Introduction

In Tianrui (International) Holding Company Ltd v China Shanshui Cement Group Ltd,[1] the Privy Council recently confirmed that a shareholder in a Cayman company has standing to bring a personal claim against that company where its board of directors is alleged to have exercised its powers to allot shares for an improper purpose.

As we explore below, in doing so, the Privy Council overturned the decision of the Court of Appeal which had followed a previous decision of the Grand Court which looked to have moved Cayman Islands law away from English and other Commonwealth common law.

Whilst this clarification of the law is certainly welcome for the jurisdiction, the practical effect is that this simply allows the claim by the shareholder in question to survive a strike out application and leaves open the determination of the underlying factual issues. In dealing with this legal point, the Privy Council assumed the facts as alleged and therefore, in the usual way, made no findings.[2] The underlying factual matters are heavily disputed in the litigation and will be up for determination in due course in these ongoing, multi-jurisdictional set of related proceedings[3] relating to the control of one of the largest cement producers in the PRC.

Appleby acts for a major shareholder in the related just and equitable winding up proceedings.

Background to Tianrui

China Shanshui Cement Group Ltd (“China Shanshui”) is a Cayman Islands exempted company that is also registered in Hong Kong and has its shares listed on the Hong Kong Stock Exchange. China Shanshui is the holding company of a number of operating subsidiaries registered in Hong Kong and mainland PRC, principally engaged in the production, distribution and supply of cement and related construction products. Tianrui (International) Holding Company Ltd (“Tianrui”) is one of four major shareholders in China Shanshui, along with Asia Cement Corporation (“ACC”), China National Building Material Holding Co. Limited (“CNBM”)[4] and China Investments Co, Ltd.

The substance of the dispute finds its origins in the decision of the PRC government, in November 2014, to prohibit any expansion of capacity or development of new projects in the cement industry. PRC cement producers were left with two options for expansion: either acquire or merge with other producers. Each of Tianrui, ACC and CNBM identified China Shanshui as an expansion opportunity and proceeded to acquire or expand their shareholdings in China Shanshui.

In 2018, when nominees of CNBM and ACC were on the China Shanshui board, China Shanshui issued various convertible bonds and new shares, which had the consequential effect of diluting all existing shareholders, including Tianrui (from approximately 28% of shares in issue to 22%).

Tianrui, perceiving the allotment as an attack on its shareholding in China Shanshui,[5] presented a petition to wind up China Shanshui on the just and equitable ground and subsequently commenced a writ action against China Shanshui, both in the Grand Court. Broadly speaking, in both sets of Cayman proceedings, Tianrui alleges that CNBM and ACC conspired to dilute Tianrui’s shareholding in China Shanshui by procuring the allotment of the convertible bonds and then issue of new shares to their associates. Tianrui alleges that these actions were an improper exercise of the powers of the board of directors of China Shanshui.

Tianrui’s allegations are firmly denied by CNBM and ACC, these shareholders explaining that the issue of new shares was done with a perfectly proper purpose so as to ensure that the shareholding in China Shanshui complied with applicable regulatory requirements.

Gao – the legal position in the Cayman Islands before Tianrui

In Gao v China Biologic Products Holdings Incorporated,[6] the Grand Court (Kawaley J) considered whether a registered shareholder had legal standing to assert a personal claim against the company for breach of fiduciary duty in respect of a board decision to allot and issue shares for an alleged improper purpose.

To put this issue into its proper context, it is important to keep in mind that:

Each company registered in the Cayman Islands has a set of constitutional documents which describe and delimit the powers and duties of its directors. Such constitutional documents are supplemented by common law and statute and include the duties to act bona fide (in good faith) and to exercise powers for a proper purpose.
Generally,[7] such duties are owed by the directors to the company as a whole, rather than to individual, or classes of, shareholders. In limited circumstances, directors may, by their actions, have placed themselves in a relationship with shareholders by virtue of which they owe duties to the shareholders as well as the company.[8] Outside of those circumstances, as it is the company, not shareholders, which is the beneficiary of the duties owed by directors, shareholders generally have no standing to sue the directors or the company for breach of such duties. Instead, in the Cayman Islands, it was understood that such action must be commenced by the shareholder on behalf of the company against the directors, by way of a derivative action pursuant to O.15, r.12A of the Grand Court Rules (“GCR”).

This position is largely underpinned by the so-called “rule in Foss v Harbottle”,[9] which is made up of two related principles:[10]

the “proper plaintiff” principle: where a wrong is done to a company (such as a breach of duty by a director or the board of directors) only the company, not an individual shareholder, can take action; and
the “majority rule” principle: the will of the majority of shareholders should, in general, prevail in the running of the company’s business (including waiving a breach of duty or ratifying irregular acts).

