Paul Scrivener, head of the Insurance Group at Cayman Islands law firm, Solomon Harris, takes a look at some of the challenges of using segregated portfolio companies.
Protected cell legislation exists in a number of jurisdictions around the world with the major offshore jurisdictions taking the lead in this respect. The concept is relatively straightforward. A particular type of company can be incorporated which is able to create one or more cells in order to ring-fence pools of assets and liabilities within the company. Generally, a creditor dealing with one particular cell can only have recourse to the assets of that cell and is denied recourse to the assets of other cells or the general assets of the company. The Cayman Islands insurance industry, in particular, has been keen to utilize the vehicle but what are the drawbacks and the challenges?
It is very important that the integrity of the structure is not compromised by lack of attention to detail or poor administration. Under Cayman legislation the directors have a responsibility to ensure that the assets of each cell are properly segregated from the assets of all other cells and from the general assets. Physical segregation of assets rather than merely accounting segregation is fundamental and therefore each cell should have its own bank account and custody account. The directors should run each cell's affairs from an operational point of view as if it were a separate legal entity even though under the Cayman legislation it is not. In that way, physical segregation should fall into place naturally and the structure should not be tainted.
It is a Cayman requirement that the words "segregated portfolio" are always used as part of the name of the cell. Assets cannot be transferred between cells otherwise than at full value and where transactions or agreements are entered into on behalf of a particular cell, it must be made clear on the face of the relevant agreement or document that the execution is on behalf of that cell. Any delinquency on these "nitty gritty" requirements might compromise the statutory ring fencing.
The message is clear – it is not simply enough to set up an SPC properly and then forget about the ongoing requirements that must be met. Any administrative or procedural deficiencies provide ammunition to any creditor seeking to challenge the statutory ring fencing. The directors must ensure that operational sloppiness does not offer an Achilles heel to any creditor.
Would a court always respect the SPC structure if a challenge came before it? In the absence of any fundamental flaws in the set up or ongoing operation of the SPC, you would certainly expect a court in the Cayman Islands to respect the integrity of the structure and the same would probably apply before a court in any of the jurisdictions that have adopted cell legislation. However, if the matter came before a court in a jurisdiction where the SPC concept was alien, there is no guarantee that the structure would be respected. It would depend upon the court's willingness to apply Cayman Islands law and upon issues of local law and public policy. Therefore, as much as possible should be done to try and avoid connecting the SPC with jurisdictions other than the Cayman Islands, for example, by ensuring that policies and other legal agreements are governed by Cayman Islands law and made subject to the jurisdiction of the Cayman courts and wherever possible assets are held within the Cayman Islands. It is never going to be possible to avoid the risk of a creditor seeking to bring a claim in a jurisdiction which he believes may support his challenge to the SPC but the greater the nexus to the Cayman Islands, the better.
Solomon Harris is a specialist commercial law firm based in the Cayman Islands with particular expertise in captive insurance and other alternative risk products.
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