The Cayman Islands continues to be a popular choice of domicile for companies seeking listings of their securities on the London Stock Exchange, AIM, NASDAQ, NYSE, HKSE and other public exchanges. The vehicle most often used for these purposes is the Cayman exempted company, and many technology companies and oil and gas exploration companies have been formed or re-organised with a Cayman holding company.

As a result we envisage an increase in M&A activity in relation to Cayman domiciled companies as more of these are listed on public exchanges and become targets of both trade buyers seeking growth by consolidation and private equity firms seeking opportunities in the emerging markets. The "public-to-private" private equity deal is now commonplace in almost every jurisdiction and the globalisation of the private equity buy-out firms will ensure these deals continue at a clip. We set out below an overview of the jurisdiction, the exempted company used as the listed vehicle, the common methods by which the exempted company may be acquired, and finally the advantages and disadvantages of these methods.

Legal system

Cayman as a jurisdiction has continued to be a popular choice of holding company for various reasons. The substantive law of the Cayman Islands is based on English common law with the addition of local statutes which have in many respects changed and modernised the common law. This gives Cayman Islands' law and legal system a common point of origin with those of many of the jurisdictions of its users, including the US. It also means that the fund vehicles and the types of securities which Cayman companies offer are well recognised and accepted around the world, and particularly in New York, London and Hong Kong.

The islands have a good legal and judicial system, which is constantly being upgraded to meet the demands of the financial industry. Practice and procedures in the Cayman Islands court system are also based on English law. Commercially significant civil litigation is tried by a judge sitting without a jury in the Grand Court of the Cayman Islands. The Grand Court is the superior court of record for the Cayman Islands. The Grand Court is currently composed of the Chief Justice and two permanent puisne judges. Visiting judges and senior lawyers, in particularly, from Jamaica, Canada and the Cayman Islands sometimes sit as acting judges.

Appeals from the Grand Court are to the Cayman Islands Court of Appeal, which usually sits three times each year. The ultimate appellate court is the Privy Council in England. The Cayman Islands have no direct taxes of any kind. There are no income, corporation, capital gains, withholding taxes or death duties. Under the terms of relevant legislation it is possible for the company to register with and apply to the Governor in Cabinet of the Cayman Islands for a written undertaking that it will not be subject to various types of direct taxation, for a minimum period, which in the case of a company is 20 years.

No exchange control restrictions or regulations exist in the Cayman Islands (unlike many other jurisdictions, including some of Cayman's offshore competitors). This means that funds can be freely transferred in and out of the Cayman Islands in unlimited amounts.

Exempted companies

Companies are almost always incorporated with limited liability, although it is possible to incorporate companies with unlimited liability or with liability limited by guarantee. The liability of a shareholder of a company incorporated with limited liability is limited to the amount paid up and agreed to be paid up on the shares taken by that shareholder. Shares of the same class in a company rank equally with each other. However, by appropriate adaptation of the Articles of Association (constitutional documents) of the company, it is possible to create separate share classes (or separate series within the same class). This may be necessary if different share classes are to be listed.

The vast majority of Cayman Islands companies issue shares of a stated par value (although no par value shares are permitted). The Cayman Islands legislation permits amounts standing to the credit of a company's share premium account to be used for dividends or other distributions, subject to the company being solvent, even if no profits are available. Shares in a Cayman Islands company may be redeemed or repurchased from capital, subject to the company being able to pay its debts as they fall due in the ordinary course of business. The statute applicable to such companies is the Companies Law (2007 Revision), which is based on the Companies Act 1948 of England and Wales, but substantially updated and modernised to cater to the offshore market conditions.

Acquiring a Cayman company

The two most common methods of acquiring a Cayman company listed on a recognised exchange are either an offer or merger by way of a scheme of arrangement, or a simple offer to acquire the shares of the company.

Offers by scheme of arrangement

A scheme of arrangement is a court-supervised procedure that provides great flexibility to companies seeking to re-organise their capital or to facilitate mergers, friendly takeovers, demergers, share for share exchanges and any number of other share transactions. A scheme of arrangement can also be used to facilitate a compromise with creditors. The process enables the company to utilise the statutory moratorium on the enforcement of claims by creditors while the directors or provisional liquidators (if already appointed) structure a proposal with the principal creditors to continue the company. Creditor schemes include debt for equity conversions and these types of schemes may become more common in the future in the event that some of the private equity acquisitions prove to have been leveraged too highly.

