Directors: exercise your powers properly or risk having your transactions overturned

Introduction

In the case of IsZo Capital LP v Nam Tai Property Inc & others¹  the BVI High Court found that a private placement of shares in the Defendant company was made for an improper purpose and therefore void.

Background

The Claimant (“IsZo”) is an investment fund and minority shareholder in the First Defendant (“Nam Tai”), a property development company listed on the New York Stock Exchange. Although incorporated in the BVI, Nam Tai’s business is conducted in the People’s Republic of China. Nam Tai’s largest shareholder is Kaisa Group Holdings Ltd (“Kaisa”), a PRC-based holding company of a number of businesses including a large property development arm, whose shares in Nam Tai were held through Greater Sail (a wholly owned indirect subsidiary of Kaisa). 

A disagreement arose regarding the way in which the business was being run. IsZo’s view was that Nam Tai should realise the profits from existing valuable land that it held in Shenzhen (which it had acquired very cheaply whilst the area was still underpopulated and rural) in order to buy back shares. By contrast, the view of the current management, however, was that Nam Tai should develop a long-term business of property development and engage in further acquisitions in this regard. IsZo considered that Kaisa’s control over the board was motivating this strategy.

In May 2020, following Nam Tai having made a major acquisition of land which used up most of its cash reserves, IsZo published an open letter to shareholders criticising the current management of Nam Tai. The letter suggested that the share price had fallen as a result of “ruinous leadership, abrogation of corporate governance and haphazard capital allocation strategy under the direction of a Kaisa-controlled management team and Board” and warned that if Nam Tai “continue[d] to recklessly deploy capital while ignoring opportunities to monetize existing assets, [its] intrinsic value [would] be in jeopardy.”

Thereafter, on 11 September 2020, on behalf of a group of Nam Tai shareholders supportive of IsZo (the "Requisitioning Shareholders"), IsZo served a requisition on Nam Tai to hold a special meeting of shareholders to consider resolutions removing five directors alleged to be associated with Kaisa and to replace them with new, independent directors (the "Requisition"). As at the date of the judgment, Nam Tai had not called that meeting.

On 5 October 2020, following the Requisition (and on IsZo’s case in order to thwart its purpose), Nam Tai placed, by way of a PIPE (a private investment in public equity), US$175 million worth of newly issued shares. Shares to the value of: US$150m were placed with Greater Sail; and US$25m were placed with West Ridge (an independent company, but one alleged to be supportive of Kaisa); Nam Tai's other existing shareholders were not given the opportunity to acquire shares pursuant to the PIPE.

The proceedings

In response to the PIPE, on 13 October 2020, IsZo issued proceedings in the  BVI High Court seeking, amongst other things, a declaration that: (1) the purported allotment of shares to Greater Sail and West Ridge pursuant to the PIPE was void and should be set aside and Nam Tai's share register rectified accordingly; and (2) a direction that Nam Tai hold the special meeting pursuant to the Requisition.

IsZo’s case was that Nam Tai’s board of directors' decision to undertake the PIPE was taken for an improper purpose, namely, to increase Kaisa’s control over Nam Tai in order to extinguish the risk posed by the Requisition and to ensure that the company remained under Kaisa’s control, and was not in Nam Tai's best interests.

Nam Tai’s position was that the PIPE was required in order to raise funds to save the company from a liquidity crisis which had allegedly arisen as a result of threats made by certain lenders. Those threats, it was said, resulted from nervousness about the business’s prospects in light of IsZo’s open letter. 

A settlement was subsequently reached with West Ridge but the claim continued against Nam Tai and Greater Sail.

The decision

The Court, which heard the claim on an expedited basis, with judgment handed down on 3 March 2021, held that in undertaking the PIPE, Nam Tai’s board of directors had not acted in the interests of the company but rather for the benefit of Kaisa, namely, to give Kaisa de facto control in order to defeat the Requisition. They had therefore breached their fiduciary duty to: (1) act in Nam Tai’s best interest under s.120(1) of the BVI Companies Act 2004 (the "Act"); and (2) exercise their powers for a proper purpose under s.121 of the Act.

There were only two possible alternatives advanced by the parties. Either the PIPE was intended to: (1) save Nam Tai from a liquidity crisis (Nam Tai and Greater Sail’s case); or (2) increase Kaisa’s control over the company in order to defeat the requisition (IsZo’s case). It was not in dispute that the second of these alternatives would have constituted an improper purpose for the purposes of s.121 of the Act.

The Court was therefore required to carry out a factual enquiry in order to establish the directors’ motivations for undertaking the PIPE. The enquiry was largely a subjective one – directors must exercise their discretion bona fide in what they consider to be in the company’s best interests. However, there is an objective element to the test, namely that the courts will look for independent, objective evidence to test a director’s claim that he or she acted bona fide. If the majority of a board follow the instructions of a single director without exercising independent judgment then the motivation of the single director should be imputed to the other directors.

