Shareholder Remedies: Tianrui (International) Holding Company Ltd v China Shanshui Cement Group Ltd
The recent judgment of the Privy Council in Tianrui (International) Holding Company Ltd v China Shanshui Cement Group Ltd1 is an important decision for company boards and shareholders. It confirms the circumstances in which a shareholder, including a minority shareholder, can bring a personal claim against a company where directors of the company allot shares for the improper purpose of diluting its shareholding.
Background
China Shanshui Cement Group Ltd (CSCG), a Cayman Islands company listed on the Hong Kong Stock Exchange (HKSE), had been the subject of a long-standing battle of control involving its principal shareholders, including Tianrui Holding Company Ltd (Tianrui), a British Virgin Islands company with a 28.16% shareholding in CSCG.
Following CSCG's suspension from the HKSE in April 2015, having fallen below the 25% minimum float threshold required, CSCG issued two tranches of convertible bonds for a total value of HKD531,600,000. Shortly thereafter, CSCG passed a resolution by majority to allot and issue new shares to the bondholders, restoring the public float to 25% and allowing them to trade on the HKSE.
Tianrui alleged that the bondholders were connected to Asia Cement Corporation and China National Building Materials Co Ltd, other shareholders of CSCG, and that the allotment and issue of new shares was an improper exercise carried out to enable them to take over the voting control of CSCG, diluting Tianrui's shareholding to 21.85%. Consequently, Tianrui could no longer block special resolutions.
Tianrui sought declarations against CSCG that the exercise of the directors' actions in: (i) issuing the convertible bonds, (ii) converting the bonds into shares; and (iii) issuing the new shares, were not a valid exercise of their powers. CSCG argued that Tianrui did not have standing to claim for breaches of fiduciary duties owed to CSCG, arguing that the claim should have been brought by way of a derivative action following the rule in Foss v Harbottle2, which provides that the proper claimant for a wrong done to the shareholders is the company.
At first instance, Segal J, sitting in the Cayman Grand Court, agreed with Tianrui and held that a minority shareholder could bring a personal claim against the company, with a declaration that the allotment and issue of the shares was unlawful, despite the existence of a derivative action as a potential remedy.
CSCG appealed. The Cayman Court of Appeal held that a shareholder had no personal right of action against the company for the dilution of its shares caused by a breach of fiduciary duties owed to the company, and that a claimant should follow the rule in Foss v Harbottle3. Tianrui appealed to the Privy Council.
Judgment
The appeal was allowed. The Privy Council held that an aggrieved shareholder has a right of action against the company to challenge the allotment of shares by directors where the allotment was made for an improper purpose to that shareholder's detriment.
The Court held that there is an implied term in the memorandum and articles of association of a company that, when directors exercise powers on behalf of the company, they must do so in accordance with their fiduciary duties; namely, to exercise powers for a proper purpose. The Court explained that there is a contract between the company and its members to observe the conditions in the memorandum and articles of association. As part of this contract, directors must allot and issue shares, as part of their fiduciary duties, for a proper purpose. If directors deliberately alter the balance of power between shareholders, exercising their power for an improper purpose, this alteration of power and the harm that does to the value of the rights embedded in a members shares becomes an actionable harm - the impropriety in the exercise of power contravenes the corporate contract binding the shareholder and the company.
Lord Hodge and Lord Bridge identified this as an "important part of the contract between shareholders and the company", irrespective of the size of an individual's shareholding. The judges emphasised that it does not matter whether the company itself has a cause of action against the directors, and that it is perfectly possible for a shareholder action and an action by the company to co-exist.
Consideration was given to the rule in Foss v Harbottle, particularly the prevailing uncertainties and "ill-defined" boundaries in bringing a derivative claim. The Court recognised the difficulties presented where members are suing to protect their own rights, rather than the rights of the company. The Privy Council considered the long recognition of shareholders' personal rights against the company in other jurisdictions, including challenges to the validity of the allotment of shares based on directors acting for an improper purpose.
While the Privy Council acknowledged that such claims may be defeated by ratification of the allotment by a majority of shareholders, it held that a shareholder will not be deprived of a claim merely because of a "theoretical possibility of ratification in the future" or where the majority uses that power to oppress the minority.
The Privy Council made clear that an improper allotment alone will not suffice. The shareholder will need to show that there has been "interference with their rights as shareholders brought about by the improper issue and allotment" eg an allotment diminished its effective voting power.
Key points to note
Whilst the decision is relevant for Cayman companies and their shareholders (because Cayman law does not contain a statutory regime for unfair prejudice/shareholder oppression), it also provides important clarification for English and other commonwealth companies and their shareholders.
In particular, it is now clear that a shareholder's principal cause of action following an interference with its rights, caused by an improper allotment of shares, is a direct contractual claim against the company for breach of the implied term that the directors (as agents of the company) will exercise their power to allot and issue shares in accordance with their fiduciary duties. Accordingly, the usual array of remedies to address contractual breaches will apply to such a claim, including seeking declarations regarding an improper allotment, injuncting an improper allotment before it is made, and seeking damages flowing from an improper allotment.
The contractual claim is separate to a derivative claim brought by a shareholder in the name of the company following a breach of directors' duties owed by the directors to the company to exercise their duties for a proper purpose. The contractual and derivative claims can coexist and, in theory, can be brought in parallel.
Direct contractual claims and derivative breach of duty claims have significantly different features, procedural requirements, and the scope for a shareholder to recover its losses may differ depending on the claim available. Whilst each case will turn on its own facts, the ability for shareholders to bring both types of claims against a company expands (potentially significantly) their ability to recover losses.
Whilst the decision in Tianrui concerns the improper allotment of shares, it could apply to other situations where directors exercise their powers improperly in a way which infringes shareholder rights. The scope of the implied term in the articles of association will no doubt be tested in future cases.
Finally, the decision emphasises the importance of boards giving careful attention to allotments that may result in a dilution or loss of voting power for one or more shareholders, including recording the reasons for the share allocation in board minutes. Further, boards should consider seeking legal advice and (where appropriate) obtaining shareholder approval before the allotment.
The DLA Piper litigation team are currently acting on a number of complex, high profile, shareholder disputes. Please do contact Charles Allin, Tom Laidler, Rosie Humphris or your regular DLA Piper contact if you would like to discuss any of the issues raised in this note.
1 [2024] UKPC 36
2 (1843) 2 Hare 461
3 (1843) 2 Hare 461
