Cayman Islands: SPCS - To Convert Or Not To Convert?

The protected cell concept is relatively straightforward. A particular type of company, known in the Cayman Islands as a segregated portfolio company or SPC (different names are used elsewhere) is set up 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 and, depending on how the company is structured, may be denied access to the core assets of the company ie assets which do not relate to any particular cell. The Cayman Islands insurance industry has for the most part embraced the vehicle and particularly in the rent-a-captive arena.

When Cayman first enacted its protected cell legislation in 1998 it was only possible to incorporate a brand new SPC and the law did not allow for an existing captive to transform itself into an SPC. This was somewhat limiting as there were those who had an existing captive and saw the advantages of an SPC structure but it was simply impracticable or cost prohibitive for them to abandon their existing captive in favour of a brand new SPC. In response to this the legislation was subsequently amended to allow the conversion of an existing vehicle into an SPC. It would be wrong to say that this has led to a stampede of conversions but there has certainly been a good level of interest in converting and a number of conversions have taken place.

For any captive considering a conversion, the first thing to assess is whether there is a good business case for it. This is fundamental and whilst obvious sometimes the issue is not fully explored. There is often a misunderstanding about what an SPC is and what it can offer and some captive owners may be led down the conversion route on the basis of recommendations from advisers or service providers that whilst well-meaning may not have been thought through in the context of the particular captive's circumstances and requirements.

So, when would a captive consider converting to an SPC? The obvious candidate would be a rent-a-captive set up prior to the protected cell legislation being introduced. Historically, rent-a-captives operated using separate accounts for the clients but this did not achieve legal segregation of the programs because at the end of the day, in the absence of non-recourse covenants, all assets of the rent-a-captive were available to any creditor (generally, of course, a policyholder under a program) and so there was no ring-fencing of the assets of each program. In contrast, the SPC enjoys statutory ring-fencing of assets between cells and therefore enables each program to be legally segregated from all other programs within the rent-a-captive. In most cases, whilst obviously not perfect in every respect, an SPC will be the optimum structure for any rent-a-captive and therefore conversion to an SPC is definitely worth considering by most rent-a-captives.

So, have conversions tended to be limited to rent-a-captives? Somewhat surprisingly, the answer is no. We have also seen examples in the healthcare arena where some healthcare systems with a limited number of existing programs have seen the opportunity to develop additional "non in-house" programs, say, for self-employed physicians or even other regional healthcare systems. In those circumstances, the healthcare system seems to have felt much more comfortable placing the new programs within separate cells in an SPC structure. However, from a commercial point of view, one does wonder whether if "push came to shove" and one of the unrelated cells became insolvent, whatever the strict legal position might be, how easy it would be for the healthcare system which owns the SPC to simply walk away from the liabilities.

How difficult is the conversion process? It is relatively straight-forward and would typically not take more than 4 to 6 weeks. As you would expect, the written consent of the Cayman Islands Monetary Authority ("CIMA") will be required and this will be applied for by the captive manager. CIMA will want to have a clear understanding of how the new structure will operate and will require an updated business plan in relation to the core and each of the new cells to be set up. Having obtained CIMA approval, it will be necessary for the voting shareholders of the captive to pass a special resolution authorizing the transfer of the captive's assets and liabilities into cells.

Potentially, the most time-consuming part of the process is the need to obtain creditor consents. The legislation requires that each creditor of the captive must consent in writing to the transfer of assets and liabilities into cells or, as an alternative to obtaining consent from every single creditor, adequate notice may be given to all creditors and consent obtained from ninety-five per cent of those creditors by value. Adequate notice means notice in writing to each creditor having a claim against the captive exceeding CI$1,000 (US$1,220). In most cases, the creditors of a captive will comprise policyholders with outstanding claims and professional services providers with outstanding fees. The more problematic issue is whether contingent or prospective creditors have to be taken into account and this has not yet been considered by the Cayman courts in the context of the SPC legislation. However, in light of the recent Cayman Islands case of Brac Construction Ltd v. Broome & Broome in relation to the standing of a creditor to issue winding up proceedings, there is an argument for saying that a contingent or prospective creditor claiming an unspecified sum from the captive would not need to be involved in the creditor consent process. However, this is not settled law and therefore a cautious approach should be adopted.

In some instances, because of timing constraints or administrative issues, it may be a problem to obtain creditor consents. If that is the case and the SPC is being established to separate an existing program from new programs which are being set up from scratch, one possibility is to retain the existing program in the core of the SPC rather than transfer that program into its own cell and establish cells only for the new programs being created. In this way, no assets and liabilities of the captive are being transferred into cells and therefore the creditor consent process is not required. This makes sense because creditors of the existing program are not prejudiced by the conversion because the assets available to them prior to conversion still remain available to them in just the same way after conversion.

The principal legal document required by the Cayman Islands Companies Registry to effect the conversion will be a declaration signed by at least two of the captive's directors. The declaration must deal with a number of matters: a statement of the current assets and liabilities of the captive (current means not more than 3 months old), details of any material changes in those assets and liabilities since the relevant balance sheet date, confirmation that the SPC into which the captive wishes to convert intends to operate and details of the assets and liabilities which the captive proposes to transfer into cells, confirmation as to solvency of the captive as of the date of conversion and that the creditor approval process has been completed. There must also be attached to the declaration a copy of the special resolution of the captive authorizing the transfer of assets and liabilities into cells together with a copy of the CIMA approval of the conversion. As part of the conversion process the captive will also adopt new articles of association suitable for an SPC as well as restructuring its share capital.

The relevant provisions of the SPC legislation strike a careful balance between the need to facilitate conversion wherever it is commercially appropriate and the need to protect both the shareholders and creditors of the captive being converted. In view of the increasing importance of the SPC to the Cayman Islands insurance industry (as at 2 January 2007 there were 117 Cayman SPCs with total premiums in excess of US$573 million), gazing into the crystal ball, it seems likely there will be an ever increasing number of captives converting to the SPC structure.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.