Cold Water Poured on Action Claiming Improper Dilution of Shareholder Rights: David Xiaoying Gao v. China Biologic Holdings

12 Min Read By: Nick Hoffman, Niall Dodd


  • A recent decision from the Grand Court of the Cayman Islands provides valuable, clear jurisprudence.
  • In addition, a clear statement of the law in the Cayman Islands emerged from the court: the dilution of share voting rights does not constitute a free-standing exception to the rule in Foss v. Harbottle.


In the recent decision David Xiaoying Gao v. China Biologic Holdings, Inc. (Dec. 10, 2018), the Grand Court of the Cayman Islands considered the following issues:

  1. the propriety of issuing new shares to dilute the voting power of existing shareholders;
  2. the extent to which it is possible for a beneficial owner of shares (i.e., not the registered shareholder) to enforce rights attaching to those shares;
  3. whether a registered shareholder is able to assert an equitable claim in respect of impropriety which occurred before he or she became a registered shareholder; and
  4. whether the right to pursue a claim relating to shares is assignable independently of the shares themselves.

This decision is wide-ranging. It touches and concerns many of the issues that regularly come before the courts of the Cayman Islands, given the international nature of the disputes that the Grand Court faces. It provides valuable, clear jurisprudence to litigators and clients alike.


On August 24, 2018, the defendant, a biopharmaceutical company in the People’s Republic of China, allotted and issued shares to four groups of investors under share purchase agreements (the SPAs) and a board resolution of the same date. The plaintiff, a shareholder, hastily responded by filing a Writ of Summons in the Cayman Islands on August 27, 2018, and Statement of Claim on September 10, 2018. Responding to challenges made by the defendant on the plaintiff’s locus standi to bring a claim, an Amended Statement of Claims was filed on September 20, 2018, and a Reamended Statement of Claim (RASC) on October 31, 2018. Prior to the court granting leave for the plaintiff to advance the third iteration of the Statement of Claim. The defendant, by way of a summons dated October 4, 2018 (which was later amended and filed on October 31, 2018), sought the court’s directions on various questions of law, including whether:

  1. the defendant owed any fiduciary, equitable, contractual, and/or other duty to the plaintiff in respect of its directors’ power to allot/issue shares pursuant to the SPAs dated August 24, 2018 (Relevant Date) in circumstances where the plaintiff was not a registered shareholder of the defendant at the Relevant Date;
  2. the plaintiff had taken any valid assignment from Cede and Co. (the registered owner of a portion of shares and the assignor of all rights and remedies to the plaintiff on October 22, 2018) of a right of action against the defendant; and
  3. the plaintiff had a cause of action against the defendant under the circumstances and, therefore, standing to bring these proceedings.

The defendant applied, in the alternative, to strike out the plaintiff’s claim pursuant to the Grand Court rules and the inherent jurisdiction of the court on the grounds that it did not disclose a reasonable cause of action and/or that it was an abuse of the process of the court.

The Reamended Statement of Claim

The plaintiff alleged in his RASC that he was a director of the defendant since October 2011, chairman from March 2012, and CEO from May 2012. These facts were not controversial. The plaintiff was removed as chairman and CEO on July 1, 2018, and July 12, 2018, respectively. The legality of those removals was not challenged by the plaintiff, although they were characterized by him as a “board coup” in the RASC. The court noted that this “coup” was likely to have been humiliating, and so his urgent reactive response was not surprising.

Other background facts not at issue were that the defendant had received an acquisition proposal from CITIC Capital Holdings Limited (CITIC) to acquire all of its shares not already owned by CITIC. The offer was publicized by the defendant on June 19, 2018. On August 17, 2018, a consortium, of which the plaintiff was a part, submitted an offer to acquire all of the other shares in the defendant. On August 24, 2018, the board of the defendant announced that CITIC’s proposal had been withdrawn and that the bid of the plaintiff’s consortium had been rejected. Instead, the board had decided to issue and allot 5,850,000 shares.

The plaintiff alleged that the share allotment had been made for an improper purpose—namely, to seek to alter the balance of power between the incumbent management consortium and that of the plaintiff, thereby thwarting the offer of the plaintiff’s consortium. He further claimed that the board of the defendant had breached its fiduciary duty to the plaintiff in entering into the SPAs and allotting the shares to the incumbent management consortium.

