vote, they therefore had no right to dissent nor were they entitled to a determination of fair value of their former shares under section 238 of the Act.
The Court of Appeal found that it would be “absurd” to deny the protections afforded to shareholders by section 238 for the merely procedural reason that no vote takes place in a short-form merger. It would deprive minority shareholders in a short-form merger of appraisal rights which the legislature intended them to have. In the Court of Appeal’s view, there had been a legislative error in not taking into account the absence of a shareholder vote in short form mergers when section 238 was drafted. The Court of Appeal also considered section 15 of the Bill of Rights of the Cayman Islands which requires the “prompt payment of adequate compensation and for securing a right of access to the Grand Court for the determination of the amount of any compensation”. The Court of Appeal concluded that there were no other remedies available to protect the interests of minority shareholders in short-form mergers as the ordinary rules of construction did not permit the legislative error to be rectified by a process of ordinary construction falling with the ambit of judicial interpretation of statute.
In light of this, the Court of Appeal adopted the following approach in relation to the dissenting process for shareholders in short-form mergers in order to resolve the legislative uncertainty in favour of compliance with the protections afforded by the Bill of Rights:
- objecting members must provide a notice of objection to the company under section 238(2) immediately after the date on which the plan of merger is given to them pursuant to section 233(7);
- the Company must give written notice of authorisation to any objecting members under section 238(4) within 20 days immediately following the filing date the plan of merger with the Registrar; and
- a dissenting member must then give written notice of their dissent under section 238(5) within the next 20 days.
The ruling in Changyou.com provides that appraisal rights for minority shareholders in Cayman Islands companies are assured in both long-form and short-form mergers. The prior perception that short-form mergers can be used as a strategy to preclude minority shareholders having appraisal rights has now been dispelled.
Appleby Hong Kong has recently acted as Cayman Islands counsel to the buyer group in the ongoing private merger transaction of First High-School Education Group (OTCQB: FHSEY), an education service provider primarily focusing on high schools in Western China. The Company entered into a definitive agreement and plan of merger for the short form merger transaction on 22 November 2024, and closing is expected to be in the first half of 2025. With the clarification provided in Changyou.com in respect of short form mergers, we believe short form mergers will continue to be an attractive form of fundraising opportunity on major stock exchanges around the world, and this will continue to allow stakeholders to achieve strategic goals more efficiently and effectively.
[1] In the matter of Changyou.com Limited CICA (Civil) Appeal 6 of 2021.
