Shareholder Irrationality (Almost) Reconsidered: a Missed Opportunity in China Agrotech?

There is, if I may say so, no obligation on a shareholder of a company to give his vote merely with a view to what other persons may consider the interests of the company at large. He has a right, if he thinks fit, to give his vote from motives or promptings of what he considers his own individual interest.” – Sir George Jessel, Master of the Rolls, Pender v Lushington (1877) 6 Ch D 70.

This statement embodies the orthodoxy that a shareholder’s voting rights are property rights, and that they can therefore be exercised in any way the shareholder pleases. But are voting rights truly unfettered, or will the law step in under certain circumstances? The issue arose recently before the Grand Court of the Cayman Islands in In re China Agrotech Holdings Limited (Unreported, 16 July 2019, Segal J). 

China Agrotech Holdings Limited (the Company) was a Cayman Islands company listed on the Hong Kong Stock Exchange. The Company was indisputably insolvent and, absent urgent debt restructuring, the share listing would be lost and it would be wound up with little or no return for creditors. Provisional liquidators were appointed to work with management to find a white knight investor and promote a compromise to the Company’s creditors. They were successful, and a restructuring was promulgated which found favour with creditors. A number of conditions precedent to the deal required special resolutions from the Company’s shareholders including that (a) the Company must reduce the nominal value of its shares (to eliminate accumulated losses and permit the issue of new shares), and (b) the Company must increase its authorised share capital (the Restructuring Resolutions). 

An extraordinary general meeting (EGM) was duly called to enable shareholders to vote on the necessary resolutions. It is not unusual for shareholders to play such a role in a company’s debt restructuring and, ordinarily, the necessary resolutions are passed without any fuss because, although shareholder interests will be diluted by the introduction of a white knight investor as a key equity holder, the reality is that a debt restructuring will allow the company to continue trading with the result that its business (and hence its shares) will retain some value. From a shareholder’s perspective, something – albeit a smaller percentage – is better than nothing.

In an unexpected twist, ahead of the EGM, a representative of a major shareholder (Perfect Gate) approached the Company’s management and informed them that Perfect Gate required a secret payment of a substantial sum of money in return for voting in favour of the Restructuring Resolutions. The initial demand was for HK$140 million, but the representative subsequently indicated that Perfect Gate would accept a lesser sum. The demands were rejected and the EGM was duly held.

At the EGM, 14,621,440 votes were cast in favour of the Restructuring Resolutions and 230,000,000 votes, being the shares voted by Perfect Gate, were cast against. A shareholder at the EGM objected to the votes cast by Perfect Gate being counted on the grounds that to vote against the resolutions was irrational. Another shareholder joined in the objection and gave an account of the ransom demands made by Perfect Gate. The original objecting shareholder then lodged an objection to Perfect Gate’s votes being counted on the grounds that they were improper. After due consideration, the Chairman of the EGM concluded, based on legal advice, that the votes of the 230,000,000 shares should not be counted and accordingly the Restructuring Resolutions were passed by the requisite majority.

The Company applied by way of Summons to the Grand Court of the Cayman Islands for declarations that the resolutions were validly passed at the EGM, or alternatively that Perfect Gate’s votes at the EGM be set aside and disregarded for the purpose of counting votes on the resolutions. At the hearing, the main issues were: (a) whether the Company’s articles of association gave the Chairman the power to decide if votes should be allowed or rejected, and (b) whether and how the Chairman’s exercise of such power could be reviewed and set aside by the Court.

In addition to these two issues, the Company had originally put forward a third ground in support of its application, namely that Perfect Gate’s votes ought to be disallowed on the basis that it had not voted in good faith, but had instead voted in a way that would destroy the economic value of other shareholders’ shares for no rational reason. The Company relied for this ground on the judgment of Mr Justice Harris of the Hong Kong Companies Court in Sunlink International Ltd v Wong Shu Wing [2010] 5 HKLRD 653. However, at the hearing of the Summons, the Company no longer relied on the ‘irrationality’ ground, and instead focussed its submissions on the Chairman’s power to disallow Perfect Gate’s vote.

