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Minority shareholders, emerging markets and initial public offerings - International Law Office

International Law Office

Company & Commercial - British Virgin Islands

Minority shareholders, emerging markets and initial public offerings

November 01 2010

Common law and general statutory protection
Looking ahead


One of the most important issues in relation to a company being accepted for listing purposes on international stock exchanges is that of shareholder protection. Some stock exchanges take this far more seriously than others. For example, while BVI companies have always been listed on stock exchanges in New York (both NYSE and NASDAQ), London, Oslo, Singapore and Toronto, until recently a listing on the Hong Kong Stock Exchange was not a possibility for a BVI company. One of the reasons given was that statutory protection for minority shareholders of BVI companies was less robust than necessary.

It is probably fair to say that in the past, one of the shortcomings of BVI corporate statutes was that protection of the rights of minority shareholders required more emphasis. Apart from protective provisions that the shareholders would (and often did) put into the memorandum and articles of association of the relevant company and protection afforded at common law, the statute gave relatively little comfort to minority shareholders. This gap in the law has now been filled.

Common law and general statutory protection

Until recently, the main protection for minority shareholders was the common law principle known as 'the rule in Foss v Harbottle'. This decision set out, among other things, the exceptions to the principle of majority rule.

A basic protection is now available to minority shareholders under the BVI Business Companies Act, 2004 (as amended), with the requirement that:

"subject to the memorandum or articles of association, any sale, transfer, lease, exchange or other disposition, other than a mortgage, charge or other encumbrance or the enforcement thereof, of more than 50 per cent in value of the assets of the company, other than a transfer pursuant to the power of the directors to transfer assets for the protection of such assets, if not made in the usual or regular course of the business carried on by the company, shall be approved not only by a resolution of directors but also by a resolution of shareholders."

In addition, the act provides that any member of a company is entitled to payment of the fair value of its shares upon dissenting from several types of transaction (eg, mergers, arrangements) which can collectively be referred to as corporate reconstructions.

Owing to the way that the act is drafted, there are real opportunities for writing bespoke protective provisions into the company's constitution. However, the main protection for minorities lies in certain remedies that are set out in the act.

Specific members' remedies
Pursuant to the act, the court has the power, on the application of a member or a director of the company, to make an order directing the company or director to comply with, or restraining the company or director from engaging in, conduct that would contravene the act or the company's memorandum or articles. This applies in a context where a company or a director engages in (or proposes to engage in) conduct that contravenes the act or the memorandum or articles.

The wording of the act suggests that the court may at any time (whether before or after the contravening action is taken) make an order either preventing the action or ordering that the action be stopped.

There is provision in the act to the effect that no action of the company is invalid by reason only that the company did not have the capacity to perform the action. While this could be read as a limitation on the ability to restrain the company from contravening the memorandum or articles, a better interpretation is that, notwithstanding the fact that a company's action is not invalid for lack of capacity only, such a lack of capacity on the part of the company may be pleaded (eg, by a shareholder) in connection with an application to restrain the company.

The court may make, at any time before the final determination of such an application, as an interim order, any order that it could make as a final order and has the power to order such consequential relief as it thinks fit. Such relief, presumably, might include compensation to parties deprived of benefits by the restraining orders. No doubt the BVI courts will, in due course, give guidance on the principles underlying statutory injunctions under BVI law.

Statutory derivative actions
Statutory derivative actions have not yet been tested by the BVI courts, but there is a clear intent that derivative actions should be brought only under the act and, accordingly, the common law right of the minority to sue derivatively under the exceptions to Foss v Harbottle appears to be of historical interest only.

This is the case in relation to so-called 'single' derivative actions only; so far as 'double' or 'multiple' derivative actions are concerned, the common law continues to apply. A distinction should be drawn between these two types of derivative action. Single derivative actions (or classic derivative actions) are those in which a member of a company that feels that a wrong has been done to the company may sue the person allegedly responsible on the company's behalf. Double (or multiple) actions involve a member of a parent company taking legal action on behalf of a subsidiary company in respect of wrongs committed against the subsidiary. Specific provision is made in the act for the former, but no mention is made of the latter. As such, while the common law right to sue derivatively under the exceptions to Foss v Harbottle has apparently been abolished with respect to single derivative actions, the common law continues to apply in relation to double/multiple derivative actions. This was confirmed in the Hong Kong decision of Waddington v Chan Chun Hoo Thomas (FACV 15/2007).

Commencing derivative actions
In terms of the statutory procedure for commencing a derivative action, the starting point is that an application to the court must be by a member, and is an application for leave to that member to bring proceedings in the name and on behalf of the company (or to intervene in the proceedings to which the company is a party for the purpose of continuing, defending or discontinuing the proceedings on behalf of the company). Accordingly, the application for leave will presumably be via interlocutory proceedings.

In determining whether to grant leave, the court must take into account several factors as follows:

  • whether the member is acting in good faith;
  • whether the derivative action is in the interest of the company, taking account of the views of the company's directors on commercial matters;
  • whether the proceedings are likely to succeed;
  • the cost of the proceedings in relation to the relief likely to be obtained; and
  • whether an alternative remedy to the derivative claim is available.

