Grand Court decides on fair value determination in merger case

There have been a number of interesting developments in the Cayman Islands’ legal scene during the third quarter of 2015.  

This quarter, of particular note, are, firstly, a recent decision of the Grand Court considering the principles to be applied for “fair value” appraisal of merger dissenting shareholders, secondly, the critical steps being taken by the Cayman Islands’ government to implement the OECD’s Common Reporting Standard and its implications for Cayman Islands entities, thirdly, amendments being proposed to, inter alia, the Mutual Funds Law to create a Cayman Islands regulatory regime for investment funds and managers consistent with the standards of regulation under the European Union’s Alternative Investment Fund Manager Directive and, finally, a new Maritime Services Park has been created in the Cayman Islands’ Special Economic Zone. 

In the courts 

On Aug. 28, 2015, the Grand Court had an opportunity to give judgment in an appraisal action brought by dissenting shareholders in a statutory merger transaction under Part XVI of the Cayman Islands’ Companies Law. Although there is nothing new or surprising in the judgment, it nevertheless provides welcome guidance and confirmation of the principles to be applied in an appraisal action, whilst recognising that the valuation exercise is fact specific and each case will be decided upon its own facts.

In the Matter of Integra Group (Jones J, Cause No. FSD 92 of 2014) a management buyout was effected by means of a statutory merger, and a price was set of US$10 per share after consideration by an independent committee and a fairness valuation.  Shareholders dissented and the appraisal remedy was triggered.

The first point to note in connection with the proceedings is that each party appointed their own valuer to provide expert evidence to the court. This would be the normal practice in the Cayman Islands, rather than appointing a single joint expert.

In order to provide a valuation, each expert required access to a large volume of corporate information and for this purpose an electronic data room was established with the intention that all relevant material would be uploaded so as to be available to the experts and the legal advisers, subject to appropriate undertakings of confidentiality.

The court was critical of the company’s management in not complying, by refusing to upload material on the basis that they considered it irrelevant. Ordinarily one would have expected that an application to court would have been made, but apparently this was not done and so there was material requested by one expert that had not been provided, to which the court said “there was no means of knowing whether material withheld by Integra’s management might have affected the experts’ judgment in any way.” The experts also conducted interviews with the company’s management.

In terms of the expert reports provided to the court, the court was critical of one expert who produced a range of valuations which the court said “was not particularly helpful.”

The court rejected the use of the accounting definition of “fair value” as it appears in the International Financial Reporting Standards as being irrelevant and not informative, but looked to the definition provided by the International Valuation Standards (2013).
The court looked to jurisprudence in both Canada and Delaware, and a number of applicable propositions were derived:

  1. The relevant date was the date immediately prior to the approval of the merger, that is, the date of the extraordinary general meeting.
  2. The business was to be valued as a going concern.
  3. The effect of the merger itself should be disregarded, whether positive or negative.
  4. There should be no premium for the forcible expropriation of the shares by the merger.
  5. There should be no minority discount.
  6. 6There is no set valuation methodology to be used.  Fair value can be proved by any admissible evidence according to any techniques or methods generally considered to be acceptable in the financial community.

The Court recognized that there are three generally accepted approaches to valuation:
(a)    The market approach;
(b)    the income approach; and
(c)    the cost (or asset based) approach.

The approach used may differ from one case to another. In the case before it, the court accepted an approach which combined an income approach using a discounted cash flow methodology, with a market approach using a guideline public company methodology with a weighting of 75 percent/25 percent in favor of the income approach.

The court did however remove from the calculation the cost saving of going private because the dissenters should not benefit from any enhancement in value attributable directly to the transaction they dissented from. In the end the court awarded the dissenters US$11.70 per share as opposed to the merger price of US$10 per share.

In addition the court awarded a “fair rate of interest” as being the midpoint between the company’s assumed rate of return on cash and its assumed U.S. dollar borrowing rate.
The decision is of significance to all parties involved in mergers and buyouts of Cayman Islands’ companies and provides much anticipated guidance on the determination of “fair value” under Part XVI of our Companies Law.

OECD Common Reporting Standard 

The Cayman Islands’ Department of International Tax Cooperation announced in June 2015 that it will implement the OECD’s Common Reporting Standard (CRS) through the introduction of domestic law in the Cayman Islands, by October 2015.

Over 60 jurisdictions, including the Cayman Islands, have committed themselves to exchanging tax information automatically under the CRS and are due to exchange the first round of information under CRS by the end of September 2017. By 2018, the number of participating jurisdictions is expected to nearly double. The CRS is another example of Cayman’s commitment to promoting international tax transparency.

The CRS, published by the OECD in 2014 and endorsed by the G20 finance ministers, is designed to stop tax evasion in respect of financial assets held in foreign accounts. The CRS reporting mechanism is broadly similar to the UK FATCA model1 and the focus is on reporting tax residency. Once implemented in Cayman, the CRS will require “reporting financial institutions” (RFIs), as defined in the CRS, to conduct due diligence on their accountholders and investors and report certain information to the Cayman Islands Tax Information Authority (TIA), for automatic exchange with other tax authorities. Non-compliant RFIs may incur financial penalties and other sanctions under domestic law.

