Privy Council rules on “fair value” in Cayman mergers
31 January 2020
In a decision of interest to shareholders and companies alike, the highest appeal court (“JCPC”) for Cayman Islands (“Cayman”) cases has delivered a judgment on how the Cayman Grand Court (“Court”) should determine the “fair value” of shares (stocks) when a Cayman company is involved in a consolidation or merger.
How does the regime work?
Mergers and consolidations involving at least one Cayman company are governed by a statutory regime under Part XVI of the Cayman Companies Law (2013 revision) (“Law”). The regime protects those shareholders who do not have control of the company to ensure they get a “fair value” for their shares. The regime applies where the shares in question are not available on the open market on a recognised stock exchange or recognised interdealer quotation system.
Who decides what is “fair value”?
Under sections 238 and 239 (“s.238”) of the Law, dissenting shareholders (“Dissenters”) have the right to apply to the Cayman Grand Court (“Court”) to have it determine what is a “fair value” for their shares. That section also gives Dissenters a right to interest payments on money outstanding at a “fair rate” and to ask the Court to determine if interest is payable and at what rate.
What did the JCPC decide?
The JCPC (the Judicial Committee of the Privy Council) held that the value of Dissenter’s shareholdings should not be by pro-rata valuation (dividing the value of the company by the number of shares (“Per-share”)). This was a line of reasoning which followed decisions in the US State of Delaware. Instead JCPC held that the Court should set a value of the minority shareholding taken as a whole and then apply a discount to reflect that the shares do not give control of the company. Then an allocation can be made to Dissenters based on the number of shares they hold.
Why apply the minority discount?
The JCPC found that s.238 requires “fair value” for the Dissenters shares should reflect the status of the shares. If they form a minority shareholding, those shares must be valued as such and not on a pro rata/Per Share basis. Without any indication to the contrary or special circumstances, the Court should value the actual shareholding which the shareholder has to sell and not some hypothetical share. This is because in a merger, the party offering to buy the shares does not acquire control from any individual minority.
Must it always be applied?
The JCPC was not convinced it could be applied as a blind rule. The Cayman legislature’s direction in the Law was that the Court should find the “fair value” of the Dissenter’s shareholding. The JCPC considered that it could not rule out the possibility that there might be a case where a minority discount was inappropriate due to the particular valuation exercise under consideration.
How should the Court set the “fair rate” of interest?
At the first hearing, the judge exercised his discretion to set the “fair rate” of interest by taking the midway point between a rate of interest representing the return on the unpaid valuation monies that a prudent investor could have made and the rate of interest that the company would have had to pay to borrow the equivalent sum. The JCPC rejected arguments that the discretion was wrongly exercised and that the fair rate should have been the borrowing costs. The argument was that the rate of interest should have been a rate to put the shareholder in the position that they would have been in had the shares been valued correctly at the appropriate time. The JCPC considered the arguments put before the judge and found the exercise of his discretion was not open to challenge.
Why does this matter?
There have been many s.238 “fair value” claims in the Cayman courts in recent years and so it is useful for shareholders and companies to have a definitive decision from the JCPC on how “fair value” should be calculated in the majority of cases, and what it considers would be an appropriate way for judges in the Court to decide a “fair rate” of interest.