The Company’s application was ultimately successful, and the Court upheld the Chairman’s rejection of Perfect Gate’s votes. The Court was not required to make a decision on the irrationality ground, although Justice Segal did express some tentative reservations as to whether the Grand Court would have followed Sunlink, had the issue fallen to be decided. He did so in the following terms:

It seems to me that the principle justifying the rejection of a vote on the basis of irrationality (particularly a negative vote) by a shareholder [...] requires further elucidation and analysis. I accept that the authorities indicate that bad faith may in some cases be inferred where a shareholder reaches a decision which no reasonable shareholder could properly reach but it is far from clear that a bad faith vote can be disallowed unless the shareholder is otherwise subject to a restriction which requires him to have regard to others’ interests.” (at para. 79(f)).

Justice Segal also cited an article by Hong Kong barrister William Wong SC in the Law Quarterly Review that analysed the reasoning in the Sunlink decision (see Can shareholders vote irrationally?, (2011) 127 LQR 522). Mr Wong had successfully appeared on behalf of the Plaintiffs in Sunlink. In the article, which is considered below in more detail, Mr Wong praised Harris J for reaching the correct decision in Sunlink but also questioned whether irrationality is a suitable criterion by which to determine the validity of a shareholder’s vote.

At the heart of the issue is the established principle that a shareholder’s vote is a property right that may be exercised (or not) in the shareholder’s own interest as he thinks fit. The principle was conveniently summarised by Walton LJ in Northern Counties Security Ltd v Jackson & Steeple Ltd [1974] 1 WLR 1133 (Ch) as follows:

I think that in a nutshell the distinction is this: when a director votes as a director for or against any particular resolution in a directors’ meeting, he is voting as a person under a fiduciary duty to the company for the proposition that the company should take a certain course of action. When a shareholder is voting for or against a particular resolution he is voting as a person owing no fiduciary duty to the company and who is exercising his own right of property, to vote as he thinks fit.

While the characterisation of a shareholder’s voting rights as proprietary in nature is settled law, a shareholder’s right to vote “as he thinks fit” is not absolute. A number of prominent and long-standing exceptions to the general rule exist. These include limitations on votes to alter a company’s articles of association (Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656), to vary class rights (British America Nickel Corpn Ltd v O’Brien [1927] AC 369) and to ratify breaches of directors’ duties (Cook v Deeks [1916] UKPC 10).

Furthermore, the circumstances in which it will be appropriate for the Court to depart from the general rule are not fixed. In Clemens v Clemens Bros Ltd and another [1976] 2 All ER 268, Foster J considered whether there existed a limiting principle that must be applied before interference with a shareholder’s vote could be justified:

“I think that one thing which emerges from the cases to which I have referred is that in such a case as the present Miss Clemens is not entitled to exercise her majority vote in whatever way she pleases. The difficulty is in finding a principle, and obviously expressions such as ‘bona fide for the benefit of the company as a whole’, ‘fraud on a minority’ and ‘oppressive’ do not assist in formulating a principle.

I have come to the conclusion that it would be unwise to try to produce a principle, since the circumstances of each case are infinitely varied. It would not, I think, assist to say more than that in my judgment Miss Clemens is not entitled as of right to exercise her votes as an ordinary shareholder in any way she pleases. To use the phrase of Lord Wilberforce, that right is ‘subject ... to equitable considerations ... which may make it unjust ... to exercise [it] in a particular way’.” (at 282)

After reviewing the authorities, Harris J concluded that the Court could and would “intervene to prevent a shareholder voting in a way which will result in the destruction of the economic value of other shareholders’ shares for no rational reason”. Following Clemens, this approach can be defended as a perfectly legitimate exercise of the Court’s equitable discretion to interfere with a shareholder’s vote according to the circumstances of the case.

