During our interview with Jerome McDonagh and Eddy Lee at MDD, we discussed the key issues and considerations relating to shareholder disputes in Hong Kong and Singapore. This Q&A examined the causes of disputes, prominent trends in this space, effective strategies for parties, potential consequences of disputes, and options for minority shareholders.
Shareholder’s Disputes
Is the number of shareholder disputes in your jurisdiction increasing? What are the main causes of these disputes?
In Hong Kong, the number of disputes has remained steady in the last few years, with the HKIAC typically dealing with around 500 arbitrations per year. In Singapore, there has been a substantial increase in disputes, with the SIAC reporting over 650 new cases in 2020, up from 479 in 2019. Of these disputes a substantial number involve shareholder disputes. Given Singapore and Hong Kong were ranked joint 1st and 3rd respectively as preferred seats of arbitration by the Queen Mary International Arbitration Survey, we see this region as a major hub for resolving shareholder disputes.
Ultimately a shareholder dispute is a breakdown in a relationship, whether this is between management and shareholders, or rival shareholders who can no longer work together. These breakdowns can be due to commercial, political or even personal reasons. One common reason for this in Hong Kong is many companies are family owned with studies showing that just over 80% of listed companies are family owned and family feuds can often result in legal disputes.
Typical examples of incidents that cause a shareholder dispute include a majority shareholder’s or management’s actions to oppress the minority shareholders (such as diluting the minorities’ shareholdings), concerns over management conduct (such as fraudulent actions or misappropriating the company’s assets), and disputes arising from a sudden transfer of shares to a 3rd party (such as when the company’s shares are held as security for debt obligations, and the lender takes control of the secured shares as the debt obligations are not fulfilled).
Are there any notable or high-profile shareholder disputes that have caught your attention recently? Why were these cases important to the market?
Toshiba’s president and CEO Tsunakawa Satoshi recently resigned due to disputes with the company’s shareholders over the company’s restructuring plans to split into 3 separate entities. This plan was subsequently revised to only involve the split into 2 entities. This is the latest twist in an ongoing saga for Toshiba since 2015, when it admitted to accounting malpractices and overestimating its pretax profits by USD 2 billion. Since then, the company has had to incur large write-downs of its US nuclear business and sell off its profitable chip business. Furthermore, a shareholder commissioned investigation found that the company colluded with Japan’s trade ministry to block overseas investors from gaining influence at its 2020 shareholder meeting.
The high-profile nature of the dispute, and the ongoing issues Toshiba faces from its shareholders raises interesting questions from the perspective of a business valuer. One question that would be of concern to shareholders, is how will the values of the new spun-out entities be determined, and if they are to be listed, what is the IPO price for these new listings? This example also highlights the long duration of these sorts of disputes. Elliott Investors, the activist investment fund took a position in Toshiba in 2017, and with the restructuring plan still being discussed, it could be quite some time before shareholders like Elliott are able to realise a return on their investment.
What actions should parties take at the onset of a shareholder dispute? What would you consider to be an effective strategy for quick resolution?
Parties should be clear on what potential outcomes are achievable when a dispute begins to arise. As a minority shareholder, they should have a clear understanding of the value of their shareholding. Conversely, if the management of a company is looking to remove a shareholder, they should identify what they are able to offer for those shares. When trying to assess the value of the shares, shareholders should be aware that, for profitable trading entities, the value of the firm is typically far greater than the net assets reported on the company’s balance sheet. This is where valuation professionals can provide advice regarding the true fair market value of a company.
In addition to seeking professional advice on the values of these shares, parties should begin to collate documents to assist their legal and valuation advisers. This can be challenging to shareholders who are not involved in the management of the target company as the books and records of the company would not be readily accessible to them. Of course, in most jurisdictions, shareholders can demand to inspect the books and records of the company, though this can take time to make the necessary legal applications. Therefore, in anticipation of a shareholder dispute, even small steps such as attending the company’s AGMs, or EGMs is still worthwhile. This can enable shareholders to understand the company’s operations, note objections to any oppressive actions, and collect documents issued (such as the audited financial statements of the Company). We often find for some disputes, with emotions running high, the minority shareholder may refuse to attend meetings due to their antipathy towards the company’s management or other shareholders. While this attitude is understandable, ultimately it may be costly for them in the future when they have an incomplete picture of the company’s operations.
From a valuation perspective, a professional valuer would require the company’s financial records to begin preparing a valuation, and any additional documents that would enable them to understand the company’s operations.
If a shareholder dispute is not resolved quickly and amicably, what could be the potential consequences – financial, reputational, or otherwise?
