In November 2017, the New York Court of Appeals, applying New York law, reversed earlier New York authority on the point, holding that it was not necessary to apply in Cayman. In January 2018, the Grand Court of the Cayman Islands, applying Cayman Islands law, reached the same conclusion. It is now clear from these two decisions that derivative claims on behalf of Cayman companies, whether they are brought in the U.S. or elsewhere, do not require permission from a Cayman court. This supposed obstacle to these types of claims has been removed.

While these decisions simplify the process for bringing derivative claims in onshore jurisdictions on behalf of Cayman companies, the remaining obstacles faced by shareholders seeking to do so should not be underestimated. This article explains the two decisions and examines the difficulties shareholders wishing to bring such claims still face.

Derivative claims are an exception to the general rule that shareholders cannot sue to enforce rights of action that belong to and are vested in their company. The exception exists to avoid the injustice that can result from applying the general rule too strictly. But the exception is strictly controlled to avoid undermining the general rule. In the Cayman Islands and certain other offshore jurisdictions, the control mechanism is a rule that a shareholder cannot maintain a derivative claim without obtaining court approval. Until the decision of the New York Court of Appeals in Davis v. Scottish Re Group Ltd..rn courts in New York had characterized the control mechanism:1 as a rule of substantive law; and2 as meaning that only a Cayman court could give the relevant approval.

In this case, the Court of Appeals recharacterised the control mechanism as a rule of procedure. This meant that the court, which in matters of procedure would apply its own rules of procedure, need not have regard to the rule and that the matter therefore did not need to be referred to the Cayman court. This was followed in January of this year by the decision of the Cayman Grand Court in Top Jet Enterprises Ltd. v. Sino Jet Holding Ltd. and Jet Midwest Inc., which held that the rule is a procedural mechanism, that it does not apply to derivative claims brought in courts outside Cayman, and (for good measure) that there is no substantive rule of Cayman Islands law that requires permission to be obtained from a Cayman court.

While in some respects this smooths a shareholder’s path, those who would bring a derivative claim overseas on behalf of a Cayman company still have to grapple with two difficulties.

The first is that the test a U.S. or English court will apply to the question of whether a derivative claim can be brought remains a test under Cayman law. That is so because the exception to the rule that permits derivative claims in limited circumstances is characterised in the U.S. and in England and Wales as a rule of substantive Cayman law,3 and therefore the test that courts in those jurisdictions must apply when deciding whether to allow a derivative claim is a Cayman test, which (as we outline below) is a narrow one.

The second difficulty is that the decision whether or not to allow a derivative claim involves, as a matter of Cayman law and as we will also explain, a question about the internal management of the company that has at its core the question of whether the directors and shareholders of the company have behaved improperly within the context of that company. There are strong arguments for leaving questions as to whether to interfere in the internal management of a company to the courts of the place where the company is incorporated.

Cayman law holds that a company, being a separate legal person from its shareholders, is the only person that can sue to enforce rights vested in the company. A shareholder can no more enforce the company’s rights of action than can any other third party. Allied to this is the fact that if a wrong is done to the company and the company does nothing about it, that is a question of internal management in which the court is very reluctant to interfere. Under the company’s constitution, the remedy for inaction in the face of a wrong lies with the shareholders as a body, which usually means it lies with the majority of the shareholders. The normal rule therefore is that it is ultimately for the shareholders to determine whether the company should bring proceedings, and therefore the rule is that only the company acting by its board or otherwise within its constitution can sue on causes of action vested in the company. This is known as the rule in Foss v. Harbottle.4

However, the law of the Cayman Islands recognizes narrow exceptions to this rule, one of which exists where a claim is being improperly stifled by those in charge of the company — usually characterised as “wrongdoer control” or “fraud on the minority.” In these circumstances, to prevent a wrong to the company going unremedied, a minority shareholder may invoke the equitable jurisdiction of the court to bring a derivative claim on behalf of the company.