The next question is: when is it appropriate for the Court to interfere? In his article in the Law Quarterly Review, Mr Wong exhibited scepticism regarding the test applied by Harris J: “it is not at all clear that ‘absence of rational basis’ or ‘irrationality’ per se is a correct satisfactory test for fettering a shareholder’s right to vote. This formulation creates more questions than it answers”. Indeed, there is force in the argument that rationality by itself is both too broad and too imprecise to serve as the test for these purposes.

The English High Court case of Standard Bank v Walker [1992] 1 WLR 561 Ch D presents a possible solution. Walker concerned the granting of a Mareva injunction to prevent a shareholder from voting against restructuring proposals in a way that would amount to the dissipation of their economic value. It was cited by Mr Wong both in his submissions in Sunlink and in his subsequent article, although Harris J declined to follow it in Sunlink owing to differences in the respective factual matrices. Nonetheless, the justification given by Vinelott J in Walker for the Court’s exercise of its Mareva jurisdiction is worth revisiting:

“To my mind, opposing or in any way obstructing the reconstruction proposals would be so pointlessly harmful that, whatever motive inspired it, it would amount to the wilful dissipation of assets which the court has jurisdiction, consistently with the Mareva principles, to prevent” (at 566H).

A new test to replace irrationality can be proposed along similar lines. This test differs from that of irrationality as it concerns the objective effect of the shareholder’s vote, rather than the shareholder’s motive. For the Court to interfere with a shareholder’s right to vote, the intended vote would have to be “pointlessly harmful” to the interests of other shareholders (and, in an insolvent context, creditors) of the company, for example if the vote would destroy the economic value of their shares.

There are a number of virtues to this approach. Firstly, by avoiding investigation into a shareholder’s motives, it offers greater certainty than any assessment of rationality could. Secondly, the test would likely be satisfied only in extreme or unusual cases, thus limiting the potential infringement of shareholders’ rights. The amended test would, however, offer valuable protection to stakeholders in the restructuring and insolvency situations similar to that in China Agrotech

Finally, an updated legal test of the kind proposed above would allow for the interests of creditors of the company to be considered in an insolvent context, which would not be the case if the Court were to judge solely whether the shareholder had voted rationally. A test able to accommodate the interests of creditors where a company is insolvent, and particularly where the vote in question pertains to a potential restructuring or other rescue proposal, would be welcome.

The issues considered in Sunlink and (obiter) in China Agrotech are of general importance to the field of restructuring and insolvency. There is a clear line of common law authority in support of the Court’s jurisdiction to interfere with shareholder votes under specific circumstances, and the general principles of Sunlink can be followed in this regard in the Cayman Islands and elsewhere. In response to the (valid) criticisms of the irrationality-based test in Sunlink from William Wong SC and Justice Segal, it is suggested that a solution can be found in a refined test inspired by the criteria applied in the Mareva context in the case of Walker. 

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Managing Partner, Harneys’ Asia
Leading offshore litigator, senior tactician and thought leader

Ian specialises in restructuring, insolvency, shareholders’ disputes and contentious trusts and has extensive experience in cross-border and conflict of laws dilemmas. He has been involved in every major recent restructuring involving offshore entities in the region and some of Asia’s highest value contentious estate litigation.
Ian is consistently recognized as a leading lawyer in Chambers, Legal 500, Who’s Who Legal and Global Restructuring Review. He was also selected to appear in Citywealth’s Top 100 trust litigators in 2020 and has featured in ALB’s Offshore Client Choice List for the last five years.

Member, Harneys’ Litigation and Restructuring Team

James Granby is a member of Harneys’ Litigation and Restructuring team in Hong Kong. James’ practice involves a broad range of offshore commercial litigation, including shareholder disputes, insolvency and contentious trusts. James also has experience advising and acting in contentious and non-contentious probate matters, including those with a multi-jurisdictional element. Prior to joining the Firm in 2017, James practised for several years as a chancery and commercial barrister at the English Bar.