[author: Murray Roberts
Companies incorporated in the British Virgin Islands (“BVI
”) have been employed as joint venture vehicles by those structuring corporate transactions in the four corners of the globe.
It is common for each of two or more joint venture partners to hold shares in a BVI Business Company which will, in turn, either directly own an underlying asset or hold shares in a foreign subsidiary which will then own the key economic asset, often located in the jurisdiction of that subsidiary’s incorporation.
In either case, the balance of decision-making power as between the board of directors and the shareholders, and the key rights of the investors (as shareholders in the BVI company) will usually be documented at the level of the BVI company.
Whether the underlying asset is a mining venture in sub-Saharan Africa, a casino in south-east Asia or commercial real estate in the City of London, there is one key element of commonality: the shareholders in the BVI company need to be properly prepared, both at the initial stage of drafting the documentation governing the joint venture and, at a later stage, when examining options for dispute resolution should things turn sour.
This article considers how shareholders in a BVI company can anticipate and avoid common pitfalls when entering into a joint venture arrangement, and describes some tactical options available to shareholders in a BVI company when the relationship between the shareholders has irretrievably broken down.
Conforming two parallel contracts
Once a term sheet has been signed, the parties often then look to draft and negotiate a shareholders’ agreement which, with respect to a BVI joint venture company, will most frequently be governed by the laws of a major onshore jurisdiction, such as England and Wales, New York or Hong Kong.
However, whilst the shareholders’ agreement will afford rights and remedies to the parties as a matter of contract under the relevant governing law, with respect to the key legal aspects of the joint venture – ranging from the constitution of the board of directors to matters reserved to the shareholders – it is the memorandum and articles of association of the BVI company (the “Memorandum and Articles”) which are important from the perspective of BVI law.
Section 11(1) of the BVI Business Companies Act, 2004 (as amended) (the “Act
”) provides that the Memorandum and Articles are binding as between: (i) the company and each member of the company, and (ii) each member of the company.
Pursuant to section 13(1) of the Act, where a resolution is passed to amend the Memorandum or Articles, the company must either file for registration with the Registrar of Corporate Affairs in the BVI (the “Registrar
”) a notice of amendment or a restated Memorandum or Articles incorporating the amendments. Importantly, section 13(2) of the Act provides that the amendment has effect from the date that the notice of the amendment or the restated Memorandum or Articles are registered by the Registrar – rather than the date on which the amending resolution is passed.
The cumulative effect of these statutory provisions is that, in the event of a conflict between the provisions of: (i) the Memorandum and Articles, and (ii) the shareholders’ agreement, it is not always clear, as a matter of BVI company law, which provisions should prevail (notwithstanding the existence of a supremacy clause, commonly found in shareholders’ agreements, that the provisions of the shareholders’ agreement shall prevail over conflicting provisions in the Memorandum or Articles).
The uncertainty which arises from such a conflict can manifest itself not only in disputes between the shareholders as to the efficacy of actions purportedly taken in respect of the BVI company (for example, transferring shares or appointing and removing directors), but also in the nature of the remedies available to an aggrieved shareholder. A failure to conform the provisions of the Memorandum and Articles to those of the shareholders’ agreement may mean that a shareholder will find that the scope of remedies available to it is narrower than first anticipated.
One critical way in which shareholders can protect themselves at the outset of a joint venture is therefore to amend the provisions of the Memorandum and Articles to reflect the provisions of the shareholders’ agreement to ensure consistency between the two contracts.
Modifying shareholders’ statutory rights: shares
The Act sets out the default position in respect of the rights attaching to shares in a BVI company. Pursuant to section 34(1) of the Act, a share in a BVI company confers on the holder the right to one vote at a meeting of the members of the company or on a resolution of members, the right to an equal share in a dividend, and the right to an equal share in the distribution of surplus assets of the company.
However, parties entering into joint ventures frequently want to create complex sets of rights attaching or related to shares, such as enhanced dividend rights for certain classes of preferred shares, put and call options which may be exercised in certain circumstances, or detailed pre-emptive rights governing restrictions on the transfer of shares.
