The general trend of Chinese businesses decoupling from the Nasdaq Stock Market (NASDAQ), the New York Stock Exchange (NYSE) and the London Stock Exchange (LSE) over recent years has seen a parallel movement in the Hong Kong market with the recent privatisations of Hong Kong-listed companies incorporated in the Cayman Islands, such as Nirvana Asia Ltd, Chinalco Mining Corporation International and Belle International Holdings Limited.
The purposes of these privatisations are manifold and have included a desire for reduced public scrutiny, reduced compliance costs, additional corporate governance flexibility and the prospect of a relisting.
Whilst listed companies in the United States and the United Kingdom have increasingly utilised the statutory merger procedure available for take-private transactions under the Cayman Companies Law (as amended) (the Law) for this decoupling process, eligible companies listed on the Hong Kong Stock Exchange (HKSE) have traditionally used a scheme of arrangement in order to implement such privatisations, as in the three examples listed above. Companies, investors and practitioners alike await an opportunity to utilise a Cayman statutory merger for the privatisation of Hong Kong-listed companies, historically challenging due to the Hong Kong Securities and Futures Commission's interpretation of the Hong Kong Takeovers Code which primarily affords fair treatment for shareholders who are affected by change of control transactions.
This article seeks to outline the process of a Cayman statutory merger and consider the advantages and disadvantages of using this as a mechanism for effecting take-privates in Asia, and also explores the right of dissenting shareholders to obtain fair value for their shares.
THE CAYMAN STATUTORY MERGER - WHAT IS IT?
A Cayman statutory merger is the process by which two or more companies (each, a constituent company) merge into one of the constituent companies (the surviving company) and the legal existence of each constituent company other than the surviving company ceases. The Law defines a merger as "the merging of two or more constituent companies and the vesting of their undertaking, property and liabilities in one of such companies as the surviving company." As such, the legal effect of a merger is that the surviving company assumes all of the undertakings, property, assets, rights obligations and liabilities of every non-surviving entity. Although perhaps not a use intended by the legislature, the statutory merger process is commonly now the preferred route by which a take private transaction is effected (including by way of a management led buyout) by Chinese businesses operating through a Cayman Islands company whose shares are listed on one of the aforementioned exchanges.
SUMMARY OF PROCESS – HOW IS IT DONE?
The Law allows two or more companies (comprising at least one Cayman company limited by shares, not being a segregated portfolio company) to merge quickly and simply. Companies and investors intending to use a statutory merger to take a listed company private (usually comprising a combination of the founders or managers of the listed company, its parent and potentially private equity investors) will as an initial step typically form a new company in the Cayman Islands which can be used as the offeror vehicle, recipient of finance and ultimately merger with the target company. In order to implement a statutory merger, the following steps must be taken:
(i) The directors of each constituent company must approve a written plan of merger, which includes certain specific information regarding each constituent company and the terms of the merger (the Plan of Merger).
(ii) The Plan of Merger must be approved by:
- a special resolution of members of each constituent company, being at least a two-thirds majority of shareholders who have the right to receive notice of, attend and vote at the general shareholders' meeting, voting as one class; and
- such other authorisation, if any, specified in the constituent company's articles of association. The Plan of Merger can be pre-cleared with the Registrar.
(iii) The consent of each holder of fixed or floating security interests of a constituent company must be obtained.
(iv) The Plan of Merger (accompanied by other specified documentation as set out below) must then be filed with the Cayman Islands Registrar of Companies (the Registrar) for approval and upon payment of the applicable fee and assuming that the Registrar is satisfied that the requirements of the Law (including any change in name of the surviving company) relating to the merger have been met, the Registrar will:
- Register the plan of merger and any amendment to the memorandum or articles of association of the surviving company;
- Issue a certificate of merger within 24 to 48 hours, on an express filing basis, or, around five working days on a normal filing basis; and
- Strike-off each constituent company other than the surviving company once the merger becomes effective.
(v) The merger is effective on either: (a) the date the Plan of Merger is registered by the Registrar (the Registration Date); or (b) such date or the occurrence of an event subsequent to the Registration Date as specified in the Plan of Merger (which must not be more than 90 days after the Registration Date).