The “rule” is subject to exceptions, including where there is a “fraud on the minority” – where the wrongdoers are guilty of dishonest conduct or misappropriating opportunities from the company, and the wrongdoers themselves control the company.[11]

In light of these principles, Kawaley J in Gao held that individual minority shareholders ordinarily have no standing to sue for breach of fiduciary duty in relation to a complaint that their voting power had been diluted by a share allotment approved by the directors for an improper purpose.[12] The Judge considered that it was a fundamental principle of company law that shareholders ordinarily acquire their shares on the explicit basis that their only means of controlling management is by way of successfully passing resolutions in general meetings and that it would be inconsistent with this principle if individual shareholders were permitted to enforce duties owed by directors not to shareholders, but to the company.[13]

Whilst this general rule is subject to certain exceptions[14], Kawaley J was not persuaded to adopt in the Cayman Islands the approach taken by the Supreme Court of South Australia in Residues Treatment & Trading Co. Ltd. v Southern Res. Ltd. (No. 4)[15] that one of these exceptions is that a minority shareholder may bring a personal action against the company if its board allots shares for an improper purpose.[16] Kawaley J held that Residues represented a departure from mainstream (British Commonwealth) common law and was not supported by previous or subsequent authorities or in principle.[17]

Tianrui – strike out application before the Grand Court[18]

In August 2019, China Shanshui filed, amongst other things, a summons seeking an order that the writ action be struck out either on the basis that:[19]

it was an abuse of process for Tianrui to pursue both the winding up petition and the writ action; or
because the claim was improperly constituted as a personal claim by Tianrui as shareholder where the cause of action relied on in the writ action could only be constituted as a derivative claim on behalf of China Shanshui (for which leave from the Grand Court must be sought and obtained pursuant to GCR O.15, r.12A).

China Shanshui relied upon Kawaley J’s reasoning in Gao. Tianrui submitted that Gao was plainly wrong and should not be followed because, as a matter of principle, a shareholder has a personal claim against the company to challenge an improper exercise by the directors of the power to issue shares, as a breach of the company’s constitution and the statutory contract to which the shareholder and company are parties.[20]

The Grand Court (Segal J) ruled in favour of Tianrui, dismissing China Shanshui’s summons to strike out the writ action. In doing so, Segal J declined to follow the reasoning of Kawaley J in Gao, observing that save for that decision “the scope and basis of the decisions in the key cases is unclear or disputed… [and] authoritative dicta in the cases and principle support [the contrary view]”.[21] Segal J considered that Kawaley J’s analysis focussed on the wrong question: whether minority shareholders have direct claims against the directors.[22] Segal J observed that the minority shareholder in the present case is not making a claim or asserting a direct cause of action against the directors, but was seeking to bring a personal claim for breach by the company of the statutory contract and the constitution.[23] Citing a text by Professor Paul Davies KC:[24]

“…[there] seems to have been… a failure by the courts to distinguish between two different aspects of a breach of the articles. If the directors fail to observe the articles they will be in breach of duty to the company… On the other hand, if the directors cause the company to act in breach of its articles, the company will be in breach of [the statutory contract] with the shareholders. In the first case, the company is the claimant and the individual can enforce the company’s rights only if she has standing to bring a derivative action. In the second case, the individual shareholder is the claimant and the company is the defendant and the individual’s standing to bring a derivative claim is simply irrelevant.”

Segal J found particular support in the hypothetical where a shareholder who, but for the dilution, would have otherwise had negative control rights because they have a sufficient shareholding to block special resolutions:[25]

“An interference with a shareholder’s right to block special resolutions (to exercise negative control) by dilution of his shareholding seems to me to affect a core entitlement granted by the corporate constitution to the shareholder and the constitutional balance of power between shareholders thereby affecting fundamental rules regulating corporate governance.”

Segal J found the analysis in Residue persuasive and the criticisms of that judgment in Kawaley J’s decision to be “overstated”.[26] Segal J observed that there are strong indications in past cases, at least where dilution has the effect of destroying an existing majority and creating a new one, of the recognition of a personal right in a shareholder.[27]

Noting the approach adopted by Kawaley J in Gao, following the first instance decision in Tianrui, the Cayman Islands law was left in the unsatisfactory position of having two contradictory first instance judgments in relation to the rights of shareholders in these circumstances.

Tianrui – CICA appeal[28]

China Shanshui appealed Segal J’s decision to the Court of Appeal of the Cayman Islands (“CICA”).

