Short-form mergers: the final word in Changyou

In its eagerly awaited judgment, the Judicial Committee of the Privy Council has confirmed that dissent rights are available to minority shareholders in Cayman Islands companies that effect short-form mergers under the Companies Act.

The Privy Council upheld the Cayman Islands Court of Appeal's decision that to deny minority shareholders dissent rights would be inconsistent with the legislative purpose of the appraisal regime afforded by section 238 of the Cayman Companies Act and would violate a shareholder's constitutional right to peaceful enjoyment of their property.

This is a landmark victory for minority shareholders which will have a significant impact on the merger and acquisition landscape in the Cayman Islands.

Changyou's position

Changyou.com Limited (Changyou) is a Cayman Islands incorporated company operating in China. In 2020, it merged with its parent company and de-listed from the NASDAQ, effectively forcing out the minority shareholders.

Certain shareholders gave notice of their objection to, and dissent from, the merger. Changyou contended that appraisal rights were not available to the dissenting shareholders, as the merger was "short-form" – the parent held over 90% of the voting power in the subsidiary. As no shareholder vote is required for short-form mergers, and the operative provisions of the appraisal provisions in section 238 are premised on there being such a vote, Changyou maintained that dissent rights were not available.

The Grand Court and Court of Appeal's decisions

The point was first determined as a preliminary issue in favour of the dissenters at first instance by the then-Chief Justice Smellie QC. For more information on this decision by the Grand Court, read: Short-form mergers: appraisal rights confirmed in the Cayman Islands in Changyou judgment

On appeal, the Cayman Islands Court of Appeal held the Cayman Companies Act did not provide for dissent rights in short-form mergers when applying ordinary principals of statutory construction. However, the court considered that this produced an absurd result arising from an obvious drafting error. In applying a greater degree of interpretative latitude when construing the Companies Act for compatibility with the Constitution, the court found that section 238 must be read in such a way as to give effect to the constitutional right of minority shareholders not to be deprived of the right to peaceful enjoyment of their property without compensation.

For more detail on the alternative way in which the Court of Appeal read down the operative provisions of section 238 to comply with the Constitution, read: Appraisal rights confirmed in Cayman Islands short-form mergers

The Privy Council's decision  

The Privy Council first looked to statutory construction principles. It agreed with the Court of Appeal that although the relevant operative provisions of section 238 do not apply to the short-form merger procedure, this plainly arose from a drafting oversight. It was not the intention of the legislature to deny appraisal rights to shareholders in short-form mergers.

However, this drafting mistake could not be corrected by applying ordinary principles of statutory construction because it was not obvious how the legislature would have adapted the operative provisions of section 238 to short-form mergers. Consequently, any judicial rectification of the drafting error would impermissibly cross the line between interpretation and legislation.

The Privy Council then considered whether, as drafted, section 238 was incompatible with the constitutional right to peaceful enjoyment of property under section 15 of the Bill of Rights contained in the Constitution. Section 15 provides that the "Government shall not interfere in the peaceful enjoyment of any person’s property and shall not compulsorily take possession of any person’s property, or compulsorily acquire an interest in or right over any person’s property of any description".  

The Privy Council found that section 15 applied to appraisal rights in short-form mergers, as:

• permitting the compulsory acquisition of shares in short-form mergers constitutes "just as much an interference" with a shareholder's peaceful enjoyment of property as if the government had taken the shares directly
• acquiring shares at a time when legislation already provided for the possibility of those shares being compulsorily acquired did not prevent a short-form merger from constituting an interference with peaceful enjoyment of property
• none of the carve-outs to section 15 applied

Having found that section 15 of the Bill of Rights was engaged, the Privy Council considered whether section 238 of the Companies Act was an "existing law" before section 15 came into effect on 6 November 2009. If it were an existing law, section 238 would need to be read and construed with such modifications, adaptations, qualifications, and exceptions as may be necessary to conform with the Constitution. If it was not an existing law, the court would be restricted to giving a declaration of incompatibility, requiring the legislature to decide how to remedy the incompatibility.

The Privy Council determined that, even though there had been amendments to parts of the Companies Act since section 15 of the Bill of Rights had come into effect, there had not been any material amendments to the provisions of section 238 during this time. The Privy Council therefore concluded that section 238 was an existing law and affirmed the Court of Appeal's earlier modifications to the operative provisions of section 238 to give effect to the exercise of dissent rights by minority shareholders in short-form mergers. Download a summary of this modified statutory process for short-form mergers: Section 238 process timeline

Conclusion

This well-reasoned judgment provides a conclusive end to the debate over whether minority shareholders in short-form mergers have dissent rights and confirms that such rights are available regardless of whether there is a shareholder vote or not.

Instead of objecting prior to a shareholder vote, minority shareholders seeking to dissent from short-form mergers must instead provide written notice of objection immediately after the plan of merger is given to them. Due to the uncertainty surrounding what "immediately" means in this context, prospective dissenters should urgently consult with their legal advisors upon receiving any plan of merger to ensure that they meet the modified statutory requirements.

Finally, the introduction of a straight-forward test for determining whether a law is an "existing law" for the purposes of the Bill of Rights, namely whether there have been any material amendments to the provisions in question since November 2009, is a welcomed development for constitutional interpretation in the Cayman Islands.

How Ogier can help

Ogier is one of the leading shareholder appraisal firms in the Cayman Islands.  For more information on this topic, contact your usual Ogier contact or one of the authors of this article.

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