Subject to certain limitations, a shareholder of a constituent Cayman company who dissents from a merger is entitled to be paid the fair value for his shares. A shareholder who intends to exercise his right to be paid fair value must provide the constituent company with a written objection to the merger before the other shareholders vote on the merger.
The documents needed to carry out a merger are listed below.
(i) Plan of merger: The content of the Plan of Merger is prescribed by the Law and comprises the following information:
a. the name of each constituent company and the surviving company;
b. the registered office of each constituent company;
c. for each constituent company, the designation and number of each class of shares;
d. the date which it is intended that the merger take effect;
e. the terms and conditions of the proposed merger including, the manner and basis of converting shares in each constituent company into shares in the surviving company or into other property (consisting of shares, debt obligations or other securities in the surviving company or a combination of these);
f. the rights and restrictions attaching to shares in the surviving company;
g. any proposed amendments to the memorandum or articles of association of the surviving company or, if none are proposed, a statement that the memorandum of association and articles of association of the surviving company immediately prior to merger shall be its memorandum and articles of association after the merger;
h. any amount or benefit paid or payable to any director of a constituent or surviving company consequent upon the merger;
i. the name and address of any secured creditor of a constituent company and the nature of the secured interest held; and
j. the names and addresses of the directors of the surviving company.
(ii) Accompanying documents: The following documents are required to be filed with the Plan of Merger:
a. a certificate of good standing of each constituent company;
b. a written director's declaration of each constituent company (signed by and including the full name and address of the director making the declaration); i. that the constituent company is, and the surviving company will be, immediately after the merger, able to pay its debts as they fall due;
ii. that the merger is bona fide and not intended to defraud unsecured creditors of the constituent companies;
iii. that no petition or other similar proceeding has been filed and remains outstanding, and that no order has been made or resolution adopted to wind up that constituent company in any jurisdiction;
iv. that no receiver, trustee, administrator or other similar person has been appointed in any jurisdiction and is acting in respect of that constituent company or all or any part of its affairs or its property;
v. that no scheme, order, compromise or other similar arrangement has been entered into or made in any jurisdiction whereby the rights of creditors of that constituent company are, and continue to be, suspended or restricted;
vi. of the assets and liabilities of the constituent company made up to the latest practicable date before the making of the declaration;
vii. in the case of a constituent company that is not the surviving company, that that constituent company has retired from any fiduciary office held or will do so immediately prior to the merger; and
viii. where relevant, that the constituent company has complied with any applicable requirements under all Cayman Islands regulatory laws; and
c. an undertaking by each constituent company that a copy of the certificate of merger will be given to the members and creditors of that constituent company and that notification of the merger will be published in the Cayman Islands Gazette.
ADVANTAGES – WHY USE IT?
The statutory merger process provides a straightforward and relatively inexpensive mechanism by which two or more companies can merge, with all rights and property of each of the merging companies vesting in a surviving company that also assumes all of their obligations. This can also involve a capital reorganisation so that some or all of the shares (of the same or different classes) may be converted into, or exchanged for, different types of property (such as shares, debt obligations or other securities in the surviving company or any other corporate entity or money or other property, or a combination of these). The fact that only one of the merging companies has to be incorporated in the Cayman Islands (provided that the overseas constituent company's jurisdiction permits the merger) provides flexibility of deal structure given that the process of establishing a Cayman Islands limited company is simple and efficient.
In contrast to typical schemes of arrangement or general offers used for the privatisation of HKSE-listed companies, companies or investors wishing to acquire 100% control of a target company incorporated in the Cayman Islands by way of statutory merger enjoy a lower shareholder approval threshold, being a two-thirds majority compared to the majority in 4 number of shareholders who vote (the headcount test) that collectively represent at least three-fourths of the value of the shares voted in the case of a scheme and the 90% acceptances required for a 'squeeze-out' in the case of a general offer.
In addition, a statutory merger entitles all shareholders to vote on the proposed transaction, including a controlling shareholder who is proposing to acquire overall control of the target, typically excluded from a vote to approve a scheme or discounted from the 'disinterested' acceptances required to effect a squeeze-out following a general offer.
Perhaps most significantly, a statutory merger does not involve a court process which forms an integral part of a scheme of arrangement and therefore a statutory merger benefits from substantial time and cost savings.
