What you need to know about the Cayman Islands statutory merger

The Cayman Islands has seen a surge in the use of statutory mergers in recent years, particularly as the most common method of takeover and privatisation of publicly listed companies (including those listed on the New York Stock Exchange and Nasdaq Stock Market) and as part of ‘de-SPAC’ business combination transactions involving special purpose acquisition companies (SPACs).

This guide seeks to outline the process of a Cayman Islands statutory merger and consider the advantages and disadvantages of using this as a mechanism for effecting take-private transactions. It also explores the right of dissenting shareholders to obtain fair value for their shares.

It is worth noting though that statutory mergers, and in particular short-form mergers, can also be used in private acquisitions and to implement the rationalisation of corporate structures.

The Cayman Islands statutory merger

What is it?

A Cayman Islands 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 Companies Act (as amended) of the Cayman Islands (the Act) 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.

What are the key steps and requirements?

The Act allows two or more companies (which must include at least one Cayman Islands company limited by shares) to merge. In the context of a take-private transaction, investors (usually comprising a combination of the founders or managers of the listed company, its parent and potentially private equity investors) intending to use a statutory merger will as an initial step typically form a new company in the Cayman Islands (Bidco).

Bidco is then used as the offeror vehicle and recipient of finance, and will ultimately merge with the target company. In a de-SPAC transaction, the SPAC, its sponsor, the target company and the target company’s significant shareholders will typically agree on the number and structure of mergers required to achieve the parties’ goals, and will often form one or more new Cayman Islands companies to facilitate the transaction.

In order to implement a statutory merger, the following key steps must be taken:

1. The directors of each constituent company must approve a written plan of merger, which includes certain specific information regarding each constituent company, the terms of the merger and other information specified in the Act (the Plan of Merger).
2. The Plan of Merger must be approved by:

(a) a special resolution of members of each constituent company, being a resolution passed by at least a two-thirds majority of shareholders who have the right to receive notice of, attend and vote at the shareholders’ meeting and who actually vote, or such higher threshold as may be specified in its articles of association (and there may also be other shareholder approvals requirements imposed by the relevant listing rules or takeover codes); and

(b) such other authorisation, if any, specified in each con¬stituent company’s articles of association.

3. The consent of each holder of fixed or floating security interests of a constituent company must be obtained. If a secured creditor does not give consent, the court may, upon application by the company that issued the security, waive the requirement for consent on any terms the court considers reasonable.
4. The Plan of Merger (accompanied by other required docu­mentation, including, amongst other things, written director’s declarations of each constituent company in respect of the company’s solvency and assets and liabilities, that the merger is bona fide and not intended to defraud unsecured creditors, and there is no outstanding petition for winding up, etc.) must then be signed by a director of each constituent company and filed with the Cayman Islands Registrar of Companies (the Registrar).
5. Upon payment of the applicable fee and, assuming that the Reg­istrar is satisfied that the requirements of the Act relating to the merger (including any change in name of the surviving company) have been met, the Registrar will:

(a)  register the Plan of Merger and any amendment to the memorandum or articles of association of the surviving company;

(b)  issue a certificate of merger within 24 to 48 hours (if filed on an express basis) or around five working days (if filed on a standard basis); and

(c)  strike-off each constituent company other than the surviving company once the merger becomes

The Plan of Merger and supporting documents can be pre-cleared with the Registrar. The merger is effective on either:

• the date the Plan of Merger is registered by the Registrar (the Registration Date); or
• another 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).

A shareholder of a constituent Cayman Islands company who dissents from a merger is entitled to be paid fair value for their shares, as outlined under ‘Rights of dissenting shareholders’ below.

There is a ‘short-form’ method of merger. If a Cayman Islands parent company seeks to merge with one or more of its Cayman Islands subsidiaries (in which the parent company holds shares that represent at least 90% of the votes at a general meeting of the subsidiary), a special resolution of the shareholders is not required. However, a copy of the Plan of Merger will need to be given to each shareholder of the subsidiary unless that shareholder agrees otherwise, and the courts have held that dissenters’ rights still apply.

As most take-private transactions are initiated with the involvement of the management of the target company, the merger process typically will have an independent financial expert appointed and an independent special committee formed to review and negotiate the take-private offer on behalf of the target company to mitigate litigation risks and, in particular, to ensure the directors’ duties to the target company are observed. Practice with respect to de-SPAC transactions varies based on the structure of the deal, including the interests of those involved in it. Cayman Islands law on this aspect of the process is not as rigid as Delaware although the process (or similar) in Delaware may be used as a point of guidance.

Financing a take-private transaction

A take-private transaction by statutory merger may often be financed by a loan which is advanced to the Bidco, one of the constituent companies, or a newly incorporated parent of Bidco (in each case, a Cayman Islands company incorporated by the sponsors of the transaction).