Any dispute with shareholders will lead to the disruption of the company’s operations. Depending on the respective shareholdings of the parties involved, these disruptions can be quite severe. As we have noted in the case of Toshiba above, there has been management turnover from shareholders seeking to remove directors. While there may be legitimate reasons for these actions, clearly they will be disruptive to a company’s operations.
An immediate concern for a company facing a shareholder dispute is whether its day-to-day operations can continue. If there is management turnover, this could result in the financial performance of the company declining, which would have an immediate impact on its profitability. In the long run, this could have wider implications. In relation to financing, it would be difficult to raise funds through a share issue for instance, and financial institutions, noting an ongoing dispute, would be more reluctant to issue debt financing, or would do so at much greater cost. This again would impact the profitability and growth of the company and would have a detrimental effect on its value.
If the dispute can’t be resolved between parties, the company may even be wound up which could be disastrous for shareholders. As we have noted above, a profitable trading entity will typically be worth more than its net asset value. If the company is wound up, the shareholders are likely to receive no more than the net asset value, a value far lower than a more amicable settlement where the company is maintained as a going concern.
Do you see the number of shareholder disputes grow in the coming years? if so, why do you think this?
We believe there is likely to be increased growth in shareholder disputes in the next few years. As the Russian military invasion of Ukraine unfolds with tragic and unfathomable humanitarian costs, and increased economic sanctions on the Russian economy, it seems likely that there could be increased disputes relating to joint ventures with Russian entities. In particular, the oil and gas sector may face major disruption as European and US entities seek to terminate their business relationships with Russian businesses.
Furthermore, in Asia, the declining relations between the US and China will have an impact on the number of Chinese companies listed on US stock markets. The US Holding Foreign Companies Accountable Act requires companies to submit documents to confirm they are not controlled by a foreign government. The increased scrutiny and hostility faced by Chinese companies may result in them delisting to seek a listing in an Asian jurisdiction where they would have a more welcome reception (and potentially list at a higher price). Currently, there are around 250 Chinese entities listed in the US, and many of these companies’ listed entity is an offshore company (e.g. Cayman Islands, BVI or Bermuda). This suggests that going forward we may see more disputes occurring in these offshore jurisdictions.
Minority Shareholders Disputes
Is there any legal protection for minority shareholders?
There are statutory thresholds for protection of shareholders that vary depending on the region. For instance, in the UK, Singapore and Hong Kong, shareholders holding above 25% of a company’s shares can block special resolutions.
There are rights that are conferred upon shareholders in most jurisdictions, which typically include being provided with the financial statements of the company, inspecting the books and records, and petitioning the court to seek remedies if they believe the affairs of the company are being conducted in a manner that is prejudicial to certain shareholders.
In the case of a company takeover, there would also be mandatory offers once the majority shareholder has reached a certain threshold (typically over 90% of the shares). These measures are usually for the purpose of protecting minority shareholders and ensuring they receive a fair pay out.
In addition to statutory remedies, shareholders should also be aware of their rights in accordance with their shareholder’s agreements. The agreement will stipulate details of how shares can be sold, whether the majority shareholder can have rights of first refusal, if there are tag-along or drag along rights in the event of a buyout, etc. Shareholders should be aware of these issues before signing the contract, as they can have a significant impact on the value of their shares, and the settlement they might receive if there is a takeover or buyout.
How can a minority shareholder benefit from a dispute?
While there will be mechanisms in place for the majority shareholder to make an offer to the minority shareholder, these offers may be far below the fair market value of the shares. In these circumstances, the minority shareholder would benefit from commencing legal proceedings to seek a higher value.
In relation to disputes involving the delisting of a public company, when the majority shareholder increases their stake in the company, the pool of shares available for trading and the volume of trading will decrease. The result of this is the listed share value of the company may not properly reflect the fair market value of the company. In these cases, the take-private offer to the remaining minority shareholders based on the current share price could result in them receiving a lower value. Therefore, a minority shareholder would benefit from taking legal action in these circumstances.
Activist shareholder funds certainly take advantage of these legal mechanisms to obtain a better result for investments that appear to be undervalued. There are investment funds known as ‘arbitrage funds’, which identify potential merger or delisting targets where the listed company’s shares may already be trading below the fair market value. These arbitrage funds then purchase a stake in these companies and commence legal proceedings in the listed companies’ jurisdiction. This has been a common theme in the Cayman Islands under Section 238 of the Companies Law, with legal practitioners noting an increase in these dissenting shareholder actions.