The statutory merger also avoids the need to grapple with the uncertainty and practical difficulties which have historically plagued the approval process for schemes of arrangement owing to the fact that the majority of shareholders of listed companies hold shares through a nominee (such as the HKSCC Nominees Limited for Hong Kong-listed companies).
DISADVANTAGES – WHY NOT?
The potential disadvantage of using a statutory merger over a scheme of arrangement is the ability of any dissenting minorities to object to the merger and demand the fair value of their shares where they believe that this ought to be more than what was offered to them. This is a right afforded to shareholders of a Cayman company at Law although it is worth noting that their dissent does not affect the merger taking effect. As such, this is effectively a separate process which runs post-merger which is examined in further detail below.
For companies or investors evaluating the cost-benefit of a privatisation, the possibility of dissenting shareholders can be a significant concern where the success of even one or two dissenting shareholders can impact the financial viability of the deal. In contrast, a scheme of arrangement, once sanctioned and approved by the Cayman court, binds all shareholders (including any dissenting minority) and therefore provides the offeror with certainty.
DISSENTER'S RIGHTS – WHAT SHOULD A POTENTIAL OFFEROR BE AWARE OF?
Shareholders of Cayman companies which have voted to merge are entitled, pursuant to section 238 of the Law, to dissent from the merger and receive payment of the fair value for their shares. Whilst such dissenting member will not necessarily impact on the timing and effect of a merger, it is prudent to identify dissenting members as early as possible as this may impact on the economics of the merger.
Fair value is determined by agreement of the parties. Where parties are not able to agree the value to be attributed to the shares, within a certain prescribed timeframe, either party may petition the court for a determination of the fair value of the company's shares. The right to dissent under the Law is restricted and will not apply to members who receive in exchange for their shares:
(i) shares of a surviving company (or depositary receipts in respect thereof);
(ii) shares of any other company (or depositary receipt in respect thereof) that are either listed on a national securities exchange or designated as a national market system security on a recognised interdealer quotation system or held of record by more than two thousand holders; or
(iii) cash in lieu of fractional shares or fractional depository receipts as described above. Upon giving formal notice of dissent, in accordance with the procedure set out under the Law, a dissenting shareholder shall cease to have any of the rights of a member except the right to be paid fair value, the right to petition the court where an agreement as to fair value cannot be reached, and the right to institute proceedings to obtain relief on the ground that the merger is void or unlawful.
In line with the increasing use of statutory mergers as the favoured mechanism for take-privates, claims by dissenting shareholders demanding fair value for their shares are no longer a rarity as they were two years ago when the landmark ruling of Integra in 2015 made headlines for its important guidance on how the 'fair value' of a dissenting shareholder's shares is to be determined.
Indeed, there now exists a rapidly evolving area of jurisprudence in the Cayman Islands concerning the dissent process, and the rights afforded to shareholders who seek the payment of fair value for their shares. Given the continued use of the statutory merger process by Chinese (and other) business to effect a take-private transactions, and the perception among some investors that those transactions are being undertaken at prices which are undervalue, it is expected that this body of case law will continue to expand.
ABOUT THE AUTHORS
Shaun Folpp is a Partner at Mourant Ozannes, Hong Kong, and head of its Litigation and Restructuring & Insolvency practices in Asia. Prior to relocating to Hong Kong in 2015, Shaun spent almost a decade practising in the Cayman Islands and the British Virgin Islands. Shaun has extensive experience acting both for and against insolvency practitioners in all forms of external administrations, as well as acting for parties involved in general commercial, financial services and trust disputes. He also has considerable experience advising on corporate governance matters, including in relation to directors' duties. He is consistently ranked as a leading lawyer by all of the leading legal journals.
Jessica Lee is a Senior Associate in Mourant Ozannes' Hong Kong finance & corporate practice. Jessica trained with and previously worked as an associate at Linklaters. She was also seconded to the in-house legal team of a UK financial institution as well as a British insurance company. Jessica's experience includes advising various local and multinational companies on cross-border corporate law transactions, including mergers and acquisitions, financings, corporate restructurings, general corporate advisory and pro bono matters.
Christopher Harlowe, is a Partner at Mourant Ozannes. He joined the firm in 2014. He previously worked at Speechly Bircham, where he was a Partner and head of the Corporate Recovery and Insolvency group in London. Christopher is a recognised expert in contentious and non-contentious insolvency, restructuring and recovery work.
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