In its concise judgment, the CICA overturned Segal J’s decision, finding that the writ should be struck out as defective because Tianrui had failed to obtain leave to commence a derivative action pursuant to GCR O.15, r.12A. The CICA held that Residues failed to provide a principled basis for the conclusion that a shareholder has a personal right to complain of a dilution of his voting power caused by an issue of shares done in breach of a fiduciary duty (that duty being owed to the company and not to the shareholder).[29]

As a result of the CICA decision, Cayman Islands law was that an aggrieved shareholder in these circumstances had no such personal right of action against the company. Nevertheless, the CICA did leave open the door for a personal claim by an aggrieved shareholder based on one of the economic torts, such as wrongful interference with contractual rights or conspiracy to injure where the breach of fiduciary duty owed to the company constitutes wrongful or unlawful means “rather than the fly wheel of the cause of action”.[30]

Whilst ultimately not determinative of the question on appeal, the CICA also disagreed with China Shanshui’s contention that a shareholder could not bring a personal claim where the voting power of its shares had been diluted by an improper allotment of shares because it is the company that suffers loss, not the aggrieved shareholder (who was said to suffer an “indirect and consequential” loss).[31] The CICA held that the injury suffered by the shareholder is the reduction in his capacity to exercise his constitutional right to cast the votes attached to his shares in a general meeting (founded on the contract based on the articles of association between himself and the company), which was separate and distinct from any loss suffered by the company.[32]

Tianrui – Privy Council appeal

Tianrui sought, and was granted, leave to appeal against the CICA decision to the Judicial Committee of the Privy Council, ultimately seeking to reinstate the writ against China Shanshui.

In its decision delivered on 14 November 2024, the Privy Council overturned the CICA, agreeing with Segal J at first instance (and disagreeing with Kawaley J in Gao), finding that a shareholder has a right of action against the company to challenge the allotment of shares by the board of directors where the allotment was allegedly made for an improper purpose and where the allotment will cause detriment to the shareholder.[33]

The Privy Council commenced its analysis by reviewing the “rule in Foss v Harbottle”, but noting that the boundaries of the exceptions to that “rule” are “ill-defined” and that the “rule” itself “is only part of the picture”.[34] This is because courts have long recognised that a shareholder has personal rights against a company which may be enforced by a personal action against that company, such as by way of an injunction where a shareholder’s vote has been improperly rejected at a general meeting, contrary to the express terms of the articles of association of the company. Importantly, in other cases, the rights of shareholders are infringed not because of a breach of the express terms of a company’s articles, but because the directors, acting as the company’s agents, have exercised powers for improper purposes (albeit within the letter of the express terms of the articles).[35] The Privy Council observed that, notwithstanding these previous cases, the juridical basis of the individual shareholder’s standing to bring such personal actions had not been decided.

The Privy Council noted that the present case was of a different nature as it did not involve the removal or restriction of rights attached to Tianrui’s shares. Instead, it involved the dilution of Tianrui’s shareholding, with consequential detriment to Tianrui’s ability to exercise its proportionate voting power (including to block special resolutions). The Privy Council reviewed a series of English and Australian cases which showed that courts, applying principles which are not materially different to those applicable in the Cayman Islands, have repeatedly recognised the right of shareholders to bring a personal action in their own names against a company (rather than by way of derivative action) to challenge the validity of an allotment of shares made on behalf of the company by its directors, based upon the allegation that the directors acted for an improper purpose.[36]

Ultimately, the Privy Council determined that Gao was wrongly decided and that the CICA was wrong to follow it. In so finding, the Privy Council laid out the following, fundamental, principles underpinning its decision:[37]

The exercise of voting rights by shareholders (whether individually or in groups) is how power over the company’s affairs is maintained, and dilution of shareholding proportions by the allotment and issue of new shares may critically affect the balance of power between shareholders.
The conferment upon the directors of the fiduciary power to allot and issue shares is an important part of the contract between shareholders and the company. It is a term of that contract that, if the exercise of the power is to be valid and binding, it should comply with all conditions necessary to make it a proper exercise (including compliance with the directors’ fiduciary duty owed to the company).
Where there is an improper exercise of the directors’ power to allot and issue shares, an existing shareholder will suffer adverse consequences arising from the shift in the balance of power between shareholders which affects the value of rights in that shareholder’s shares. That is an actionable harm because the impropriety in the exercise of the power contravenes the contract between the shareholder and company, even thought the relevant fiduciary duty breached by the directors is not owed to the shareholder.
The size of the claimant’s shareholding is, in principle, irrelevant; the right to sue the company is not dependent upon the alteration in the balance of power being adverse only to a minority of shareholders, nor an existing shareholder is deprived of majority control. What matters is that the claimant has suffered from an interference with its rights as a shareholder brought about by an improper issue and allotment of shares.
It is also, in principle, irrelevant whether or not the company itself has a cause of action against the directors for breach of fiduciary duty owed to it; usually it will.
Finally, a personal claim by a shareholder may be defeated by ratification, whether before or after proceedings have been commenced or even tried; however, ratification cannot validly occur where the directors have acted for an improper purpose of, for example, assisting an existing majority to oppress a minority.

