Greg Knowles takes a look at the recent trend of Chinese companies using Cayman Islands businesses for their IPOs

International capital markets are currently experiencing something of a boom in initial public offerings (IPO) of Chinese businesses, with many top Chinese internet companies in particular seeking to list overseas, especially in the US. Among the largest and most striking examples of the recent crop is Weibo, a leading social media platform (or micro-blogging site) that enables its 120 million-plus monthly active users to create, distribute and discover Chinese-language content. Another is JD.com, which is the largest online direct sales company in China in terms of transaction volume, according to market research.

Further IPOs of companies with a similar background are likely to follow – although there has been talk of a slowdown many sectors of the Chinese economy remain thirsty for foreign capital and many billions of dollars are planned to be raised. Despite the increasing sophistication of domestic Chinese capital markets, for many sectors – particularly internet, telecoms and technology – international markets are still seen as providing better valuations.

From a legal perspective, one of the most interesting features of these transactions is that the listing vehicles are predominantly Cayman Islands companies. 

These businesses are following a large number of other Cayman Islands companies onto the world's stock exchanges – there are currently more than 700 Cayman Islands businesses listed in Hong Kong and upwards of 100 on NASDAQ and the New York Stock Exchange. There are also Cayman Islands companies listed on stock exchanges in London, Taiwan, Korea and elsewhere.

In Maples and Calder's Hong Kong office – which is a long way away from the Cayman Islands – there are a dozen or more lawyers, the majority of whom can speak Mandarin and read and write Chinese, spending a substantial proportion of their time on IPOs of Chinese businesses. The firm's lawyers regularly visit Beijing, Shanghai and elsewhere in China, and are very much at home doing business there. This raises an interesting question: why do Chinese businesses use companies domiciled in these small Caribbean islands, half a world away, for all this international capital-raising?

The promoters of these IPOs would, of course, be the people to ask (and no two IPOs are identical), but from a Cayman Islands counsel perspective, in many of these listings, the following would be considered key:

(a) Cayman Islands company law is relatively straightforward – it does not get in the way; in terms of concept and terminology it largely follows the 'Anglosphere' model and so its characteristics are readily understood by, and familiar to, legal practitioners and other financial professionals who lead on structuring IPOs;

(b) Cayman Islands companies can pay dividends and redeem and repurchase shares out of capital provided solvency is maintained, which gives great flexibility in the way funds may be returned to shareholders;

(c) Cayman Islands businesses are simple to maintain and operate – there is no requirement to hold an annual shareholder meeting or to conduct an annual audit in accordance with any particular set of accounting principles. These matters are left to the articles of the relevant company and, of course, any applicable listing rules or regulatory requirements of the jurisdictions in which such companies are listed;

(d) share and bond issuances by Cayman Islands companies and other sorts of capital-raising and transactional activities do not require any regulatory or governmental consents or registrations;

(e) Cayman Islands businesses do not require local directors or other service providers (except for a registered office);

(f) the Cayman Islands is a politically stable democracy with rule of law and no likelihood of any change to its status as a British overseas territory;

(g) the legal system is underpinned by a right of appeal to the highest court in the UK;

(h) Cayman Islands legal advice is available (increasingly in the Chinese language) from lawyers with broad experience of significant corporate transactions during the business day in Asia.

The 'take private' de-listing

Of course, for many listed companies there comes a point when the listing no longer makes sense, and, for some of the smaller companies listed in the US, a combination of the ever-present and increasing US regulatory burden and negative market sentiment to certain types of company means a 'take private' de-listing may become a compelling option. 

A typical scenario here would be the executive management, led by the founder/chairman of the company, with the backing of private equity funds and bank finance, making a cash offer to public shareholders, followed by a de-listing. Where this is the best outcome economically, Cayman Islands law provides a relatively straightforward mechanism, familiar to US practitioners, to effect the take private – a statutory merger. The largest transaction of this nature to date was the US$3.7bn (£2.2bn) take private of Focus Media led by chairman and CEO Jason Jiang, with the backing of a consortium of private equity firms headed by Carlyle. The merger between Youku and Tudou, the two leading online video providers in China, was also effected by way of a Cayman Islands merger (both companies were listed in the US utilising Cayman Islands listing vehicles). This was not a take private and the combined businesses remain listed.

A familiar legal structure for a take private involves a bidder group forming a Cayman Islands subsidiary for the purpose – this subsidiary is then merged or subsumed into the listed company, which survives the process as a wholly owned subsidiary of the bidder group, with the public shareholders receiving cash upon the cancellation of their shares. 

Key features of a take private from the Cayman Islands legal perspective are that only a special resolution of the shareholders of the listed company is usually required. Typically, the required majority for such a resolution will be two-thirds of those voting on the resolution – this is often relatively straightforward to obtain where the chairman and executives retained a significant minority stake at listing, as they are permitted to vote on such a resolution. Protection for shareholders is provided in the form of the statutory right to an appraisal process before the Cayman Islands court, guaranteeing that a dissenting shareholder receives 'fair value' as determined by the court for his shares. In practice it is rare for shareholders in US-listed companies to trigger such a process, as their interests are protected by a committee of independent directors and a 'fairness opinion' from an independent financial adviser. 

Creditors are protected by the requirement that directors of the merging companies provide a formal declaration that the businesses are and will remain solvent post-merger, that the merger is bona fide and not intended to defraud unsecured creditors and that the consent of any secured creditors is obtained. The liabilities and obligations of the constituent businesses will of course survive the merger, so that creditors will continue to have rights against the surviving company.

There is no requirement for a court hearing (unlike for a traditional 'scheme of arrangement') and a merger avoids some of the US tax and regulatory disadvantages of a takeover or tender offer. 

A further legal trend arising from capital-raising by Chinese companies is the utilisation of trusts by founders for the purpose of benefitting both family members and employees. Again, the Cayman Islands has been the natural choice for the domicile of such a trust.

For all of these reasons, the use of Cayman Islands vehicles as an efficient conduit for foreign capital to flow to China looks set to continue – to the benefit of international investors and, above all, to China itself.

Greg Knowles is head of the corporate team in Maples and Calder's Hong Kong office.