A shareholder’s personal standing to challenge dilution of shareholding (Tianrui IHC Ltd v China Shanshui Cement Group Ltd (Cayman Islands))

Mini-summary

The Privy Council was asked to consider whether the appellant, Tianrui IHC Ltd a minority shareholder (“Tianrui”) enjoyed personal standing to claim against a company when the directors of the company allot shares for an improper purpose.

The Privy Council was particularly concerned with the question of whether Tianrui enjoyed a private right to sue the company for a declaration that the power of the company had been invalidly exercised by the board of directors on the company’s behalf?

A natural subsidiary question was whether the possibility of ratification by a general meeting was sufficient to cure the irregular exercise of power by the board.

Written by Lauren Godfrey, Barrister at Gatehouse Chambers.

Tianrui (International) Holding Company Ltd v China Shanshui Cement Group Ltd (Cayman Islands) [2024] UKPC 36

What are the practical implications of this case?

The Privy Council clarified the juridical basis on which a shareholder might sue to hold a board of directors to the company constitution without resorting to derivative action.

The significance of the case is best set out in the Judgment (para 4):

“It has long been held in cases of high authority, by the Board [of the Privy Council], the UK Supreme Court, the High Court of Australia and other appellate courts, that in these circumstances proceedings may be brought by shareholders personally, rather than by derivative action on behalf of the company, to challenge such allotments, notwithstanding that the duty of directors to exercise their powers of allotting shares for proper purposes is owed not to shareholders personally but to the company alone. Although it has never previously been doubted that shareholders personally have standing to bring proceedings in these circumstances, the juridical basis for their standing has not been decided, and barely discussed, in most cases. In the present case, the Court of Appeal, reversing decision of the first instance judge, held that the claimant shareholders had no personal standing to bring the present claim.”

Central to these considerations is the application of the is the so-called “rule in Foss v Harbottle” ((1843) 2 Hare 461) which engage two inter-related questions:

• The proper plaintiff rule: Where the relevant harm done is on true analysis done to a company then that company is the proper plaintiff in a claim to rectify that harm or seek damages for it.
• The “majority rule” principle: the idea that the will of the majority of the shareholders of the company should, as a general rule, prevail in the running of the company’s business. This principle raises the practical point that if the majority support the impugned actions then what is the real utility in allowing a challenge to a decision which could be readily ratified by the majority.

The “fraud on the minority” principle is a well-known exception to the operation of these principles where the wrongdoers are guilty of dishonest conduct or attempting to appropriate or have appropriated to themselves property or opportunities to which the company is entitled or in which other shareholders are entitled to participate, and the wrongdoers are themselves in control of the company. In that event, the aggrieved shareholder or minority may bring a derivative action seeking relief on behalf of the company in whom the cause of action is vested.

However, there are other exceptions are grounded in rights personal to the shareholder under the company constitution such as the right to vote itself.

What was the background?

The case arose out of a long running struggle for control of the company, China Shanshui Cement Group Ltd which is a Cayman Islands exempted company that is also registered in Hong Kong as a non-Hong Kong company.  The company is listed on the Hong-Kong stock market.

The appellant, Tianrui is a shareholder who prior to the issue subject of challenge held 28.16 percent of the issued share capital which was sufficient to block special resolutions which were necessary to authorise certain actions and changes, including changes to the company’s constitution and public listing decisions.

The case concerned the board of directors converting bonds into a new issue of share capital which had the effect of diluting Tianrui’s stake in the company from 28.16 percent to under 25 percent (in fact 21.85 percent).

Thus, the key allegation in the appeal was that the allotment was made with the express purpose of reducing Tianrui’s stake in the company below 25 per cent, thereby removing Tianrui’s negative control so as to assist the other shareholders to consolidate their control over the company.

Tianrui accepted that there were proper reasons for the transactions but averred that these co-existed with the dominant motive which was to wrest control of the company from Tianrui.

Tianrui’s case was that this exercise of the power to issue and allot the shares was in breach of the directors’ fiduciary duty owed to the company to exercise their powers for a proper purpose.

Tianrui had also applied for a just and equitable winding up of the company in the Cayman Islands.  An appeal by the company against a refusal to strike out that application had been refused.

Relevant to the current appeal, Tianrui sought a declaration that the share issue was void due to the improper purpose.  The company had succeeded in getting the claim for a declaration struck out as an abuse of the court’s processes due to Tianrui’s lack of personal standing to sue for a breach of the company’s constitution.

The appeal reached the Privy Council after a successful claim by the company to strike out the shareholder’s case as disclosing no viable cause of action.  The case proceeded on assumed facts consistent with the approach of the first instance court considering an application to strike out a cause of action.

What did the court decide?

On the key issue the Privy Council held: “… a shareholder has a right of action against the company to challenge the allotment of shares by the board of directors on the basis that the allotment was made for an improper purpose in circumstances where the allotment will cause detriment to the shareholder.”

On the exceptions to the rule in Foss v Harbottle, the Privy Council viewed Tianrui’s case as being about a shareholders’ right to exercise power as a shareholder – and therefore a personal right with a personal cause of action attaching – even though it did not amount to a complete removal of the right to vote.

The Privy Council overruled the Cayman Island’s line of authority to contrary effect: see Gao v China Biologic Products Holdings Incorporated.  The Privy Council provided a strong a rationale for the approach in England and Wales (and Australia) for affording a shareholder standing in these and similar circumstances: see Mills v Mills 60 C.L.R. 150, Howard Smith Ltd v Ampol Petroleum Ltd [1974] A.C. 821, [1974] 2 WLUK 61 and Eclairs Group Ltd v JKX Oil & Gas Plc [2015] UKSC 71, [2016] 3 All E.R. 641, [2015] 12 WLUK 68.

Critically, the fact that the transaction might have been ratified (hypothetically) by a majority vote at a general meeting of all shareholders will not provide a defence where any such vote – not having been taken – might amount to minority oppression if it were taken: see Hogg v Cramphorn [1967] Ch. 254, [1963] 10 WLUK 62 and Bamford v Bamford [1970] Ch. 212, [1969] 1 WLUK 613.

Further, the Privy Council appeared to accept as a matter of general principle that a general meeting of shareholders could not act to ratify the company’s decision to remove a personal claim by a fellow shareholder.

Case details

• Court: Privy Council
• Judge: Lord Hodge; Lord Briggs; Lord Sales; Lord Leggatt and Lord Richards
• Date of judgment: 14/11/2024

Article by Lauren Godfrey, originally published by LexisNexis here.