A Tale of Two Jurisdictions: Red-Chip Companies Going Private

Over the past quarter century, hundreds of Chinese companies have listed on major U.S. stock exchanges. These firms are commonly referred to as “red-chip” companies, a colloquial term referencing the color traditionally associated with China. Most red-chip firms entered U.S. capital markets through initial public offerings (IPOs), while a smaller number became public through reverse mergers with public shell companies. Companies that went public through IPOs are almost always incorporated offshore in the Cayman Islands. By contrast, firms that became public through reverse mergers frequently inherited the incorporation jurisdiction of the shell companies they acquired, which were often organized in Delaware.

In the past decade, waves of privatizations have swept through this population of U.S.-listed Chinese firms. Because red-chip firms are incorporated in different jurisdictions, the legal regimes governing these going-private transactions diverge accordingly. A minority of these firms are subject to Delaware corporate law, whereas the majority are governed by the corporate law of the Cayman Islands.

This jurisdictional divergence raises an important question: do differences in corporate law affect the outcomes of controller-initiated privatizations? In particular, does stronger legal protection for minority shareholders translate into more favorable deal terms for those shareholders?

Delaware corporate law has long subjected controller-sponsored take-private transactions to stringent judicial scrutiny. Prior to the Delaware Supreme Court’s decision in Kahn v. M&F Worldwide Corp. (MFW, 88 A.3d 635 (Del. 2014)), such transactions were reviewed under the demanding entire fairness standard. Following MFW, however, a controller may obtain review under the more deferential business judgment rule if the transaction employs two procedural safeguards from the outset: approval by an independent special committee and approval by a majority of the minority shareholders (MOM). Moreover, prior to recent statutory amendments to the Delaware General Corporation Law (DGCL), Delaware courts interpreted the concept of “control” broadly. Even founders holding relatively modest equity stakes could be treated as controlling shareholders for purposes of judicial review. For example, Vice Chancellor Noble was willing to treat a founder holding as few as 17% shares as a controlling shareholder in In re Zhongpin Stockholders Litigation (C.A. No. 7393-VCN (Nov. 26, 2014)).

The legal framework is markedly different under Cayman Islands corporate law. Although controlling shareholders may be treated as shadow directors in certain circumstances, fiduciary duties in such cases are owed primarily to the company rather than to shareholders individually. In the context of mergers and acquisitions, this distinction is consequential. A lowball merger does not necessarily harm the corporation itself; instead, it redistributes value from minority shareholders to the acquiring controller. As a result, the shareholders who suffer the economic loss may lack a direct cause of action for breach of fiduciary duty. Litigation against controlling shareholders or directors for fiduciary breaches in privatization transactions is therefore exceedingly rare in the Cayman Islands.

For minority shareholders in Cayman-incorporated companies, the principal remedy is an appraisal action. Appraisal proceedings, however, impose substantial procedural burdens and can be costly and time-consuming. Moreover, unlike fiduciary-duty class actions, appraisal relief is available only to shareholders who formally dissent and pursue litigation. Appraisal actions are also filed after the transaction closes, meaning that they typically do not delay or prevent deal completion. As a result, appraisal litigation imposes relatively limited expected costs on defendants and provides a weaker deterrent against opportunistic low-premium privatization offers.

We construct a matched sample of controller-led going-private transactions involving red-chip companies incorporated in Delaware and the Cayman Islands. Specifically, we examine six pairs of privatization transactions. Within each pair, one firm is incorporated in Delaware and the other in the Cayman Islands, while the two firms are otherwise broadly comparable in terms of industry sector, market capitalization prior to the transaction, the timing of the deal, and profitability status.

Our analysis of merger agreements and transaction disclosures reveals notable differences between the two groups. Delaware-incorporated firms in our matched sample offered an average takeover premium of 38.88 percent, nearly twice the 19.95 percent average premium observed among Cayman-incorporated firms. We also observe systematic differences in deal structure. All Delaware transactions in our matched sample required MOM approval and conducted pre-signing market checks. By contrast, only one Cayman transaction included MOM voting requirements, but the majority was based on voting, rather than outstanding, shares as mandated by MFW, and another two involved an ex ante market check. Taken together, these findings suggest that stronger procedural protections for minority shareholders are associated with more favorable transaction outcomes. Regression analyses confirm the significant difference in privatization premiums between Delaware and Cayman red-chip companies in an expanded sample comprising all controller-led going-private transactions involving such companies from 2010 to 2025. We analyzed the potential mechanisms behind the observed differences. Among the channels considered, controller’s concern about deal delays—specifically from pre-closing litigations and the resulting preliminary injunctions—likely drive the disparities in privatization terms and processes between the two jurisdictions.

Our findings provide a useful lens through which to evaluate the potential consequences of SB 21. In three of the six Delaware-incorporated red-chip firms in our sample, founders who initiated privatization transactions did not hold one-third of the voting power so would not be treated as controllers and subject to MFW under SB 21. Moreover, even for those deals within the purview of MFW, SB 21 eviscerates the MOM process by watering the majority down to that of voting shares, which also appears occasionally in Cayman transactions. In practical terms, SB 21 therefore moves Delaware rules regulating controller-led privatizations closer to those under the Cayman law. If the patterns observed in our study hold more broadly, such changes could result in less favorable outcomes for minority shareholders in general.

The full article can be accessed here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=7519262.

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