Court of Appeals Ruling Eases the Way for Shareholders to Bring Derivative Suits Against Cayman Islands Companies in the New York Courts

by Kramer Levin Naftalis & Frankel LLP
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On Nov. 20, 2017, the New York Court of Appeals held that in a derivative action brought in a New York court against a company incorporated in the Cayman Islands, the plaintiff need not comply with Rule 12A of the Cayman Islands Grand Court.[1]  Under Rule 12A (the Rule), a plaintiff proceeding in a Cayman Islands court is required to seek leave of court before pursuing a derivative claim.  Reversing the appellate court ruling below, the unanimous decision from New York’s highest court permits a shareholder of a Cayman Islands corporation — assuming personal jurisdiction and other substantive requirements have been met — to bring a derivative action in New York without leave of court where such permission would have been necessary if the action had been filed in the Cayman Islands, the place of the corporation’s formation. 

A derivative action is a lawsuit brought by a shareholder that seeks recovery on behalf of the corporation itself, typically for mismanagement of some kind.  Here, Paul Davis, an investor in the Cayman Islands company, Scottish Re Group, Limited (Scottish Re), sued members of its board and certain other parties, asserting that Scottish Re engaged in a series of transactions that allegedly unfairly enriched majority shareholders at the expense of minority shareholders like himself. 

The issue presented in Davis was whether, since the derivative action was brought in a New York court against a Cayman Islands company, the plaintiff needed to comply with Rule 12A of the Cayman Islands Grand Court and seek leave from a Cayman Islands court before pursuing his derivative claim in New York.  In a derivative action, a New York court generally applies the substantive law of the jurisdiction of incorporation under the internal affairs doctrine, but the procedural rules of the New York courts.  The court therefore focused its discussion on whether Rule 12A is a procedural rule or a substantive point of Cayman Islands law. 

After parsing the language of the Rule, the Court of Appeals construed Rule 12A as procedural, not substantive, and therefore not binding on New York courts.  The court concluded that Rule 12A was intended to apply to actions brought in the Cayman Islands courts, pointing out that the Rule only purports to apply to “action[s] begun by writ” and after the defendant has “given notice of intention to defend” the derivative action.  The Court noted that these are references to procedural aspects of Cayman Islands litigation that do not take place in New York courts, where derivative actions are not begun by writ and defendants do not serve notices of intention to defend.

Defendants argued that Rule 12A acts as a substantive “gate-keeper” provision under Cayman Islands law,[2] and pointed to similar rules in other nations.  Indeed, the Court of Appeals acknowledged that other jurisdictions can and do have substantive “gate-keeping” provisions that limit a plaintiff’s ability to bring derivative actions abroad.  For example, the British Virgin Islands’ Business Companies Act requires that any shareholder bringing a derivative action first obtain leave from a court in the British Virgin Islands, and the Canada Business Corporations Act requires that a shareholder first obtain leave from a Canadian court and, once granted leave, only commence the derivative action in certain Canadian courts.  The Court of Appeals, however, did not find such an intention in the Cayman Islands rule:  “Had the Rules Committee . . . intended that Rule 12A apply to derivative actions involving Cayman Islands companies anywhere in the world, it could have expressly provided as such,” Justice Feinman wrote for the unanimous court.  Davis, No. 111, slip op. at 9.

In the end, the Court of Appeals declined the invitation to read Rule 12A as a “gate-keeping” provision applicable in New York actions, noting that New York has its own “gate-keeping” provisions: “New York applies other states’ and countries’ substantive laws with regularity. . . .  We also have our own ‘gatekeeping’ statutes, CPLR 3211 and 3212, that effectively weed out claims which are insufficient or meritless; these are the procedural rules that apply when a Cayman company is sued in New York.”  Id. at 13–14.

Having found that Cayman Islands Grand Court Rule 12A did not apply in this New York action, the Court of Appeals remitted the case to the Appellate Division without deciding the question whether the plaintiff has standing to bring a derivative action under Cayman Islands substantive common law.  That question turns on an application of the rule of the 1843 English case, Foss v. Harbottle (2 Hare 461 [1843]).  The Foss case gives a shareholder plaintiff standing to bring a derivative claim only: “(1) if the conduct infringed on the shareholder’s personal rights; (2) if the conduct would require a special majority to ratify; (3) if the conduct qualifies as a fraud on the minority; or (4) if the conduct consists of ultra vires acts.”  See Davis v. Scottish Re Grp. Ltd., 46 Misc. 3d 1206(A) at *15, 9 N.Y.S.3d 592 (Sup. Ct. N.Y. Co. 2014).  The Supreme Court had dismissed the case on this ground as well, but neither the Appellate Division nor the Court of Appeals reached that issue.

 


[1]           Davis v. Scottish Re Grp. Ltd., No. 111, 2017 WL 5557936 (N.Y. Nov. 20, 2017).

[2]           Upon receiving the plaintiff’s application for leave, Rule 12A allows the Cayman Islands court to grant the application, dismiss the action, or to request “the filing of further evidence, discovery, cross examination of deponents and otherwise as it may consider expedient.”

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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