This recent case, heard before the Privy Council (JCPC) sitting in the Cayman Islands, has confirmed that shareholders may bring personal claims against a company where shares have been issued by the directors in breach of their directors’ duties.

Whilst decisions of the JCPC are not necessarily binding on UK law as a whole, the judgment cited UK law, and may be relevant should a similar case be heard in the UK.

Background

China Shansui Cement Group (CSCG) is a large Chinese cement production company registered in the Cayman Islands. CSCG’s shareholders are predominantly other large Chinese cement producers in competition with each other and who have all been vying for control of CSCG, including Tianrui (International) Holding Company Ltd (Tianrui).

Tianrui held just over 25% of the shareholding in CSCG, which meant that it had the power to block any ‘special resolution’ requiring 75% shareholder approval to, for example, alter CSCG’s constitution.

However, Tianrui’s rival shareholders, Asia Cement Corporation (ACC) and China National Building Materials (CNBM), had representatives who sat on CSCG’s board of directors, whereas Tianrui had no board representation. The ACC and CNBM directors proposed that new shares in CSCG be allotted and issued, thereby increasing the total number of shares and diluting the existing shareholders’ stakes in the company. The transaction went ahead, and was ratified by the majority (over 50%) of CSCG’s shareholders.

The allotment and issue of shares was ostensibly to repay CSCG’s debts, but, as alleged by Tianrui, its real purpose was to reduce Tianrui’s shareholding below 25%, thereby removing its ability to prevent its competitors from changing the company’s constitution.

Tianrui brought a personal claim against CSCG to court and won. The judgment was appealed by CSCG and was overturned. Tianrui then appealed to the JCPC who reached a final judgment that the directors of CSCG appointed by ACC and CNBM had breached their duties to the company, but that Tianrui nonetheless had the right to bring a personal claim against CSCG, and that the allotment and issue was invalid and must be reversed.

The Law

It is a long-established company law principle that directors of a company owe fiduciary duties to the company.

Subject to a company’s own internal procedures, directors have the statutory power to allot and issue new shares. Any director’s decision to allot and issue shares must be for the benefit of the company as a whole in good faith; as a general rule, this means that an allotment / issue must be for the purposes of raising capital in the company, and must not be for an improper purpose (such as altering shareholder control).

The JCPC found that the ACC and CNBM directors had acted improperly in allotting and issuing the new shares, as their true intention had been to wrest power away from Tianrui, thus breaching their fiduciary duties to the company.

However, as directors’ duties are owed not to a company’s shareholders, but directly to the company, it is generally the company itself which has a right of action to bring a claim against a director who has acted improperly. Further, where there has been any breach, if the majority of the company’s shareholders confirm their approval, they can waive any claim which the company may have. This has been a long-recognised common law principle since the mid-19^th century.

Since then, case law has shifted somewhat to allow shareholders to bring claims as ‘derivative actions’ whereby they bring a claim on the company’s behalf, but rarely have personal claims been allowed.

Despite this, the JCPC allowed Tianrui to bring a personal claim against CSCG, pointing to a clear board-level conflict and a breach of the directors’ duties, and declared that the allotment and issue must be reversed, despite majority shareholder consent at the time.

Why is this important?

The JCPC’s judgment in Tianrui has demonstrated that where directors have acted improperly in allotting and issuing shares, the shareholders may have a personal claim against the company itself, in addition to any ‘derivative action’ they may have.

Although not binding on UK law at large, the JCPC’s discussion of legal authorities and justification of their decision to allow a personal claim and reverse the transaction does represent a shift away from the principle that majority shareholders can ratify breach of duties in all cases.

This judgment is a warning sign to directors, but also companies, that directors should abide by their duties, or else legal action by shareholders may not be far away.

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