Meaning of 'fair value'
Shareholders in a company that is the subject of a takeover and merger have certain intrinsic rights available to them in the event that they dissent to the merger, most notably a right to have their shares purchased at a 'fair value'. This update explores the manner in which courts interpret 'fair value' in the Cayman Islands.
Carly Fiorina, a former chief executive of Hewlett-Packard and an early US presidential candidate, once commented that "a merger is hard to pull off under any circumstances. It's harder when everybody is against you". This is particularly true when those against you are dissenting shareholders to which a merging company will need to account for the 'fair value' of its shares.
This update explores the merger and consolidation regime in the Cayman Islands, focusing on the right afforded to dissenting shareholders to have their interests bought out at a fair value and the meaning of that concept.
Although typically used synonymously, 'mergers' and 'consolidations' are afforded unique meanings as a matter of company law. Broadly speaking, a 'merger' is the process by which two or more existing companies merge into one of the constituent companies. A 'consolidation' is the process by which two or more existing companies are consolidated into a new company.
Mergers are becoming increasingly common in the current competitive economic climate, in which businesses are being forced to explore synergies with former competitors, and this can often lead to a leaner, more efficient business as a result.
The principal legislation dealing with company law in the Cayman Islands is the Companies Law (2013 revision). This includes the statutory framework by which mergers are governed and provides flexible structuring mechanisms. Mergers are well used and continue to be a favoured method of takeover or consensual restructuring; one recent example is Silver Wheaton's billion-dollar acquisition of Anani Investments Ltd from Glencore PLC for mixed cash and commission consideration.
Mergers can take place between companies incorporated in the Cayman Islands or between a company incorporated in Cayman and one or more overseas companies, provided that the laws of the overseas company permit the merger. Cayman law also allows a merger to take place between a parent company and its subsidiary, which means that the provisions are often used in facilitation of a group restructuring. The effect of the merger will be that the merged entity (in the case of a merger) or the new entity (in the case of a consolidation) will hold all assets and liabilities of the constituent companies, and all of the rights, privileges, immunities, powers, objects and purposes of each constituent company will be transferred to it.
A great deal of flexibility is available in the manner in which mergers are conducted and structured, and typically mergers will allow shares to be cancelled, reclassified, converted into money or other assets, including shares, debt obligations or other securities in the merged or new entity. Indeed, even shares of the same class can be treated differently in a merger or consolidation plan, such that some shareholders in the constituent companies are made shareholders of the merged or new entity while others may be bought out.
While minority shareholders that do not want the merger to go ahead cannot stop the merger, they can dissent and, pursuant to statute, insist upon a right built into the Companies Law to dissent and be bought out at a fair value. In this case the merging company must agree on a fair value amount, which typically means that parties will have to spend approximately 60 days trying to agree to the fair value; failing which they may ask that the court appraise the fair value of the dissenting shareholders' shares.
The manner in which the courts decide what constitutes fair value will depend on the facts of individual cases.
Meaning of 'fair value'
For most people, 'fair value' will have a natural meaning correlated to the intrinsic value of the company in respect of which fair value is sought and a pro rata share of that intrinsic value based on the shareholding that a person may have in the company. In the Matter of The Integra Group, unreported (Jones J, August 28 2015) is the first (and so far only) case in which a Cayman court has had to consider the meaning of 'fair value' in the context of a compulsory buy-out of a minority shareholder.
Integra was a London Stock Exchange-listed, Cayman-incorporated provider of oilfield services in Russia. In 2013 the management of Integra sought to buy out the outstanding shares of the company at $10 per share, representing an approximately 45% premium over the preceding 30-day trading average, and a committee of independent directors resolved that the offer was fair. The deal was structured as a merger pursuant to Section 233 of the Companies Law and a number of minority shareholders, representing approximately 17% in aggregate of the issued shares of Integra, dissented to the merger pursuant to Section 238 of the Companies Law. This triggered a statutory provision by which the surviving company and the dissenting shareholders were to agree on a price, failing which an application could be made to the Cayman court for determination of the fair value.
In Re Integra, the court ruled in favour of the dissenting shareholders and awarded them $11.70 per share. In terms of guiding principles when considering the question of fair value, the Cayman court held that no discount or premium should be ascribed to the forced taking of shares in a merger context, and that the business should be valued as a going concern and without any adjustment to value (whether higher or lower) which is attributable to the effect of the merger (ie, a dissenting shareholder cannot avail itself of a premium that may be ascribed to the value following the merger, but equally should not be burdened with a fall in value that may be ascribed to the merger). In particular, the Cayman court considered that valuation in circumstances where a minority shareholder is a forced seller should be "just and equitable'"
No direction as to the preferred valuation methodology was given by the Cayman court and the appropriate valuation methodology will be fact and industry dependent. The mere fact that Integra was a listed company did not necessarily mean that one could accurately look at the average trading price as a gauge. In particular, the fact that Integra was not heavily traded and was not as liquid as other traded shares would not make it appropriate simply to look at the traded price to ascertain value. The Cayman court, in that regard, considered that the assessment of fair value may be proved by established valuation techniques that are generally acceptable in the financial industry and which otherwise be admissible as valuation evidence in court. While the matter will ultimately turn on individual facts, the starting point is that no minority discount (or merger premium) will apply in ascertaining fair value.
In reaching that conclusion, the Cayman court applied principles set out in an article entitled "Dissenting Shareholders' Appraisal Rights in Cayman Islands Mergers and Consolidations", which suggested that the Cayman court should have no trouble in applying principles established in Delaware and Canada (given that the drafting of the Cayman law was heavily influenced by those jurisdictions). That article proposed that:
"he [a dissenting minority shareholder] is thereafter deprived of his proportionate share of an active enterprise and is entitled to be compensated for it…the Court should be guided by the following considerations:-
1.1 Fair value does not include any premium for forcible taking (i.e. expropriation of the shares);
1.2 It is neither appropriate nor permissible to apply a minority discount when making the determination."
The Cayman courts will approach the issue of fair value on the individual facts. The starting point is a valuation approach on the basis of no discount or premium attributable to the merger itself, with the aim being to mitigate against the potential for mergers being abused. The issue remains live and is a dynamic area of law which will continue to challenge the courts and be built upon.
For further information on this topic please contact Ian Mann or Jayesh Chatlani at Harney Westwood & Riegels' Hong Kong office by telephone (+852 3195 7200) or email ([email protected] or [email protected]). The Harney Westwood & Riegels website can be accessed at www.harneys.com.