Takeovers by scheme of arrangement

A key point to note about a takeover by way of a scheme of arrangement is that this is a scheme of arrangement of the company (Targetco) subject to the offer or acquisition, and not that of the offeror. Targetco is principally responsible for preparing the shareholder circulars and setting the meetings with its shareholders and the conduct of the scheme of arrangement. A scheme of arrangement is therefore not an option for hostile takeovers. It requires the full cooperation of the board of directors of Targetco to ensure the takeover is implemented within the scheme of arrangement structure. For this reason, there is often a merger agreement between the offeror and Targetco setting out contractually the obligations of Targetco with respect to the conduct of the scheme of arrangement and timetable of the meetings and court hearings. The merger agreement will also provide for certain other matters such as break fees, composition of the board of Targetco, rights to terminate if a competing offer is made, and other commercial matters outside the scope of the scheme of arrangement documents.

The steps in relation to a scheme of arrangement are as follows:

1) Targetco applies to the Grand Court of the Cayman Islands to convene a meeting of the appropriate class or classes of shareholders. (Subject to the structure of the proposed scheme of arrangement, it is unlikely that creditors' consent will be required, as their interests will not be affected by the scheme of arrangement in a friendly takeover deal.)

2) The proposed terms of the scheme of arrangement are submitted to the Grand Court, setting out the terms and conditions of the scheme of arrangement, its effect, expected timetable, draft circular and draft proxies to be sent to shareholders.

3) The Grand Court will at the first hearing consider and determine the constitution of the relevant classes of shareholders (although it is the responsibility of the directors of Targetco to identify the relevant classes to the Grand Court) for voting purposes and consider whether the explanatory statement to shareholders contains sufficient information to allow the shareholders to make an informed decision on the proposed scheme of arrangement. This is a key hearing in the procedure as the Grand Court is required to make a preliminary determination as to the constitution of the relevant classes with the aim of ensuring that the proposed scheme does not falter at the second hearing.

4) The notices convening the meetings are sent and the proxies collected. If at each meeting of the relevant class a majority in number representing 75% in value present and voting at the meeting vote in favour of the scheme, the Grand Court will be asked at a second hearing to approve the scheme of arrangement.

5) At the second hearing, the Cayman counsel for Targetco will present evidence of the requisite approvals at the meetings and petition for approval of the scheme. If the Grand Court approves the scheme at the second hearing it becomes binding on all the shareholders of each class of Targetco who were required to vote for or against the scheme. Dissenting shareholders who voted at the relevant class meeting (and creditors if it is a creditor scheme) have rights of audience at the second hearing to present their concerns and objections.

6) If the Grand Court approves the scheme it becomes binding on all the members of the relevant classes.

7) The scheme will become effective upon registration with the Cayman Islands Registrar of Companies. (This is key. The timing of the filing is often contractually agreed on in the merger agreement to ensure that all other conditions to the acquisition are satisfied before filing – for example, regulatory/ anti-trust approvals.)

The timetable for a scheme of arrangement is typically between eight and 12 weeks from the first application to the Grand Court. Accordingly, from a deal timetable perspective, it may take several weeks of intense drafting and negotiations to agree the merger agreement and to draft the scheme documents, including draft circular, explanatory statement and proxies, before the Grand Court process is initiated. The disclosure requirements for the draft circular are, for all practical purposes, substantially the same under the Grand Court rules as they are for the relevant listing rules of the recognised public listing exchange.

Advantages

The scheme allows greater flexibility in the structuring of the takeover. It also reduces the deal risk of the takeover offer as, provided the requisite consents are obtained at the meetings, all the shareholders are bound by the scheme and their shares will be acquired. Thus, 100% of the shares of Targetco can be acquired with a much lower level of consent from shareholders than that by way of a takeover offer. Depending on the jurisdiction of listing of Targetco and the domicile of the offeror, there may also be significant stamp duty savings to proceeding by way of a scheme of arrangement rather than a tender offer.

Disadvantages

If Targetco receives an offer from another bidder after the scheme of arrangement has commenced through the Grand Court, it is likely that Targetco would be required to abandon the scheme and, subject to negotiations with the original offeror, start a new scheme with revised terms, thus adding several months to the timetable for completion of the acquisition. If material new information that should be disclosed to the shareholders becomes available mid-way through the scheme, the shareholder meetings should be adjourned to allow disclosure to be made or increase the risk that the Grand Court would not sanction the scheme without a further shareholder vote. A scheme of arrangement can only be used for takeovers that are friendly, as Targetco's full cooperation is required to ensure the scheme of arrangement is approved by its shareholders and by the Grand Court.

