Minority discounts in appraisal rights cases


The Cayman Islands have been a popular place for Chinese companies to locate their registered seat in combination with a listing in New York, but this route has recently fallen out of fashion. Chinese companies have realized that a listing in New York does not give them the same recognition of value that other companies have been able to achieve with a listing in Shanghai. Hence they have sought to buy-out their minority investors and delist from the New York stock exchange.

This raises questions of valuation. In most delistings minority shareholders have received a premium over the prevailing market price, but shareholders have argued that the market for the shares is not a perfect market and that consequently the share price offered does not reflect the companies’ fair value.

Under the laws of the Cayman Islands, companies can force minority shareholders to tender their shares against cash as part of a merger or scheme of arrangement. Shareholders then receive the right to dispute the price offered.

The courts of the Cayman Islands, in similar fashion to Delaware courts, have commonly followed the shareholders’ argument that the market price does not reflect fair value when the market on which the shares are traded can be considered inefficient. Courts rely on a mix of various valuation methods to determine fair value, of which the discounted cash flow approach is the most commonly used. However, in a recent decision in the Shanda Games case, the Court of Appeal of the Cayman Islands showed that it was willing to go its own way and depart from established principles in Delaware case law. In particular, the court found that a minority discount should be taken into account when determining the fair value of shares held by minority shareholders who are forced to sell their shares following a merger or scheme of arrangement.

The Grand Court of the Cayman Islands (the lower court) had ruled that no minority discount should be applied, with reference to Delaware and Canadian case law. In Delaware, the approach is to assess the overall value of the company, and then to award the minority shareholders their fractional share of that value. The Cayman Court of Appeal took a different approach, namely that what is to be valued is the actual shares owned by the dissenter. In that context, according to the court, valuation principles mandate that a minority discount should be applied, since the shareholder is a minority owner within the company.

This is an absolute novelty in the broader spectrum of appraisal rights cases, where minority shareholders are usually forced to tender their shares in exchange of which they receive the legal right to dispute the offered price. When they are forced to sell their shares, minority shareholders are deprived  against their will  of their right to receive future dividends and/or to benefit from future capital gains. This situation is therefore fundamentally different from a shareholder who receives an offer or solicits an offer to sell shares, and where the transaction is the result of the free will of the parties.

In Deminor’s view, there is no economically justifiable reason to impose a discount on the value of shares which a shareholder is forced to tender. Similarly, most countries have ruled that in mandatory takeover bids (following a change of control) the mandatory takeover price should be equal or close to the price offered to acquire control. The rationale is that when control over a company changes, minority shareholders should not be forced to hold on to their shares, instead they should be given the right to sell at equal conditions to the ones received by the controlling shareholder.

The Court of Appeal of the Cayman Islands sought inspiration in principles of English law, where according to the Court, minority discounts can be applied in squeeze-out cases. Whether this principle will be upheld by the Supreme Court of the Cayman Islands, is an open question. But it is certainly an important development, which should be watched by shareholders in companies registered in the Cayman Islands.

Note: Deminor advised Zhaopin shareholders, in connection with the delisting of their shares following the merger between Zhaopin Limited and a group of investors, including its controlling shareholder Seek International Investments. Zhaopin Limited is a company with its registered office in the Cayman Islands and whose shares were listed under the form of ADS on the NYSE.


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