The plaintiff sought, inter alia, a declaration that the SPAs and the board decision of August 24, 2018, were invalid and unenforceable, together with an order requiring the defendant to rescind the SPAs and to rectify the register of the company accordingly.

The Court’s Approach

Of particular note was the court’s findings in respect of the four questions posed above:

Does a registered shareholder possess legal standing to assert a personal claim for breach of fiduciary duty in respect of a board decision to allot and issue shares for an improper purpose?

The defendant argued that fiduciary duties owed by company directors to act bona fide in the best interests of the company are not owed to individual shareholders,[1] but to the company, and that a “special factual relationship” would have to be established in order to create a right of action in favor of an individual shareholder against a company for breach of duty. Principally, the court was invited to follow the decision of the English Court of Appeal in Bamford v. Bamford,[2] where two minority shareholders sought a declaration that an allotment had been made to block a takeover bid. The issue of whether the shareholders could ratify the allotment was determined as a preliminary issue on the assumption that the allotment had been approved by the directors for an improper purpose. In Bamford, the court at first instance held that the shareholders could ratify the directors’ invalid decision. Dismissing the appeal against this decision, the court held:

It is trite law, I had thought, that if directors do acts, as they do every day . . . because they are actuated by improper motives . . . can, by making full and frank disclosure and calling together the general body of shareholders, obtain absolution and forgiveness of their sins and provided the acts are not ultra vires the company as a whole, everything will go on as if it had been right from the beginning . . . .

The only question is whether the allotment, having been made, as one must assume, in bad faith, is voidable and can avoided at the instance of the company . . . because the wrong, if wrong it be, is a wrong done to the company. . . .

Citing an Australian appellate decision,[3] the plaintiff submitted that there was clear authority in support of the proposition that shareholders could pursue personal claims for breaches of fiduciary duty with a view to invalidating an improperly motivated allotment of new shares which diluted the power of existing shareholders. In the Australian case, the court at first instance held that the plaintiffs (minority shareholders) lacked standing because they did not fall within the exceptions to the rule in Foss v. Harbottle (that subject to certain exceptions, shareholders have no separate cause of action for wrongs committed against the company). The appeal court unanimously rejected the finding:

Diminution of voting power stands on a fundamentally different footing from other detriments resulting from abuse of power by directors. . . . The rule in Foss v Harbottle has no application where individual membership rights as opposed to corporate rights are involved. . . .

In answering this question, the Cayman court in China Biologic held that individual minority shareholders ordinarily have no legal standing to sue for breach of fiduciary duty in relation to a complaint that their voting power has been diluted by a share allotment approved by directors for an improper use. The court considered the comments in Argentine Holding accurately, albeit obiter, to state the law. The court further found:

Shareholders ordinarily acquire their shares on the explicit basis that their only means of controlling the management is by successfully passing resolutions at general meetings. It would be inconsistent with what is essentially a functional rule, and potentially expose companies to limitless litigation, if shareholders were permitted to enforce duties which are not owed to them.[4]

The court rejected the view that the dilution of voting rights constitutes a free-standing exception to the rule in Foss v. Harbottle. Instead, the court found that the general position of a minority shareholder facing a dilution of his or her voting power through an improperly motivated share allotment does not constitute special circumstances giving rise to a fiduciary duty on the directors’ part owed to the shareholders.

Does the beneficial owner of shares possess legal standing to assert a personal claim for breach of fiduciary duty in respect of a board decision to allot and issue shares for an improper purpose?

Citing section 38 of the Cayman Islands Companies Law (2018 Revision), the court found that a “member” is by statutory definition a registered member and quoted with approval the submission of the defendant’s counsel, which relied on the following statement of the court in JKX Oil and Gas v. Eclairs Group:[5]

Companies are, in general, both entitled and obliged to deal with those who are registered as having the legal ownership of their shares. Companies are, in general, entitled to decline to deal with mere beneficial owners . . . .