There will usually be a robust security package, including share security, debentures and guarantees at various levels up the bidder group structure and, post-merger, from the target. The loan proceeds, together with equity injected from the investors, are usually used to meet the costs of buying out existing shareholders of the target and funding the working capital requirements of the business post its de-listing. The debt obligations of the constituent companies will be assumed, upon merger, by the target if it is the surviving entity, along with all other rights and liabilities of the constituent companies.

Pros and cons of the Cayman Islands statutory merger

Advantages – why use it?

The statutory merger process has a number of advantages over a scheme of arrangement and/or a general offer/tender offer followed by a ‘squeeze-out’ (which are usually used for the privatisation of companies listed on the Hong Kong Stock Exchange). These include:

1.       Cost and speed

It 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 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 or other securities in the surviving company or money, or a combination of these).

It does not involve a court process, which forms an integral part of a scheme of arrangement, and therefore benefits from substantial time and cost savings.

2.      Shareholder approval threshold

It typically enjoys a clearer shareholder approval threshold, being the two-thirds majority described above (subject to the articles of association of the constituent company which may specify a higher threshold or require additional approvals), compared to the shareholder approval threshold required under the Act for a scheme (being shareholders that collectively represent at least three-quarters of the value of the shares represented and voted). However, any listing rules or takeover codes applicable to the companies party to the transaction may require other shareholder approvals.

It entitles all shareholders of a constituent company to vote on the proposed transaction, including a controlling shareholder who is proposing to acquire overall control of the target. Offering shareholders are typically excluded from a vote to approve a scheme (pursuant to the applicable listing rules or takeover code) or discounted from the ‘disinterested’ acceptances required to effect a ‘squeeze-out’ following a general offer.

3.      Flexibility

It may provide greater flexibility around transaction terms, including the consideration to be received by shareholders and post-acquisition shareholdings, due to the permissive drafting of the merger regime.

Disadvantages – why not?

The most significant potential disadvantage of using a statutory merger over a scheme of arrangement is the ability of any dissenting shareholder to object to the merger and demand fair value for their shares. This is a right afforded to shareholders of a Cayman Islands company at law, although their dissent does not affect the merger taking effect. As such, it is effectively a separate process which runs post-merger (see ‘Rights of dissenting shareholders’ below for further details).

For companies or investors evaluating the costs and benefits 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 Islands court, binds all shareholders (including any dissenting shareholders) and therefore provides the offeror with certainty. Dissenters’ rights are typically less of an issue for de-SPAC transactions, given the availability of redemption rights for public shareholders of a SPAC, the fact that the SPAC’s assets will generally be limited and easily valued and the transaction consideration typically being in the form of publicly listed securities.

Rights of dissenting shareholders

Shareholders of Cayman Islands companies are entitled, pursuant to section 238 of the Act, to dissent from the merger and receive payment of the fair value for their shares if the merger proceeds. Whilst dissenting shareholders will not necessarily impact on the timing and effect of a merger, it is prudent to identify dissenting shareholders as early as possible as this may impact on the economics of the merger.

Fair value can be determined by agreement of the parties. Where the parties cannot agree the value to be attributed to the shares within the prescribed timeframe, a dissenting shareholder may, and the company must, petition the court for a determination of the fair value of the company’s shares. The court can also determine a fair rate of interest to be paid by the company on the fair value of the shares.

The right to dissent under the Act is restricted for publicly traded companies. It will not apply to the shares of any class for which an open market exists on a recognised stock exchange or recognised interdealer quotation system on the relevant date specified in the Act, unless the Plan of Merger requires those shareholders to accept anything for their shares other than:

• shares of a surviving company (or depositary receipts in respect thereof);
• shares of any other company (or depositary receipts in respect thereof) that are, on the effective date of the merger, 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; and/or
• 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 in the Act, a dissenting shareholder will cease to have any of the rights of a shareholder except:

• the right to be paid fair value for their shares;
• the right to petition the court where an agreement as to fair value cannot be reached;
• the right to participate fully in all court proceedings relating to the dissent process until the determination of fair value is reached; and
• the right to institute proceedings to obtain relief on the ground that the merger is void or unlawful.

As a result of the increasing use of statutory mergers and corresponding increases in the exercise of dissenters’ rights in recent years, 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, including with respect to interim payments to dissenting shareholders. To date, the courts have held that fair value may not be the same as market value, and that fair value is that which is just and equitable – meaning, among other things, that fair value may be more than, less than, or equal to the merger consideration offered.

Given the continued use of the statutory merger process by Chinese (and other) businesses to effect take-private transactions, and the perception among some investors that those transactions are being undertaken at prices which are undervalued, it is expected that this body of case law will continue to expand.

Conclusion

The Cayman Islands statutory merger regime provides a flexible mechanism for implementing a broad range of corporate transactions, including public company acquisitions, take-privates and group restructures. Although the merger process itself is extensively used, there is continued judicial activity, particularly in relation to dissenters’ rights, which is fast-moving and needs to be carefully considered. Accordingly, it is important that the transaction structure, including any financing and related security arrangements, is carefully mapped out in advance.

Contacts

A full list of contacts specialising in Cayman Islands corporate law can be found here.