The term "special purpose vehicle" is not a term of art . A special purpose vehicle ("SPV") can appear in several forms and guises. The common element in all cases, however, is that an SPV is a company which is inserted in a financial structure to achieve a specific objective. This may not be and, indeed , is unlikely to be related to the jurisdiction in which the SPV is established . Typically the purpose has more to do with the financial structuring of a transaction or the applicable laws or other requirements of other jurisdictions . Vehicles for similar purposes may also be established in trust or partnership form, but corporate entities predominate in practice and are the principal subjects of this memorandum.
COMMERCIAL AND STRUCTURAL MATTERS
Arrangers and investors are attracted to the Cayman Islands SPV's as the combination of the following attributes render the jurisdiction a favoured location for structured transactions.
- There are no forms of corporation, income or capital taxation in the Cayman Islands what so ever whether direct (on t he SPV or holders of Securities issued by the SPV) or indirect (by way of withholding on payments made by the SPV). The Cayman Islands is a "no tax", rather than "low tax" jurisdiction so no applications, exemptions or approvals are required to obtain an entirely tax neutral status for the SPV. The term " exempted" company, as which SPVs are typically incorporated, reflects the availability of an undertaking from t he Cayman Islands government not to impose any such taxes on the Company for a period of up to 30 years in the unlikely event of their introduction in the future.
- There are no foreign exchange controls in the Cayman Islands.
- There are no restrictions or regulatory requirements applicable to an SPV in the Cayman Islands lending, borrowing or issuing debt securities (none of these activities, for example, constitute banking business requiring the SPV to be licenced as a bank). However, see below in relation to certain insurance related products.
- Under Cayman Islands law it is only in certain specific and very limited cases (English case law is persuasive in this context) that the separate corporate personality of an SPV will be ignored so as to allow creditors of an SPV to proceed against its shareholders. Most of these cases involve impropriety or fraud. The establishment of bankruptcy remote vehicles in the Cayman Islands is well established and accepted by all major rating agencies. In particular:
- Charitable and purpose trusts are both well recognised methods of having an independent person own shares in an SPV and serve to isolate the vehicle from the balance sheets of the arranger and originator. Such trusts are established by an independent Cayman Islands trust company, such as QSPV Limit ed. The trustee will covenant not to wind up the SPV or interfere in the conduct of the SPV except to the extent it is necessary in the interests of the discretionary charitable beneficiaries or, depending on the precise drafting, if the trustee is directed to do so by another specified transaction party, for example, the trustee of the instrument constituting debt issued by the SPV.
- The same Cayman trust company will usually provide directors and officers to the SPV either exclusively or in addition to individuals who are connected with other transaction parties. However, it is generally not appropriate or advisable for these connected directors formally to control the board.
- Cayman Islands law recognises limited recourse arrangements and non-petition covenants provided their effect under the governing law of the document in which they are contained is to remove any residual claim against the SPV once the relevant underlying assets have been exhausted.
Cayman Islands law requires directors to observe certain fiduciary duties. In the context of a structured finance transaction this typically translates into the directors needing to determine independently that the proposed transaction is in the best commercial interests of the SPV itself. In the case of an off-balance sheet company, where the cash flows are usually structured in such a way that the SPV derives no net benefit from the transaction itself, this is usually resolved by having the SPV receive a fee for undertaking the transaction and contractually limiting recourse against the SPV under the transaction documents. As a result the directors can generally approve the transaction in principle on the basis that there is ultimately little risk to the SPV and, if the SPV receives a fee of, say, US$1,000, the SPV should make a healthy return on its share capital (which is generally in the order of US$1,000 or less).
The Directors will also need to be satisfied of the overall integrity of the transaction documents. In particular, ongoing expenses of the SPV will need to be covered either out of future cash flows from a suitably high point in the "waterfall" or pursuant to a reimbursement obligation of the arranger or other creditworthy transaction party. Additional care is required in relation to SPVs issuing series of securities backed on separate assets to ensure that the respective pools are effectively "ring-fenced" by appropriate security arrangements in favour of the different creditor classes as a matter of the law governing those assets and the relevant documents. There is no inherent difficulty with that concept as a matter of Cayman Islands law.