The mechanism for information exchange under the CRS is provided for in a model Multilateral Competent Authority Agreement. The MCAA builds on existing frameworks for the exchange of tax information such as the OECD Convention on Mutual Administrative Assistance in Tax Matters, to which the G20 countries and most major international financial centers, including the Cayman Islands, are parties.

Due diligence and account classification 

For due diligence purposes, the CRS is similar to FATCA in distinguishing between individual and entity “financial accounts” and between “pre-existing accounts” (opened on or before Dec. 31, 2015) and “new accounts” (opened on or after Jan. 1, 2016). Due diligence procedures for identifying high value pre-existing individual accounts are to be completed by Dec. 31, 2016, and due diligence procedures for identifying lower value pre-existing individual accounts and for entity accounts are to be completed by Dec. 31, 2017.

It is anticipated that the first reporting to the DITC will be required on or about May 31, 2017.

Preparing for CRS 

To prepare for CRS adequately, Cayman RFIs may wish to take the following actions in 2015.  Such issues will have been considered previously as regards FATCA and UK FATCA but many RFIs will need to update their documentation and procedures to some degree.

Review “pre-existing accounts”: All pre-existing individual accounts will require to be reported on. RFIs – and particularly RFIs which maintain numerous financial accounts – may wish to begin reviewing AML/KYC and other information currently held on file and, if necessary, contact accountholders to update information. Equally, when opening new accounts in 2015, RFIs may wish to gather all relevant information at the outset, so as to be as prepared as possible for CRS.

Prepare new account-opening policies: From Jan. 1, 2016, RFIs will be required to gather self-certifications from all new accountholders (or their controlling persons, as defined in the CRS), particularly as regards tax residence. Consideration should be given as to how this legal requirement can be effectively incorporated into existing “on-boarding” procedures, including for AML/KYC purposes. 

Review and update documentation: Subscription or similar agreements should be updated to ensure CRS compliance costs are allocated appropriately and to require accountholders to represent and undertake: (i) that they will co-operate with the RFI in complying with its CRS obligations and provide information requested in a timely manner; and (ii) that they will comply with their own domestic tax obligations as regards their interests in or accounts with the relevant RFI.

RFIs may wish to require accountholders to indemnify them against any costs or liabilities incurred by the RFI as a result of such representations and undertakings being false or breached and also to limit any potential liability to their accountholders resulting from CRS.  RFIs may also consider including provisions in their documentation enabling them to redeem interests or close accounts where accountholders are recalcitrant or non-cooperative or where the nature of the accountholder would give rise to excessive costs or liability for the RFI.

Any offering documents should be updated to ensure the RFI’s CRS obligations and any associated risks are adequately disclosed to accountholders in accordance with applicable regulatory requirements.

While the implementation of CRS will likely increase the cost and regulatory burden for RFIs, it is a further demonstration of the willingness of the Cayman Islands to participate in international tax cooperation. Further consideration will be given to the Cayman Islands implementation of the CRS as the domestic legislative process evolves over the remainder of this year.

New AIFMD regime for Cayman Islands investment funds and managers 

Cayman Islands based investment funds and investment managers are regulated by the Cayman Islands Monetary Authority under the Mutual Funds Law (MFL) and the Securities and Investment Business Law (SIBL) respectively.

The Cayman Islands government has recently passed amendments to these laws2 in order to create a Cayman Islands regulatory regime which is consistent with the standards of regulation under the European Union’s Alternative Investment Fund Manager Directive (AIFMD)3.

It is hoped that by introducing a regime in the Cayman Islands, which is consistent with the AIFMD, the European Securities and Markets Authority and European Commission will consider the Cayman Islands for an AIFMD passport extension when it completes its country by country review, perhaps later this year4.

Currently, Cayman Islands entities are able to operate within the national private placement regime under the AIFMD but this regime is anticipated to remain in place only until 2018.

Amendments to the Mutual Funds Law 

It is anticipated that the proposed amendments to the Mutual Funds Law will facilitate the management and marketing of Cayman Islands investment funds under the AIFMD in the European Union member states.5

The amendment to the MFL will introduce a concept of an “opt in” designation as a regulated “EU connected fund”, being an investment fund (whether open-ended or closed-ended) carrying on business in or from within the Cayman Islands which: (i) is either managed by a person whose registered office is in a member state or marketed to investors or potential investors in a member state of the European Economic Area, as contemplated under AIFMD, and (ii) elects to fall within the Cayman AIFMD regime.

Amendments to the Securities Investment Business Law 

It is anticipated that the amendments to SIBL will allow the regulation of a Cayman Islands investment manager who manages an EU connected fund, markets the shares, trust units or partnership interests of an EU connected fund or acts as a depositary of an EU connected fund.