In order to grant leave, the court will further need to be satisfied that either:

  • the company does not intend to bring, diligently continue or defend, or discontinue the proceedings, as the case may be; or
  • it is in the interests of the company that the conduct of the proceedings should not be left to the directors or to the determination of the shareholders or members as a whole.

This provision is worded so that one factor or the other applies, but not necessarily both.

Furthermore, unless the court otherwise orders, 28 days' notice of the application for leave must be served on the company, which may appear and be heard. Ex parte applications will not be available, but the BVI courts may accept in an appropriate (and perhaps extreme) case that less notice might be required. The absence of BVI decisions means that the position is not crystal clear.

Other considerations
In terms of costs of the derivative action, where the court grants leave to a member to bring or intervene in derivative proceedings, it must (on the application of the member) order that the whole of the reasonable costs of bringing or intervening in the proceedings be met by the company. The only exception is where the court considers that it would be unjust or inequitable for the company to bear those costs.

Within certain procedural and legal confines, the manner in which litigation is conducted is normally up to the parties. However, the act provides that at any time after granting leave, the court may make an order it considers appropriate in relation to proceedings brought by the member or in which the member intervenes. The court therefore continues to have control over the matter, to ensure that it is conducted in the interests of the company. The same control by the court applies in relation to settlement, discontinuing or compromise of proceedings.

A shareholder may bring an action against a company for breach of a duty owed by the company to it as a member. Unfortunately, the act does not indicate what duties are owed, so common law subsists in this area.

A member that considers that the affairs of the company have been, are being or are likely to be conducted in a manner that is likely to be oppressive, unfairly discriminatory, or unfairly prejudicial to it in that capacity may apply to the court for an order. If on an application the court considers it just and equitable, it may make an order as it thinks fit.

Where a member of a company brings proceedings against the company and other members have the same or substantially the same interest in relation to the proceedings, the court may appoint that member to represent all or some of the members having the same interest, and may for that purpose make such order as it thinks fit, including an order:

  • as to the control and conduct of the proceedings;
  • as to the costs of the proceedings; and
  • directing the distribution of any amount ordered to be paid by a defendant in the proceedings among the members represented.

This is the so-called representative action.

Looking ahead

With these statutory provisions, BVI companies have come of age and the British Virgin Islands has convincingly addressed the criticism that its laws left the minority out in the cold. This has been recognised by the Hong Kong Stock Exchange, which recently approved the listing of BVI companies on the exchange. Indeed, for listing purposes, there is little distinction today between using an SPV domiciled in the British Virgin Islands or the Cayman Islands; the differences are limited to, in the case of the British Virgin Islands, faster incorporation and being generally more cost efficient.

However, the game continues to change. The main challenge for BVI or Cayman Islands holding companies now lies in the constraints (some justifiable) applied by so-called emerging market jurisdictions. Across the world several jurisdictions are, in different ways, tightening up on the use of offshore structures in international finance transactions. One of the latest and perhaps most prominent examples is the judgment of the Indian High Court in the Vodafone case. In its simplest terms, this involved a sale of shares in a non-Indian company (which very indirectly owned an Indian company) by a non-Indian company to a non-Indian company, and the issues surrounded capital gains tax and withholding tax. The end result (so far) is that Vodafone must pay about $2 billion in capital gains tax. It is said that the Indian authorities are also scrutinising the tax aspects of several other cross-border deals.

Meanwhile, in China, the so called Circular 10, in no way related to the Vodafone case, purports to control 'round tripping' by making it a requirement that certain approvals be obtained from various Chinese governmental bodies in the context of a Chinese company that is typically either:

  • seeking a listing on a non-Chinese stock exchange by using an offshore company; or
  • merging into an offshore company.

Notwithstanding Circular 10 (and the likes of Vodafone), offshore vehicles continue to be used by Chinese operating companies for initial public offerings, and several interesting structures have been devised to address the constraints of the Chinese rules. While the structures used in this context have met with market approval, the more interesting point is that Chinese business owners and Chinese companies continue to use offshore vehicles, notwithstanding restrictions imposed by their governments.

At its simplest level, it has to do with the restrictive nature of their capital markets on the one hand and the flexibility afforded by using BVI and Cayman holding companies on the other. It may be that vehicles in tax treaty jurisdictions, such as Cyprus and Mauritius, have a positive role to play, given the tightening up by emerging market countries. Yet special purpose vehicles, whether based in tax treaty countries or in 'pure' offshore jurisdictions, are tools that can be usefully deployed as part of the mix within a financial system.

Too much regulation will cause a system eventually to break down. Like all things organic, it needs outlets. Therefore there is a role for such companies helping countries the world over to achieve that balance.

For further information on this topic please contact Leonard A Birmingham at Harney Westwood & Riegels by telephone (+44 20 7842 6080), fax (+44 20 7353 0487) or email (leonard.birmingham@harneys.com).

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