The importance that Cayman law attaches to the principle that the internal management of the company is ultimately a matter for its shareholders means that no derivative claim can be maintained unless the shareholders could not lawfully decide against the company itself bringing the claim. This is where the requirement of a fraud on the minority comes into play. In general, minority shareholders have no choice but to respect the decision of the majority, but under Cayman law, the limit of this principle is that a majority cannot use its power to commit a fraud on the minority. Where the company’s inactivity could not be sanctioned by the majority without fraud on the minority, the derivative claim will be permitted. But not otherwise. In this context, it is salutary to note that although the plaintiff in Davis succeeded in the Court of Appeals, when the case was remitted for a determination of the substantive question of whether the plaintiff came within the exception to Foss v. Harbottle, his claim was dismissed for his inability to prove fraud on the minority.

According to the Grand Court in Top Jet, it is not enough to show fraud on the minority — the derivative plaintiff must also either be bringing a claim against a person related to the company or, if bringing a claim against a third party, satisfy a further test:
Where a third party has a liability to the company (whether in contract or tort) but the third party has neither participated in the conduct constituting the fraud on the minority nor received corporate assets, then it would not be possible for a claim against them to be brought derivatively.

The requirement that the claim must either be against a related person or, if against a third party, against somebody who has participated in the fraud on the minority is revealing. It demonstrates that the claim is no more or less than a claim by shareholders of a company for wrongs done by them to the company, its other shareholders or its directors. The issues will be the application of principles of Cayman company law and the exercise of discretionary powers of management by the directors of a Cayman-incorporated company. It has been suggested in England and Wales that this means that the courts of the Cayman Islands have exclusive jurisdiction over the dispute. Although that suggestion has been rejected in favor of the view that this is only a factor to be taken into account in determining what forum is appropriate for deciding the claim, it is, however, considered to be a “significant factor.”5

Therefore, while there is now no requirement to seek permission of a Cayman court to bring a derivative claim in a foreign jurisdiction, that does not avoid the need to address whether the foreign court is the appropriate forum rather than Cayman. It should also be remembered that the absence of a requirement to seek permission in Cayman does not equate to an absence of jurisdiction in Cayman to rule on foreign derivative claims. In Top Jet, the Grand Court was invited to and did consider whether a derivative claim in Missouri was appropriate as a matter of Cayman law and issued a declaration on the point. The declaration was in favor of the claim, but the Grand Court can issue negative as well as positive declarations. The Grand Court in Top Jet was clear that a defendant that challenges standing in a foreign court “could, if it considered it to be necessary and justifiable, also apply to this Court for relief.”

The decision in Top Jet, while making clear that there is no mandatory requirement to seek permission in Cayman to bring an overseas derivative claim, also makes clear that the scope in principle for such claims is narrow. The limiting concept of fraud on the minority is, however, an elastic construct based on English and Cayman equitable principles whose application in practice requires specialist knowledge and understanding of the relevant jurisprudence. As we have shown, overseas derivative claims will also frequently raise questions about the appropriate forum, and complications may arise if a party to a claim proceeding overseas applies to a Cayman court for declaratory relief on the derivative standing issue.

Appendix
Davis v. Scottish Re Group Ltd., 30 NY3d 247.
Top Jet Enterprises Limited v. Sino Jet Holding Ltd. and Jet Midwest Inc. (Unreported, Jan. 19, 2018)
See the Court of Appeals in Davis for the U.S. position; Konamaneni v. Rolls Rovce [2002] 1 WLR 1269 at H 50 for England and Wales and Top Jet Enterprises Ltd. v. Sino Jet Holding Ltd. and Jet Midwest Inc. at H 13(h) for the Cayman Islands.
(1843) 2 Hare 461 Ch.
See Konamaneni v. Rolls Royce at ^ 65.

Type

Insight

Locations

Cayman Islands

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