Despite these disadvantages, the scheme of arrangement has been a popular vehicle for takeovers of listed companies in Cayman.

Section 88

The most common alternative to the scheme of arrangement takeover is a tender offer for shares, and compulsory acquisition of minority shares held by dissenting shareholders pursuant to Section 88 of the Companies Law (2007 Revision) of the Cayman Islands. Unlike the UK, the Cayman Islands does not have a Takeover Code regulating the acquisition of securities of listed entities. Even though Targetco may be subject to certain rules and regulations because of the jurisdiction of listing of its shares, there will be no additional overlay of Cayman regulation with respect to the conduct of the tender offer. As a result, the offer to shareholders can comply with the timetables set by the jurisdiction of listing and can provide for terms that would allow the offeror to go unconditional at a minimum acceptance level of more than 50%. The "squeeze-out" provision allows the offeror to acquire the minority shares from those who do not accept the offer. If acceptances are received within four months of the holders's offer, of not less than 90% in value of the shares affected by the offer, the offeror may at any time within two months of the expiry of that four months give notice to the dissenting shareholders that their shares will be acquired. The dissenting shareholders have one month from the date of such notice to apply to the Grand Court to give reasons why the shares should not be purchased and the Grand Court has discretion to make any order it considers appropriate. However, it is highly unlikely that the Grand Court will interfere with the compulsory acquisition of the shares unless the dissenting shareholder in question has been treated differently from other shareholders of the same class. The form of the tender offer document will follow that used for offers of other companies listed on the same exchange as Targetco.

The advantages of this type of offer to shareholders are the speed at which the acquisition can be made and effective control of the target achieved. Even though the squeeze-out mechanics may take a number of months after the offer has gone unconditional in all respects, the offeror can commence de facto control of the board of directors of Targetco immediately. This ensures minimum disruption to the business. The offer route provides for greater flexibility as the offeror may revise the terms at any time to counter any competing offers by other bidders. The principal disadvantage is the knowledge that acceptances of at least 90% in value of the shares must be obtained before the squeeze-out provisions can be implemented to compulsorily acquire the remaining 10% of the shares. If less than 90% are acquired, Targetco may need to retain its listing and be subject to the continuing reporting obligations of the relevant exchange. Accordingly, unless the offer is likely to be very attractive to the shareholders it may be more prudent to approach the company and suggest a scheme of arrangement which will require a lower consent threshold to obtain 100% of the shares. However, if the offeror's approaches are unwelcome a tender offer will be the only method open to the offeror to achieve a hostile takeover.

Finally, a third option is technically open to achieve the acquisition of a Cayman company by way of migration and merger. At the time of writing, Cayman has not adopted a "statutory merger" regime similar to that of Delaware but the legal fraternity in Cayman eagerly anticipates its introduction. Notwithstanding, it is possible to migrate a Cayman company to another jurisdiction, which has a statutory merger regime. Once Targetco has migrated to the new jurisdiction, it can then comply with the statutory merger provisions of the new jurisdiction.

Although technically possible, this has not been seriously considered in the past for a number of reasons. It would be difficult for the board of directors of Targetco who owe a fiduciary duty to Targetco to recommend moving Targetco to a jurisdiction that may provide less protection from unsolicited offers than Cayman or diminishes the shareholders' control over the decision whether to accept the offer (by lowering the threshold for consent to the merger or takeover). In addition, the laws in the new jurisdiction may not be as well tested or the legal system and infrastructure as mature or as well served as in Cayman. Finally, the disclosure to shareholders, whose consent is required for the move, may be very difficult to present in a manner that otherwise suggests the reason for moving jurisdiction is to facilitate a sale of Targetco with a lower level of shareholder approval than would have otherwise been required by a scheme of arrangement.

As the Cayman Islands exempted company continues to be a popular vehicle for listed entities on foreign stock exchanges we anticipate more schemes of arrangements to facilitate these offers.

Author biography

Iain McMurdo Maples and Calder Iain McMurdo specialises in investment funds, with an emphasis on private equity and hedge funds. He also has significant experience in corporate finance and M&A.