In reaching its conclusion that the directors’ motivation was to ensure that the Requisitioning Shareholders did not succeed in their efforts to change the composition of the board, the Court considered the following facts to be of particular relevance:

• The PIPE was first considered before any of the banks had made any demands for repayment;
• Nam Tai had exaggerated the threats posed by the lenders and there did not appear to be any realistic prospect that the banks would call in their loans. Further, even if they did, it appeared that Nam Tai would have had the funds to repay those loans. There was, therefore, no urgent liquidity crisis;
• Advice from Nam Tai’s lawyers failed to mention a number of key issues and a presentation given to the board appeared to be designed to create the (false) impression that the lenders posed a genuine risk from a liquidity perspective;
• Further, the lawyers had deliberately chosen not to keep attendance notes on the grounds that they might ultimately be discoverable (legal professional privilege did not apply as against Nam Tai's shareholders). The Court inferred from this that the lawyers were preferring the interests of those instructing them (i.e. Nam Tai’s board of directors), over their true client, the company (and, by extension, its shareholders);
• Nam Tai did not appear to have given any real consideration to alternative means of raising funds, even though a number of alternatives were available, such as a rights issue, which would have been far less prejudicial to non-Kaisa shareholders (who as a result of the PIPE were denied majority control of Nam Tai); and
• In addition to a wealth of evidence that the directors were not independent and were concerned to ensure that Nam Tai remained a ‘fiefdom’ of Kaisa, the Court found them to be unreliable witnesses. They were evasive, failed to give direct answers to simple questions in cross-examination and were deliberately misleading as to their relationship with Kaisa.

The Court considered that, in light of this, the allotment of shares to Greater Sail was void (as opposed to voidable)².

Notwithstanding this, in the first instance, no order was made for repayment of the US$150m paid for the shares which it acquired in the PIPE (the "GS Amount"), as Nam Tai's position throughout the proceedings was that but for the PIPE it would be insolvent. By contrast, an order was made restraining Nam Tai's board from returning the GS Amount to Greater Sail pending a special meeting of shareholders, which Nam Tai was ordered to convene in accordance with the Requisition as soon as reasonably practical. The Court also noted that Nam Tai's new board (if there is one) might be entitled to pursue claims to recover its own costs, and costs which it was ordered to pay IsZo, from Greater Sail.

Commentary

What constitutes an improper purpose?

The duty under s.121 of the BVI Companies Act 2004 is analogous to the duty under s.171(b) of the Companies Act 2006, which partially codified the pre-existing common law position and provides that a director must “only exercise powers for the purposes for which they are conferred”. This case is a salutary reminder of the potential consequences of breaching that duty (which in this case have exposed Greater Sail, and by proxy Kaisa, to a potentially significant loss).

Cases on improper purpose before the English Courts are relatively rare, but they do arise, particularly in the context of allotment of shares. There is a line of English (and other Commonwealth) authorities which suggest that if a power to issue shares is used to affect the voting structure of a company, rather than for the purpose of raising capital, that will be considered an improper purpose. In the case of Hogg v Cramphorn and others³, for example, the Court found that the issue of shares for the purpose of preventing a proposed takeover was void. Similarly, in Howard Smith Ltd v Ampol Petroleum Ltd⁴, a company had issued shares in order to defeat a hostile takeover and this was held to be an improper purpose.

More recently, in Eclairs Group Ltd and Glengary Overseas Ltd v JKX Oil & Gas Plc⁵, a company served notices on two minority shareholders pursuant to s.793 of the Companies Act 2006 requiring them to give disclosure of the parties who held the beneficial interest in their shares. The company then served notices on the shareholders restricting their voting rights for failure to give full disclosure. The Supreme Court reinstated the decision of the trial judge (which had been overturned on appeal) that the restriction notices had been issued for an improper purpose, namely, to prevent the minority shareholders from acquiring control over the company.

Minimising the creation of disclosable documents or improperly withholding information from shareholders?

Separately, the Court was heavily critical of Nam Tai’s lawyers’ approach in relation to the manner in which their advice to the company was recorded. The judge considered that Nam Tai’s lawyers’ decision not to keep a paper trail was likely to have been made in order to avoid having to disclose their advice to their ‘true’ clients (i.e. the shareholders in Nam Tai), and that if that was the context, it constituted a “grievous breach of the most fundamental imperatives of legal ethics, to act in the best interests of the client with honesty and integrity”.

In addition to the analysis on improper purpose, this case, although BVI authority, serves as a useful reminder of the English law principle that a company cannot generally claim legal professional privilege as against its own shareholders, save in the case of advice relating to a dispute between the company and a shareholder.

The advice in question in this case related to the risks posed by the lenders and to the PIPE, rather than the dispute between IsZo and Nam Tai. This exception did not, therefore, apply, hence the Court's serious expressions of concern. In light of those concerns, the Court ordered a copy of the judgment be sent to the senior partners of each of Nam Tai’s lawyers so that they could consider the ethical issues raised.