The proposed amendments to SIBL will introduce a concept of an “opt in” designation as a licensed “EU connected manager”, being a person who: (i) falls within the existing scope of SIBL; (ii) conducts management, marketing or depositary activities for an EU connected fund, as contemplated under AIFMD; and (iii) elects to fall within the Cayman AIFMD regime.

Who can elect to be under the Cayman AIFMD regime? 

It is proposed that: (i) both open-ended and closed-ended EU connected funds will be able to elect to be regulated by CIMA under the Cayman AIFMD regime; and (ii) EU connected managers will be able to elect, notwithstanding they may be “excluded persons” under SIBL, to become fully licensed under SIBL and be subject to the Cayman AIFMD regime.
What will the regulatory standards of the new Cayman AIFMD regime be?

In addition to the foregoing, new regulations will be made under the MFL and SIBL that will set forth new regulatory standards, consistent with AIFMD, to be followed by regulated EU Connected Funds and EU Connected Managers, respectively.  These new regulations are expected to be released shortly after the amendments to the MFL and SIBL come into force.

Cayman AIFMD regime will be optional 

As the new Cayman AIFMD regime is optional for Cayman Islands investment funds and investment managers, there will be no change to the normal regulation of Cayman Islands investment funds and investment managers who do not elect to fall within the Cayman AIFMD regime.

It is hoped that this new Cayman AIFMD regime will place the Cayman Islands in a favorable position for consideration by the ESMA and the EC as a country eligible for an AIFMD passport extension in relatively short order.

Special economic zone creates new Maritime Services Park 

The Cayman Islands is the global leader for mega-yacht registrations. Intent on bringing shipping companies and maritime service providers to Cayman, the special economic zone in the Cayman Islands has recently created the Cayman Maritime Services Park. 

The SEZ is a special economic zone established in the Cayman Islands, for which government concessions have been made, in order to stimulate economic growth. The principal statute governing the formation and operation of SEZ companies is The Special Economic Zone Law (Revised). Among other advantages, a company located in the SEZ will benefit from guaranteed protection of intellectual property and will be exempt from direct or indirect taxes, certain import duties and fees and work permit requirements.  

Originally created in 2011, the SEZ has grown rapidly and now comprises seven parks: (1) the Cayman Internet Park; (2) the Cayman Science and Technology Park; (3) the Cayman Media Park; (4) the Cayman Commodities & Derivatives Park; (5) the Cayman Outsource Park; (6) the Cayman International Academic Park; and (7) the Cayman Maritime Services Park. 

The Cayman Maritime Services Park has been designed to attract further maritime services businesses to the Cayman Islands, including the following types of entities: ship owners, shipbrokers, shipping financiers, technology companies engaged in innovative maritime research and development, offices of maritime industrial businesses, yacht manufacturing and repair businesses, companies involved in demurrage calculation and post deal expenses calculation, freight trading and brokerage businesses, crew salaries and benefits processing companies, bunker brokerage companies, shipping operations, logistics planning and vessel management companies and other specialized services to maritime sector businesses, who can all now move their operations to the Cayman Islands under the SEZ regime.

The addition of this latest park enhances the offerings of the Cayman Islands SEZ and it is hoped that, going forward, this will generate significant additional maritime services business for the Cayman Islands.

Conclusion 

As we move into the final quarter of 2015 we expect to see further developments with respect to local implementation of the CRS and the Cayman AIFMD Regime. We will consider these and other key legal developments, in the Cayman Islands context, in the next installment of Law Talk.

Endnotes:

  1. We have discussed in detail the foreign account tax compliance provisions (“FATCA”) of the Hiring Incentives to Restore Employment Act, 2010 of the United States of America and the equivalent reporting regime of the United Kingdom (“UK”) in relation to UK tax residents (“UK FATCA”) in earlier versions of Law Talk.
  2. The Mutual Funds (Amendment) Bill, 2015 and The Securities Investment Business (Amendment) Bill, 2015 were each issued in the Cayman Islands Gazette on Friday 10 July 2015.
  3. The Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.
  4. A recommendation was made by the ESMA to the EC on 30 July 2015 to defer the extension of AIFMD passports until ESMA has been able to prepare and deliver advice on a sufficient number of countries.  The actual decision on extension of an AIFMD passport to any country is that of the EC rather than ESMA.  While it was originally anticipated that the EC may make some announcements in this regard in October 2015, if it follows ESMA’s advice, this is likely to be delayed.
  5. Member State for this purpose means a state which is a member of the EU or a part of the European Economic Area in which the AIFMD has been implemented.
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Tania Dons

Tania advises on all areas of corporate and commercial law but with a particular focus on establishing and advising hedge funds and private equity funds and related regulatory matters. Tania has over 12 years of legal experience and represents major institutions, investment banks, fund managers, directors and trustees in all aspects of investment funds, including structuring and ongoing operations. Tania regularly advises on fiduciary duties, side letters, managed accounts, managing illiquid assets and other key issues facing investment funds.

Tania Dons
Partner/Shareholder
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T. +1 (345) 814 7766
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