The flexibility of the Act means that it is possible to incorporate into the Memorandum and Articles bespoke provisions to reflect the shareholders’ commercial intentions. Section 9(1) of the Act is relevant in this regard, since it provides that the Memorandum must state the classes of shares that the company is authorised to issue and, if the company is authorised to issue two or more classes of shares, the rights, privileges, restrictions and conditions attaching to each class of shares.
By ensuring that all of the rights which are intended to attach to the shares are set out in the Memorandum of the Company, and that other bespoke mechanics (such as rights of pre-emption or put and call options) are set out in the Memorandum or Articles, shareholders can minimise the prospect of shareholder disputes arising as a result of the unintended supremacy of the Act’s default provisions which might otherwise apply.
Modifying shareholders’ statutory rights: appointing directors
This analysis applies not only to the rights attaching to shares. It also applies to other issues in respect of which the parties may have reached a commercial agreement, but in respect of which the Act sets out a different, default position. Unless this default position is modified in the Memorandum and Articles, it may confer on the parties an unintended and undesirable legal effect.
In practice, one such area is in relation to the appointment of directors.
By way of illustration, four parties may embark on a joint venture, each with a 25% shareholding in the BVI joint venture company. The parties agree pursuant to the terms of a shareholders’ agreement that each shareholder shall be entitled to appoint one director to the board of directors of the joint venture company.
The default position under the Act is that directors may be appointed by the members (unless the Memorandum or Articles provide otherwise) or by the directors (where permitted by the Memorandum or Articles). Since resolutions of members and directors are typically passed by simple majority (unless the Memorandum or Articles provide otherwise) and since, under the Act, the mere fact of holding 25% of the shares in a BVI company does not carry with it an automatic right to appoint one of four directors to the board, the statutory position is inconsistent with the parties’ commercial intentions. Unless the Memorandum and Articles have been properly tailored, one 25% shareholder may find itself, as a matter of BVI law, unable to exercise its contractual right to appoint a director.
The practical advice is therefore the same: the Memorandum and Articles should clearly modify the default position set out in the Act in order for the shareholders to avoid the prospect of litigation arising out of frustrated commercial intentions.
A deadlocked BVI company can create enormous frustration for its shareholders: decisions often cannot be taken either at shareholder or board level (either because quorate meetings cannot be held, or because no affirmative resolution can be passed even at a quorate meeting), and decision-making in respect of the affairs of downstream subsidiaries may also be frustrated for the same reasons. Practically speaking, this may mean that the BVI company is incapable of entering into key transactions, obtaining new debt financing, or closing new rounds of equity investment.
Deadlock at the level of the BVI company most often occurs where shareholders have equal rights to vote (for example, where 2 shareholders each hold 50% of the shares, or 4 shareholders each hold 25% of the shares), and an equal number of directors are appointed by each shareholder. A dispute at shareholder level therefore frequently also becomes a dispute at board level.
One key way in which deadlock can be anticipated and prevented is by incorporating appropriate provisions into the Memorandum and Articles of the BVI company.
There are various share transfer provisions (so-called "Russian roulette" and "Texas shoot-out" provisions) which may be incorporated into the Memorandum and Articles, and which would operate in the event of a deadlock to enable one party to acquire the shares of the BVI company held by the other party. These provisions could be triggered by a deadlock at board or shareholder level, and could be drafted only to operate when shares are held by two 50% shareholders.
These types of provisions can, however, lead to an extreme result since their exercise would potentially involve breaking the deadlock by one party buying the shares of the other party. In some circumstances, this may not be commercially viable (for instance, if one party does not have sufficient financial resources to be capable of acquiring the shares of the other party, or if both shareholders provide an invaluable asset or service to the BVI company which would cease to be available to the BVI company once that party is no longer a shareholder).
Deadlock could instead be referred to arbitration, and the Memorandum and Articles could be amended to incorporate a provision which would operate broadly as follows:
(i) when a deadlock occurs (at board or shareholder level) and it cannot be resolved within prescribed parameters, each party appoints a representative to try to resolve the deadlock, and each party would be bound by any agreement made by those representatives; and
(ii) in the event that the representatives are unable to agree on a course of action, the dispute is referred to an arbitrator, whose decision would be final and binding on the parties.
