In this article, José-Antonio Maurellet SC and Michael Lok consider how a recent authority of the Judicial Committee of the Privy Council revisits the right of minority shareholders in a company to bring a personal claim against a company when directors allotted shares for an improper purpose.
The Dispute
This case concerns a prolonged battle between shareholders – who themselves are competitors in the cement industry – for control over the Respondent company, China Shanshui Cement Group Ltd (“CSCGL”). CSCGL is a Cayman Islands exempted company that is also registered in Hong Kong as a non-Hong Kong company (§6). The principal shareholders of CSCGL are as follows (§7):
- Appellant Company (“Tianrui”): 28.16%;
- Asia Cement Corporation (“ACC”): 26.72%;
- China National Building Materials Co Ltd (“CNBM”):16.67%;
- China Shanshui Investment Company Ltd (“CSI”): 25.09%.
On 23.10.2017, CSCGL faced the risk of being delisted by the Hong Kong Stock Exchange, unless its public float could be restored above the 25% minimum threshold by 31.10.2018 (§9). A reconstituted board of directors, containing 1 director each from ACC and CNBM, approved the issuance of 2 tranches of convertible bonds (§§10,11). These were later converted into shares in CSCGL by various subscribers. This in effect diluted Tianrui’s shareholding to under 25%, such that they can no longer block special resolutions (§16).
- CSCGL’s case is that the reconstitution of a new board of directors and the allotment of convertible bonds, was for the purpose of restoring CSCGL to a public float of 25% (§9).
- However, Tianrui said this was not the whole story (§16). In fact, there was a secret concert agreement between ACC and CNBM to dilute Tianrui’s shareholdings and take over CSCG. This is so that they could together expand their cement production capacity and bypass relevant regulations (§17).
Key Issue – Standing of Shareholders
The JCPC opined that the CA was wrong to strike out Tianrui’s claim on the basis that Tianrui lacked standing (§§5,22,23,66). In principle, shareholders should be able to bring personal claims against the company.
Although common law jurisprudence supports such view, there is no principled basis (if any) on which those cases were decided (§27).
The key questions to be answered by the JCPC are therefore, (1) what the cause of action for minority shareholders is, and (2) how we can surpass the rule in Foss v Harbottle1 (§29).
Analysis of the Position in Cayman Islands
There are no statutory personal remedies for aggrieved shareholders in the Cayman Islands. They can only bring derivative actions Order 15, rule 12A of the Grand Court Rules (§39). Since Gao2, it is clear that a shareholder lacks standing to challenge the allotment and issue of shares to others. The JCPC opined that this was wrong.
- The starting point is the rule in Foss v Harbottle, which is made up of 2 subrules, i.e. (1) proper plaintiff rule (a wrong has been done to a company so only the company can take action) and (2) majority rule (if the majority of a company does not want to take action against directors who have breached their duties, they could either waive the breach or ratify them) (§36), operates under the presence of an ill-defined exception, i.e. the “fraud on the minority” exception (which allows shareholders to bring a derivative action seeking relief on behalf of the company in whom the cause of action is vested) (§37).
- However, a review of common law jurisprudence (UK and Australia in particular) suggests that this is only part of the picture (§40). Shareholders do have rights to bring personal actions in their own names against the company, by way of challenging the validity of shares allotted for an improper purpose (§65).
Unfortunately, case law has not clarified why this is so. The following attempts to rationalise long lines of authorities show that there is no principled basis on their juridical basis (i.e. cause of action):
- There are cases (i) where the shareholders’ rights were directly impugned by ultra vires acts of the directors (Pender v Lushington3; Edwards v Halliwell4); and (ii) those where shareholders’ rights were invaded due to an intra vires act exercised for an improper purpose (Hindle v John Cotton5; Re Smith and Fawcett Ltd6; Eclairs Group Ltd v JKX Oil & Gas plc7).
- There are also cases suggesting that directors are not entitled to issue shares just to alter rights of parties under the articles, as this constitutes an improper purpose (Fraser v Whalley8; Punt v Symons & Co Ltd9; Piercy v S Mills & Co Ltd10) (§48).
