Rights of minority shareholders and investors: guidance from Tianrui v China Shanshui

In Tianrui (International) Holding Co Ltd v China Shanshui Cement Group Ltd [2024] UKPC 36, the Judicial Committee of the Privy Council considered whether a minority shareholder had a personal claim – a private right – against the company as a result of the directors of the company issuing shares for an improper purpose.   The Privy Council was sitting as the final court of appeal for the Cayman Islands.

The assumed facts

There had been a prolonged battle for control of the respondent, China Shanshui Cement Group Ltd.  China Shanshui is a Cayman Islands exempted company that is listed on the Hong Kong Stock Exchange (“HKSE“).  It’s a holding company for operating subsidiaries registered in Hong Kong and mainland China.  The group is involved in the supply and distribution of cement.

There are four principal shareholders and one of those is the appellant, Tianrui (International) Holding Co Ltd.  Those four are competitors in the cement production industry in China, and China Shanshui is in part at least a joint venture between them.

In October 2017, the HKSE gave notice that China Shanshui would be delisted unless it restored its public float to a level above the 25% minimum required by the HKSE, needing to do so by the end of October 2018.

In August and September 2018, China Shanshui issued convertible bonds in two tranches to eight subscribers so as to raise US $531.6 million in new capital, with the primary purpose of repaying US $500 million in loan notes that were repayable in March 2020 but which were repaid in November 2018.

In between the two convertible bond issuances, Tianrui filed a petition to wind up China Shanshui on the basis that it was just and equitable to do so.  One of the complaints was that the shares to be allotted on conversion to the convertible bond holders would not be issued for a proper purpose.  That purpose, it was alleged by Tianrui, was to dilute Tianrui below a 25% shareholding so that it could no longer block a special resolution and as a result no longer block a merger of China Shanshui with another company and with it a compulsory acquisition of Tianrui’s shares.

In October 2018, China Shanshui agreed to the accelerated conversion of most of the convertible bonds at a discounted conversion price.  The new shares were issued and the China Shanshui public float was restored to a level above 25%.  Trading in China Shanshui’s shares on the HKSE resumed the following day.

China Shanshui sought to strike out Tianrui’s application on the basis that it did not have standing to make claims amounting to alleged breaches of fiduciary duties owned by the directors of China Shanshui to China Shanshui and not to Tianrui.

Grand Court, Court of Appeal and Gao

The Grand Court originally found in favour of Tianrui and held that Tianrui did have legal standing to bring a personal claim against China Shanshui.

The Court of Appeal in the Cayman Islands (“CACI”) then proceeded to overturn the decision of the Grand Court and struck out Tianrui’s claim on the basis that it had failed to establish the basis on which a shareholder has a personal right to complain of a dilution of its voting power caused by an issue of shares effected in breach of the directors’ fiduciary duties (those duties being owed to the company and not to the shareholders).

Privy Council

The Privy Council overturned the decision of the CACI and allowed the Tianrui’s claim to continue.

The Council, and the Grand Court originally, overturned the decision in Gao v China Biological Products Holding Incorporated. Gao had held that individual minority shareholders ordinarily have no right or legal standing to bring a personal claim for breach of a director’s fiduciary duty to allot and issue shares for an improper purpose.

Although seemingly a novel point of law in the Cayman Islands, there is a body of law in other common law jurisdictions (including England and Wales and Australia) that a shareholder may have a direct claim against a company if that company’s directors issue its shares for an improper purpose.  Nevertheless, the legal basis for such a claim had not previously been examined in detail.

In its judgment, the Privy Council confirms that the basis of the claim lies in the law of contract.  The constitutional documents of a company – the articles of association in the case of a UK company – contain an implied term that the directors of the company – acting as its agents – will exercise the company’s powers to issue shares only for a proper purpose.

If shares are issued for an improper purpose, two separate claims may result:

1. A claim by the company against the directors for breach of their fiduciary duties.
2. A claim by the affected shareholders against the company itself as a result of the breach of that implied term of the constitution.

What the judgment also confirmed is that an issuance for an improper purpose can be ratified by way of a resolution of the shareholders, and so by the majority.  However, the majority must not use that power to commit a “fraud on the minority” and the minority may in such cases claim unfair prejudice.

Key takeaways

1. Although the decision relates to Cayman Law, the courts in England and Wales are likely to follow it and it will be of significant persuasive authority.
2. Now that the basis of the personal claim of the shareholder against the company has been further established as arising from breach of contract, it is now clear as to what the available remedies might be (breach of contract after proving losses and causation; pre-emptive injunctions to prevent issuances taking place; etc).
3. As ever, the decision highlights the importance of producing well-drafted and comprehensive board minutes. In particular, the minutes should outline the purpose for which shares are being issued.
4. The judgment does not set out a perimeter for ‘proper purpose’, but it can be assumed that raising capital on arm’s length commercial terms will be within it absent other factors from which impropriety can be established.
5. For edge cases, if there is a doubt as to the proper purpose, the directors should consider having their decision ratified by the shareholders.  They will need to understand that although ratification by the majority may defeat the claim for breach of contract against the company, the minority may then advance claims of a fraud against it or of unfair prejudice or both.
6. The importance of statutory duties should be kept at the forefront of directors’ minds when taking any action relating to the company they serve and the purpose of such actions.  In the case of venture- and private-equity-backed companies, thought should be given in particular to the position of investor directors who are appointed by particular investor shareholders.
7. The case concerned in part shares issued upon conversion of certain bonds.  A feature of convertible debt on venture capital transactions is that it typically does not come with a ‘floor’ price for a conversion that is triggered by the occurrence of the next ‘priced’ funding round.  If the price of that round is very low, the debt may convert in such a way so as to wipe out the existing shareholders and leave them with de minimis percentage shareholdings.  Even so, in the ordinary course the conversion mechanics are baked into the terms of the convertible instrument, which was itself entered into to raise capital, and so arguably that is a proper purpose even if the dilutive result ends up being somewhat perverse.  But aggrieved shareholders in that scenario might well be going back to this case of Tianrui v China Shanshui for guidance.

This Insight piece was written by Henry Humphreys with input from Sanya Bhambhani.  If you have questions or queries about the judgment, or as regards corporate or company law questions generally, do reach out to Henry or another member of the team.

All the thoughts and commentary that HLaw publishes on this website, including those set out above, are subject to the terms and conditions of use of this website.  None of the above constitutes legal advice and is not to be relied upon.  Much of the above will no doubt fall out of date and conflict with future law and practice one day.  None of the above should be relied upon.  Always seek your own independent professional advice.

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