CAYMAN ISLANDS LEGAL SYSTEM
Cayman Islands law is creditor-friendly and therefore well suited to structured finance transactions. Specifically:
- There is no system of corporate rehabilitation, such as the English "administration" procedure or the United States Chapter 11 proceedings under the Bankruptcy Code where by a debtor can effectively "freeze" the rights of all creditors, including, in certain cases, the creditors’ rights to enforce security upon a default.
- Secured creditors are able to enforce their security in a liquidation. There is no concept of an insolvency "stay" applicable in the context of secured creditors.
- Liquidators of a Cayman Islands company cannot disclaim onerous contracts. The contractual rights of creditors continue to exist following a liquidation.
- The fraudulent preference rules require, as a minimum, that any disposition must be made with an intent ion to preferring one creditor over another before that disposition can be attacked. It is not sufficient simply that an asset or payment was made in circumstances which resulted in one creditor recovering more than another.
- Netting and set-off arrangements are recognised by express statutory provisions and will be enforced both pre and post insolvency (assuming they are effective as a contractual matter under the governing law of the instrument in which they are contained).
- There is no general concept of substance over legal form. This means that heavily subordinated debt, long term and perpetual debt, for example, will be treated as debt for the purposes of Cayman Islands law and therefore benefit from the favourable treatment given to creditors, rather than being treated as equity. Similarly, participating debt will not be regarded as equity for Cayman Islands purposes notwithstanding that it can have most of the economic features of equity.
- The list of "preferred creditors" in the Cayman Islands (which generally rank ahead of all creditors other than those with fixed security) is limited and, in practice, in the case of an SPV, which will have no employees in the Cayman Islands, restricted to unpaid Government fees.
- Fees payable to the Cayman Islands Government are based on authorised share capital (a minimum fee of US$500 and up to a maximum fee of US$1,750). Annual Government fees are also based on authorised share capital.
- Cayman Islands legal opinions are routinely accepted by the rating agencies. Where assets originate in a developed jurisdiction the relevant receivables and security documents will typically be governed by the laws of that jurisdiction, the contractual and proprietary rights created thereby being recognised in principle by Cayman Islands law: no further security filings or "perfection" are required simply by reason of security being created by a Cayman SPV over foreign assets. Industry organisations such as the International Swaps and Derivatives Association, Inc, and numerous professional associations recognise that SPVs established in the Cayman Islands are acceptable counterparties in derivative transactions.
- Regulation is carried out on two main fronts: first, the regulation of the local service providers and professionals who participate in structured finance transactions; secondly, in certain cases, the regulation of specific transactions. In the context of securitisations, Cayman Islands regulation is only likely to be applicable to the SPV where it is considered to be conducting "insurance business". The precise boundaries are yet to be conclusively defined in relation to various types of insurance-linked products, currently an area of rapid development. However, t he Cayman Islands Monetary Authority is open to discussion and restricted insurance licences are readily obtainable, where determined t o be appropriate. Indeed, a "regulated" issuer may be desirable for marketing purposes in some circumstances. Unlike some other offshore jurisdictions, the Cayman Islands does not insist on the use of any local service providers such as paying agents or custodians.
- The Cayman Islands Stock Exchange lists both debt and equity securities of SPVs and has rules specifically designed to assist the listing of asset-backed securities of the kind issued in structured finance transactions.
All indications are that the deregulation of the financial markets globally will increase the use of structured finance transactions. The need for capital throughout the world and in particular in emerging markets in addition to more developed jurisdictions is likely to see an increasing demand for structured products.
The corollary of deregulation and increased demand is an increased awareness of the need to ensure that controls are in place to prevent fraud, money laundering and fiscal evasion. As a result of the introduction of new laws in the Cayman Islands over a number of years, most recently The Proceeds of Criminal Conduct Law, the Cayman Islands have positioned themselves to ensure that only legitimate business is transacted and in this way have increased the comfort provided to the financial community structuring transactions through the jurisdiction.
It should be noted that this memorandum is general in nature and does not purport to constitute formal advice in relation to any specific transaction.