Since it is a commercial reality that shareholders may seek to exit their investment if the business objectives of the joint venture have failed or if the relationship between the shareholders has broken down, the range of remedies available to shareholders in BVI companies should be regarded as being as attractive as the initial advantages of incorporating a joint venture company in the BVI.
Disputes between shareholders at the level of the BVI company are often driven by one party’s attempt to gain control of an underlying asset or, if there are various subsidiary companies between the BVI joint venture vehicle and the underlying asset, control over the affairs of the downstream subsidiaries. The mechanics of seeking to achieve this control have innumerable permutations, and may take the form of a majority shareholder seeking to dilute the shareholding of one or more of the other shareholders, creating classes of preferred shares which are only issued to one shareholder, and seeking to exercise influence at board level through one or more board appointees to control the convening and conduct of board and shareholder meetings in their favour.
Shareholders in BVI companies should be aware that there are a number of useful tools that can be employed in the event of a dispute:
• Court ordered shareholders’ meeting
Where a quorate shareholders’ meeting is incapable of being held (for example, because one shareholder deliberately fails to attend a shareholders’ meeting in order to paralyse the company’s decision-making), section 86 of the Act can provide a useful remedy.
The Court may (on the application of a shareholder or director) order a meeting of members to be held and conducted in such manner as the Court orders if it of the opinion that it impracticable to call or conduct a meeting in the manner prescribed by the Memorandum or Articles, and it is in the interests of the members that a meeting be held.
The Court could therefore order that a shareholders’ meeting be held with a reduced quorum requirement, although it should be noted that, in order for the Court to grant this remedy, it is likely to be necessary to demonstrate a pattern of frustrating behaviour by the shareholder in question, which could take time to establish.
• Remedies for unfair prejudice and restraining or compliance orders
Section 184I of the Act contains an arsenal of potential remedies for a shareholder who is able to demonstrate that the company’s affairs are being conducted in a manner which is oppressive, unfairly discriminatory or unfairly prejudicial to him in his capacity as a shareholder.
The Court has discretion to make such an order as it considers fit including, but not limited to: requiring the company or any other person to acquire the shareholder’s shares or to pay compensation to the shareholder, regulating the future conduct of the company’s affairs, amending the Memorandum or Articles, or directing the rectification of the records of the company.
Under section 184B of the Act, if a company or a director engages in, or proposes to engage in, conduct that contravenes the Act or the company’s Memorandum or Articles, then the Court may make an order directing the company or director to comply with, or restraining the company or director from engaging in conduct that contravenes, the Act or the company’s Memorandum or Articles. This provision may be employed, for example, in seeking to restrain a director from engaging in conduct which contravenes his statutory duty, inter alia, to exercise his powers as a director for a proper purpose and not to act, or agree to the company acting, in a manner that contravenes the Act or the Memorandum or Articles.
• Just and equitable winding up
Under the BVI Insolvency Act 2003, a company, its board of directors or a shareholder (amongst others) may apply to the Court for the appointment of a liquidator on the grounds that it is “just and equitable” to do so.
This phrase is widely interpreted and, rather than being confined to particular instances, includes situations such as fraud or bad faith in the formation or the running of the company, the failure of a company’s objects, disappearance of the justification for the company’s continued existence, deadlock in the company’s management, and a breakdown in trust and confidence between the members in a “quasi-partnership” company.
Since the ultimate consequence of this route is the dissolution of the company (the assets of the company having been realised, a dividend paid to creditors and any surplus returned to the members), it may be something of a last resort for a disgruntled shareholder.
Joint ventures will often carry with them a degree of commercial risk for the parties involved – whether in relation to the expected financial performance of the underlying business, the impact of adverse events in the global financial markets on the business’ market sector, or disagreement between the shareholders as to the joint venture’s ongoing strategic direction. It is therefore vital that shareholders in BVI joint venture companies take control over one area in which they can determine events: in mitigating the prospect of a dispute arising between shareholders due to conflicting contractual arrangements, and employing careful tactical planning if a dispute does arise.
For more information on this topic please contact the author, Murray Roberts, in our British Virgin Islands office.
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