The Appellate Division of the New York Supreme Court, First Department recently held that a minority shareholder’s claims against directors and majority shareholders of a Cayman reinsurance company were barred under Cayman Islands law. On its face, the decision in Davis v. Scottish Re reaffirms the exacting pleading requirements for shareholders to bring derivative claims against Cayman companies and their directors. More significant, however, is a rule recognized by a New York appellate court for the first time, requiring plaintiffs asserting derivative claims under Cayman law to first obtain leave of the Cayman courts. The decision will likely serve as a significant hurdle to shareholders seeking to bring derivative claims under Cayman law in New York courts.
Scottish Re Group Limited (“Scottish Re”) is a reinsurance company incorporated in the Cayman Islands. In January 2011, the majority shareholders of the company acquired all of its outstanding ordinary shares in a merger transaction that was approved by both the board and shareholders. Shareholders received a 76-percent premium on the pink sheet trading value of their shares.
Plaintiff Paul Davis was a significant holder of Scottish Re ordinary and preferred shares. In November 2013, Davis filed a complaint containing 10 causes of action, including two claims for breach of fiduciary duty against the Scottish Re directors and majority shareholders.
The Arguments and Decision Below
The directors and majority shareholders moved to dismiss Davis’ fiduciary duty claims on the grounds that they were actually derivative claims, which, under Cayman law, Davis lacked standing to assert. In support, the defendants cited Order 15, Rule 12(A) of the Grand Court Rules of the Cayman Islands. That rule requires a shareholder purporting to bring a derivative claim on behalf of a Cayman company to first seek leave from a Cayman Islands court before proceeding with the claim. The defendants argued that Rule 12(A) is a substantive rule with which Davis was required to comply before bringing his claims in New York.
There was no dispute over whether Davis had sought leave of the Cayman courts to assert his derivative claims — he had not. Rather, Davis argued that he was not required to seek leave because the fiduciary duty claims were direct, not derivative, and because Order 12, Rule 15 of the Grand Court rules is procedural, not substantive. The Supreme Court, New York County disagreed, holding that the claims were, in fact, derivative, and that Davis lacked standing to assert his derivative claims because he had not sought leave of the Cayman courts, pursuant to Rule 12(A). Davis appealed.
First Department Holding and Comment
Considering the issue for the first time, the Appellate Division, First Department agreed with the lower court and rejected Davis’ argument. Reasoning that because a Cayman derivative action is extinguished if a plaintiff fails to comply with Rule 12A, the court held that it is substantive rule with which the plaintiff had failed to comply. The court’s holding is the first instance in which a New York appellate court has upheld rule 12(A) as a substantive rule under New York conflict of law principles.
The holding in Davis v. Scottish Re will provide an important tool to counsel for Cayman companies and directors in defending against shareholder derivative claims, as it recognizes a significant hurdle for plaintiffs seeking to assert those claims. In the wake of the court’s decision, under New York law, before proceeding in a New York court with a derivative claim against a Cayman company, a shareholder plaintiff must first seek and be granted leave of the Cayman courts to proceed with the action. In seeking leave, Cayman counsel must make a prima facie showing that the shareholder has the right to sue on the company’s behalf — a difficult prospect in its own right under Cayman law. In other words, shareholder plaintiffs must first litigate in the Cayman Islands simply as a means of opening the door to the New York courts. Under the First Department’s holding in Davis v. Scottish Re, failure to do so will result in dismissals of their cases.