That principle having been confirmed by the Cayman Islands Court of Appeal in Schultz v. Reynolds[6] (albeit that case was not actually decided on the standing issue) and Svanstrom v. Jonasson,[7] the China Biologic court considered itself bound by those decisions. Notwithstanding that the relevant standing rule is not an absolute one, the plaintiff was unable to make out a case based on special circumstances in this instance.

Does a shareholder who acquires legal title to his or her shares after the impugned board approval of a share allotment have standing to assert a personal claim to set it aside?

The court considered the above question upon the hypothetical premise that it had incorrectly found that the plaintiff had no standing to assert a shareholder claim at all, but was correct in a secondary finding that a beneficial owner cannot assert a personal shareholder claim. This was an altogether more vexing question. The court found that a shareholder does have standing to pursue an equitable claim to impugn an allotment of shares authorized by the directors prior to him or her becoming a registered shareholder. The court posed the question: if prior wrongdoing can be complained of in the absence of statutory language, why, then, should there be a general bar to shareholders complaining of conduct before they became shareholders at all?

In order to answer that question, the court accepted the submission of the defendant’s counsel that an assessment would be necessary as to whether an equitable claim passed with legal title to the shares. The court cited Guest on the Law of Assignment:[8]

A “mere equity,” for example a right to rescind or rectify a contract, is probably not a chose in an action. It is not assignable unless it is transferred as an incident of property conveyed or a chose in action assigned and is not sought to be assigned separately from the property or chose in action to which it is incident.

The court preferred the view that there could be no general prohibition on a new shareholder complaining about a continued wrong that first occurred before he or she became a shareholder. This victory was, in light of the finding, a Pyrrhic one for the plaintiff.

Does the plaintiff have standing to pursue a personal claim based on the Cede & Co assignment?

The court’s consideration of this question revolved around whether Cede & Co had validly assigned the equitable right to sue, which they held as at August 24 (they purportedly assigned all rights and remedies to the plaintiff on October 22, 2018) in respect of shares they continued to hold as the plaintiff’s nominee. The question was a free-standing one, which referenced the document assigning the shares. The assignment was characterized by the court as a “rush job” in order to appease an impatient and aggrieved litigant. The defendant submitted that the document, by virtue of its incoherence and ambiguity, had not assigned any right to pursue proceedings. It was held that the plaintiff’s skeleton argument concluded with a “lifeboat submission”[9]—namely, an application that Cede & Co be joined to the proceedings as co-plaintiff. Unsurprisingly, given the tenor of the court’s remarks, it was held that the assignment  did not transfer effectively from Cede & Co to the plaintiff the right to pursue an equitable breach of fiduciary duty claim. The court found the speech of Lord Hoffmann in Investors Compensation Scheme Ltd v. West Bromwich Building Society[10] irresistible:

[W]hat is assigned is the chose, the thing, the debt or damages to which the assignor is entitled. The existence of a remedy or remedies is an essential condition for the existence of the chose in action but that does not mean the remedies themselves are property in themselves, capable of assignment separately from the chose.


The claim was struck out. It is worth noting the fact that the court remarked[11] that the plaintiff had a derivative claim and pointed to it being, potentially, a more appropriate remedy—something for litigants and practitioners to bear in mind when considering their strategy. These proceedings evidence a clear statement of the law in the Cayman Islands—namely, that the dilution of share voting rights does not constitute a free-standing exception to the rule in Foss v. Harbottle.

[1] Citing Smellie, J. (as he then was) in Argentine Holding Ltd v. Buenos Aires et. al [1997] CILR 90 at 104.

[2] [1970] 1 Ch. 212 at ¶¶ 237H, 238F-G.

[3] Residue Treatment & Co. Ltd v. Southern Resources Ltd. (No.4), (1988) 51 SASR 196 (S. Australia Supreme Court en banc).

[4] At ¶ 30 of the judgment.

[5] [2014] Bus LR 835 (CA).

[6] [1992-1993] CILR 59, as per Zacca P.

[7] [1997] CILR 192.

[8] Third Edition, Dr. Ying Khai Liew, ed., at ¶ 1-07.

[9] As per Kawaley, J. at ¶ 86.

[10] [1998] 1 W.L.R. 896 at 915.

[11] At ¶ 60.

By: Nick Hoffman, Niall Dodd

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