- However, even in the landmark decision of Howard Smith11, where the directors acted intra vires for an improper purpose and hence the decision was avoided – the issue of the standing of the plaintiff shareholder (Ampol) was not addressed (§55).
It would therefore seem to be that the juridical basis for those cases where shareholders have personal claims against their companies remain somewhat unclear and which may benefit from a more principled justification.
- That said, a common thread underpinning these claims is that all these cases do not involve the removal or restriction of rights attached to shares (§44). The present case is thus considered to be distinguished from these long lines of authorities.
- The detriment to Tianrui shareholders pertained to their ability to exercise their proportionate voting power, which resulted from the improper allotment and issue of new shares to other parties (§44) – not on rights attached to their existing shareholdings.
Legal Basis of the Shareholder’s Personal Action
The JCPC opined that the underlying corporate contract between directors as agents of the company, and shareholders, is key (§70).
- A shareholder’s rights and value depend on the fortunes of the company (§67). The active power of a shareholder is critically dependent upon the proportion which his/her share bears to the other shares in the company. A dilution of their shareholdings critically affects the balance of power between all shareholders (§68).
- The directors’ power is a fiduciary duty regulated by a corporate contract constituted by the articles of association. If the existing shareholding is to be upset, it must only be done by a proper exercise of such powers. In other words, it must be exercised bona fide for the benefit of the whole company (§71).
- Otherwise, there would be an adverse alteration in the balance of power in the company, causing disproportionate harm to the value of rights embedded in that particular shareholder’s shares (§72).
- It is an actionable harm because the impropriety in the exercise of the power contravenes the corporate contract binding him and the company, even though the relevant fiduciary duty breached by the directors is not owed to him (§72).
In the meantime, the following clarifications by the JCPC are also worth noting:
- It is irrelevant whether or not the company itself has a cause of action against the directors for the breach of the fiduciary duty owed to it, as they are not mutually exclusive actions. The same breach of duty can harm different parties (§79).
- The mere presence of a theoretical possibility of ratification of improper acts is insufficient to deprive the claimant shareholder of a cause of action (§§81, 84). This is because whether the ratification itself would be successful is at issue (as in Hogg12 and Bamford13) (§§81-82); or that the nature of the breach of directors’ duties is so grave that it could not be ratified (Residues14, where the directors assisted the existing majority to oppress the minority) §83).
Outcome
The JCPC advised that the writ should not have been struck out by the CA (§87):
- If it is true that the directors issued and allotted the disputed shares for an improper purpose of diluting Tianrui’s shareholdings; the purported ratification of such would be vitiated by the intent of the majority to oppress Tianrui, the minority shareholder (§86).
- Equally, if there exists a concert party between the majority and recipients of the disputed shares, the recipients, once identified by discovery and joined as defendants, would unlikely be able to resist the setting aside of allotments on the basis that they are bona fide purchasers without notice of the impropriety (§86).
Key Takeaways
- The legal basis for shareholders’ personal claims rests in the corporate contract (articles of association), which implicitly requires directors’ powers to be exercised properly.
- A breach of this requirement creates an actionable harm to shareholders, even though directors’ fiduciary duties are owed to the company, not individual shareholders.
Co-Authors:
José-Antonio Maurellet SC (Barrister, Des Voeux Chambers Hong Kong; associate member, 3 Verulam Buildings London), Registered Foreign Lawyer (SICC)
Michael Lok (Barrister, Des Voeux Chambers Hong Kong; associate member, South Square London), Registered Foreign Lawyer (SICC)
Link to the Judgment: https://www.bailii.org/uk/cases/UKPC/2024/36.pdf
[1] (1843) 2 Hare 461
[2] 2018 (2) CILR 591
[3] (1877) 6 Ch D 70
[4] [1950] 2 All ER 1064
[5] (1919) 56 ScLR 625
[6] [1942] Ch 304
[7] [2015] UKSC 71
[8] (1864) 2H & M10
[9] [1903] 2 Ch 506
[10] [1920] 1 Ch 77
[11] [1974] AC 821
[12] [1967] Ch 254
[13] [1970] Ch 212
[14] (1988) 6 ACLC 1160
