Privy Council confirms shareholders can bring personal claims against company that allots shares for improper purpose

The Privy Council has held that where (on assumed facts) a company's directors acted in concert with its majority shareholders to allot shares to connected outsiders in order to dilute the claimant's shareholding, the directors had acted for an improper purpose and the shareholder could bring a personal claim against the company: Tianrui (International) Holding Company Ltd v China Shanshui Cement Group Ltd [2024] UKPC 36.

The decision is significant because it provides one of the first principled discussions of the juridical basis on which a shareholder may bring a claim challenging the allotment of shares for an improper purpose. Such a claim represents an exception to the "proper plaintiff" rule in Foss v Harbottle, which ordinarily means that only the company – not an individual shareholder – can take action where a wrong has been done to the company.

While the directors' duty to exercise their powers to allot shares for a proper purpose is owed not to shareholders personally but to the company alone, the Privy Council held that breach of that duty contravened the shareholder's rights under the "corporate contract" comprised of the articles and memorandum of the company. A director's breach of duty can ordinarily be ratified by a majority of shareholders, but that is limited by the equitable constraint that a majority cannot ratify its own oppression of a minority, and so in such circumstances a shareholder's claim cannot be defeated by ratification. 

While previous authority from England and Australia had confirmed the existence of such a claim, it had not decided or discussed the specific basis for doing so in any detail (save for one Australian decision, but the Privy Council did not entirely agree with the court's analysis in that case).

Further, Cayman authority had rejected the standing of a shareholder to bring such a claim on at least two prior occasions (one of which being the Court of Appeal decision which the Privy Council overruled). The decision provides long-awaited clarity on this point.   

The assumed facts of this case, including the apparently clear connection between the majority shareholder group and the outsiders to whom the disputed shares were allotted, belie some of the limitations a court may face in applying this cause of action in the future. For example, questions of how to identify what is and is not an improper purpose in the exercise of director power, how to address director conduct with multiple motivations, and the practical benefit of relief when the outsiders are bona fide purchasers for value without notice, were not engaged in this judgment. If the claim continues at first instance, some of these matters may be explored.  

Background

This case arises from a prolonged battle for control of the respondent company, China Shanshui Cement Group Ltd ("CSCGL"), a cement production company operating in China but registered in the Cayman Islands. CSCGL is also registered in Hong Kong and listed on the Hong Kong Stock Exchange ("HKSE").

The principal shareholders in CSCGL (between whom there was no shareholders' agreement) are competitors in the cement production industry in China. Before the events of May to October 2018 the appellant company, Tianrui, owned 28.16% and three other shareholders owned, respectively, 26.72%, 16.67% and 25.09% of CSCGL.  

From April 2015 CSCGL’s shares were suspended from trading on the HKSE. The HKSE later gave notice that CSCGL would be delisted unless it had restored its public float above the required 25% minimum threshold (among other conditions) by 31 October 2018.

From May to October 2018 the three principal shareholders apart from Tianrui (acting via their appointed directors) caused CSCGL to issue and allot new shares to third parties. This had the effect of restoring CSCGL to trading status on the HKSE, as well as diluting Tianrui's shareholdings below 25%.

Tianrui alleged that the new shares were issued and allotted for the improper purpose of reducing Tianrui's shareholding so as to remove its negative control right to block special resolutions of the shareholders. Tianrui alleged that it was an implied term of the articles of association that the directors' exercise of such powers could not result in a valid issue of securities if it was materially affected by an improper purpose.

Tianrui applied for a declaration that the issuance of the new shares was invalid. CSCGL sought to have that application struck out. The Grand Court of the Cayman Islands ruled in favour of Tianrui, but the Court of Appeal of the Cayman Islands allowed CSCGL's appeal, striking out Tianrui's original application.

Tianrui appealed to the Privy Council. At each stage it was assumed that the facts alleged by Tianrui were true. The only issue for considering by the Privy Council was whether Tianrui's claim was an abuse of process because it did not have standing to sue CSCGL for what were essentially claims arising out of alleged breaches of fiduciary duties that the directors owed to CSCGL.

Decision

The Privy Council allowed the appeal. After undertaking a detailed survey of commonwealth jurisprudence on the topic, it determined that "a shareholder whose holding is diluted by an improper allotment of shares by the directors may bring a personal claim against the company challenging the validity of that allotment" but that "in certain circumstances (not applicable here) the claim may be defeated by ratification of the allotment by a majority of the shareholders (other than the allottees) at a general meeting".

In reaching this conclusion the Privy Council stated that the Cayman Islands case of Gao v China Biologic Products Holdings, Inc 2018 (2) CILR 591 (upon which the Court of Appeal had based its decision) was wrongly decided, and the Cayman court of first instance in Tianrui was right to decline to follow it. In Gao, a shareholder's standing to bring such a claim was denied on the basis that the company was the only proper claimant (as per the "proper plaintiff" principle in Foss v Harbottle), but a shareholder could assert the company's claim by derivative action, where available and permitted by the relevant rules.

The Privy Council's analysis instead proceeded on the basis that shareholders have personal rights which are capable of being adversely affected by a director exercising their fiduciary powers for an improper purpose. While prior authority had identified such instances as "obvious cases for intervention by the courts", the Privy Council's judgment located for the first time a specific cause of action for such intervention.

This cause of action arose not solely from equity (as the Australian court had held in Residues Treatment & Trading Co Ltd v Southern Resources Ltd (1988) 6 ACLC 1160) but from the fact that under Cayman law the memorandum and articles comprised a "statutory contract" between the company and its shareholders, and between the shareholders inter se. This contract confers on the directors a fiduciary power to allot and issue shares, with an implied constraint on such power to be exercised only for proper purposes. Such a constraint is a "necessary legal incident" of the relationship between shareholder and company, and between shareholders inter se. When directors exercise such powers for an improper purpose, that gives rise to actionable harm because "the impropriety of the exercise… contravenes the corporate contract binding [the shareholder] and the company", even though the duty breached by the directors is not owed to the shareholder.

Exercising this power in accordance with fiduciary duties owed to the company will necessarily exclude, for example, an allotment and issue of shares which is deliberately aimed at altering the balance of power between shareholders, so as to advance the power of one (or one group) at the expense of another.

The Privy Council further held that both the size of a claimant’s shareholding and whether or not the company itself has a cause of action against the directors for the breach of the fiduciary duty are, in principle, irrelevant. What matters is that the claiming shareholder (together, in an appropriate case, with those other shareholders they claim to represent) has suffered from an interference with their rights as shareholder brought about by the improper issue and allotment.

As regards ratification, the Privy Council confirmed that, when acting by a majority, shareholders are constrained by the principle that they may not do so by way of oppression of the dissenting minority. The Privy Council acknowledged that whether this principle arose from equity or the "corporate contract" identified above was a matter for debate, but the distinction made no difference for the purposes of the judgment.

On the assumed facts of this case, the shares had been allotted to outsiders who were acting in concert with the majority shareholder group and the directors to consolidate control over CSCGL, and that allocation had been purportedly ratified by the same majority in a general meeting. In light of the principles above, this would mean the directors had acted for an improper purpose in the issue and allotment of the disputed shares. The ratification was vitiated by the equitable principle against minority oppression and the recipients of the shares (having acted in concert with the majority) would be unlikely to be able to resist setting aside the allotments on the basis that they were bona fide purchasers without notice of the impropriety.

It followed that the Court of Appeal was wrong to strike out Tianrui's writ.