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Offshore jurisdictions such as the British Virgin Islands (BVI) and the Cayman Islands play a significant role in series finance transactions as they offer a cost-competitive, tax-neutral and tried and tested means of deal structuring.

Although the flexibility that both jurisdictions offer has also contributed to their popularity, there are certain nuances and pitfalls to consider in investment transactions from an offshore legal perspective.

Is it necessary for the parties to amend the memorandum of association and articles of association (M&A) of a target company in addition to entering into a shareholders’ agreement (SHA) to document the rights of investors in a series finance transaction?

The M&A of a BVI and a Cayman Islands company must set out the rights, privileges, limitations and conditions that attach to each class of shares.
In practice, the M&A of a company will invariably be amended to ensure that a conflict does not arise between its items and the contractual provisions of the SHA.

Although there is no “one size fits all” approach, there are important differences between the M&A on one hand – which first and foremost binds a BVI and a Cayman Islands company – and an SHA on the other hand, which must be considered when transcribing provisions of the SHA into the M&A.

For example: (1) the M&A of a BVI company is a matter of public record, whereas the M&A of a Cayman Islands company and an SHA are each a matter of private record; (2) the target company and its shareholder(s) are automatically bound by the M&A, whereas the terms of the SHA will only bind a person that is a party to it; (3) there will most likely be different consent thresholds to amend the M&A and the SHA; and (4) statutory remedies may be available for breach of the M&A, whereas only contractual remedies will be available for breach of the SHA.

It is relatively usual for the SHA to provide that its terms will prevail in the event of a conflict with the M&A. However, this provision is potentially unenforceable against the relevant BVI or Cayman Islands company, which is principally bound by its constitution, the M&A.

For this reason, best practice is typically to limit application of the conflicts provision in the SHA to shareholders, and to impose a covenant on them to amend the M&A to resolve any conflicts that may arise with the terms of the SHA.

Is it permissible for an investor with board appointment rights to direct the conduct of its appointee(s)?

Although it is common for a key investor to be given the right to appoint a director to the board of directors of the target company, directors of BVI and Cayman Islands companies generally owe their duties to the company and not to other parties, such as the appointing shareholder(s).

For this reason, a provision that purports to require a director to act in the best interests of the appointing shareholder(s) – and/or which otherwise curtails the discretion of the relevant director – is potentially unenforceable as a matter of BVI and Cayman Islands law, and arguably exposes directors to the risk of breaching their fiduciary obligations.

Is it lawful to reserve certain matters to the directors and/or the shareholders of a BVI and/or a Cayman Islands company?

Yes, this is relatively common in a series finance transaction, as it may protect the interests of an investor. However, investors should be mindful that a statutory fetter, which purports to bind the target company, will potentially be invalid and unenforceable. As an example, this may include where the change of name of a company purportedly requires the approval of the board of directors.

Does the SHA need to be governed by offshore law?

No, this is not necessary. Commonly, the SHA is governed by the laws of another jurisdiction, such as Hong Kong or English law. However, it is important to retain offshore counsel if the target company is incorporated in the BVI or the Cayman Islands to ensure compliance with local law, as there are nuances to consider.

For example: (1) title to shares in a BVI and a Cayman Islands company passes when the register of members of the relevant company is updated, as opposed to when share certificates (if any) are delivered; (2) there is no concept of “bought and sold notes” or “endorsing share certificates” in the BVI or the Cayman Islands; (3) BVI companies no longer have a concept of “share capital”; and (4) the threshold for passing board and shareholder resolutions is divergent across BVI and Cayman Islands law.

Peter Vas is a partner at Spencer West.