Comment

The Privy Council in Tianrui has provided some welcome certainty in the Cayman Islands regarding the circumstances in which shareholders have standing to bring personal claims against a company to challenge an improper exercise of power by the company’s directors. In effect, the decision brings the Cayman Islands into line with other common law jurisdictions, whilst also providing a juridical basis for the standing of shareholders in such actions. This is particularly significant for minority shareholders of Cayman Islands companies, as that jurisdiction has preserved the common law principles applicable to derivative actions (albeit as supplemented by GCR O.15, r.12A). Further, as there is no equivalent under Cayman Islands law to section 994 of the UK Companies Act (which gives a minority shareholder the right to petition the court for a remedy on the ground that it is being unfairly prejudice), the decision provides a further, direct avenue for shareholders to seek relief from the improper exercise of power by directors.

Whilst the Privy Council’s decision is certainly interesting from a legal perspective, and means that Tianrui can continue its writ action, it does not speak to the ultimate resolution of the substance of Tianrui’s complaints. Both the winding up petition and writ action commenced by Tianrui remain in their infancy and Tianrui has yet to substantiate its allegations of, in effect, conspiracy between ACC and CNBM.

Those proceedings, including the just and equitable winding up petition in which Appleby act for CNBM, continue.

[1] [2024] UKPC 36 (“Privy Council Judgment”).

[2] Privy Council Judgment, [5].

[3] Including two sets of proceedings in Hong Kong: HCA2880/2015 and HCA548/2019.

[4] Appleby acts for CNBM in the related just and equitable winding-up proceedings commenced by Tianrui against China Shanshui, ACC and CNBM currently before the Grand Court.

[5] Albeit Tianrui does not dispute that, on its face, the allotment “may appear to be a rational response to the notice which the [Hong Kong Stock Exchange] gave” China Shanshui requiring it to, amongst other things, restore its public float above the 25% minimum threshold requires by a rule of the HKSE Main Board Listing Rules: Privy Council Judgment, [16].

[6] [2018 (2) CILR 591].

[7] Exceptions to the general rule include where the company is on the brink of insolvency, where the directors’ duties will extend to the company’s creditors.

[8] Such as where a duty of good faith arises when giving shareholders advice whether to accept a takeover offer for their shares.

[9] (1843) 2 Hare 461.

[10] Privy Council Judgment, [34]-[36].

[11] Privy Council Appeal Judgment, [37].

[12] Gao, [29].

[13] Gao, [30].

[14] Including in relation to ultra vires acts (as the company is not competent to ratify such acts) and where a particular shareholder has an individual right of action against the company in respect of a transaction which affects that shareholder in its own right (e.g. where the shareholder asserts a personal contractual right to receive dividends or redemption proceeds): Gao, [31].

[15] (1988) 51 SASR 196, on appeal (1988) 51 SASR 196; 48 ACLR 599.

[16] Gao, [26].

[17] Gao, [33].

[18] Tianrui (International) Holding Company Limited v China Shanshui Cement Group Limited (Unrep, Grand Court, FSD 161 of 2018 and FSD 93 of 2019 (NSJ), 6 April 2020) (“Grand Court Decision”).

[19] Grand Court Decision, [10].

[20] Grand Court Decision, [89].

[21] Grand Court Decision, [102].

[22] Grand Court Decision, [103(b)].

[23] Grand Court Decision, [103(c)].

[24] Grant Court Decision, [103(c)], citing Introduction to Company Law (OUP, 2020) at page 282.

[25] Grant Court Decision, [105(b)].

[26] Grand Court Decision, [105(c)].

[27] Grand Court Decision, [106].

[28] China Shanshui Cement Group Limited v Tianrui (International) Holding Company Limited (Unrep, CICA, CACV 11 of 2021, July 2022) (CICA Decision).

[29] CICA Decision, [51].

[30] CICA Decision, [52].

[31] CICA Decision, [44]-[45].

[32] CICA Decision, [46].

[33] Privy Council Judgment, [4].

[34] Privy Council Judgment, [39]-[40].

[35] Privy Council Judgment, [41].

[36] Privy Council Judgment, [65].

[37] Privy Council Judgment, [68]-[83].