Cayman Islands: Cayman Islands Funds: What Does 2015 Teach Us About The Year Ahead?

Increase in winding-up petitions

In the PRC, a potentially toxic mix of a slowing economy and an ever-increasing corporate debt burden (as a proportion to GDP) is already leading to impaired loans in a number of key sectors, including steel and real property. If contagion eventuates, we may see increased insolvency and restructuring of Cayman Islands companies which have been used to raise offshore finance for PRC operating subsidiaries. In these circumstances, we take a look at some of the decisions made by the Grand Court of the Cayman Islands in 2015 and early 2016 involving winding up petitions. In 2015, the Harneys litigation and insolvency team acted on two thirds of all insolvency cases commenced in the Cayman Islands, and represented China Shanshui Investment Company Limited (CSI), Rhone Holdings LP, and Harbinger Class PE Holdings (Cayman) Ltd in the cases discussed below.

Re China Shanshui Cement Group Limited

Following a unanimous resolution of its board of directors, China Shanshui Cement Group Limited (CSCG) presented a winding up petition to the Court and applied for provisional liquidation orders. The Court heard certain noteholders and shareholders (including CSI) on the application and agreed with CSI's argument that the directors of CSCG did not have standing under section 94 of the Companies Law (2013 Revision) to present the petition or apply for the appointment of provisional liquidators, in the absence of either an ordinary resolution of CSCG's shareholders or an express provision in its articles of association authorising the directors to present the petition. Mangatal J declined to follow Jones J's decision in Re China Milk Products Group Ltd, which arrived at a contrary interpretation of section 94and allowed the directors of an insolvent company to present a winding up petition.

Re Rhone Holdings LP

The petitioners (all limited partners of Rhone Holdings LP) were precluded by their partnership agreement from presenting a winding up petition in respect of the partnership. Mangatal J struck out their petition, concluding that the agreement did not offend any public policy principle. In any event, any such principle could not override the clear statutory provision of subsection 95(2) of the Companies Law, which requires the Court to dismiss or adjourn a winding up petition where a petitioner is contractually bound not to present one. Mangatal J also concluded that common law recognition of the ability of partners to agree that a partnership should be determinable only by mutual agreement has survived both the Partnership Law (2013 Revision) and the Exempted Limited Partnership Law, 2014, and that nothing in the ELPL is inconsistent with or renders section 95(2) of the Companies Law inapplicable to exempted limited partnerships.

Re Harbinger Class PE Holdings (Cayman) Ltd

Until the Court of Appeal clarifies the test for loss of substratum, it is likely that a petitioner will need to show that the main object of closed ended entity has been rendered impossible, following Clifford J's decision in Re Harbinger. Clifford J confirmed that the test for winding up of a closed ended entity for loss of substratum is whether the attainment of the main object for which a company was formed has been rendered "impossible in some sense". This conclusion contrasts with the lower threshold articulated by Jones J in Re Belmont Asset Based Lending Ltd in respect of open ended entities, which the Court will wind up where it has become "impractical" for the open ended entity to carry on its investment business.

Recently, in Re Washington Special Opportunity Fund Inc, Mangatal J decided that it was not necessary to resolve the tension between Jones J's decision and decisions in other jurisdictions because the petitioner had not shown it was impossible or impractical for the fund to carry on its business.

Comment

The outcomes in these cases might be interpreted by some as a growing reluctance by the Court to make winding up orders and, in particular, reluctance by the Court make such orders where it is really dealing with a shareholders' dispute. It will be interesting to see if it is possible to draw such a conclusion following what we expect will be a year in which the Court will consider a high number of winding up petitions.

Increase in derivative actions

The Grand Court could see an increase in derivative actions following the decision of the New York Supreme Court in Davis v Scottish Re Group Ltd. The Court dismissed certain derivative claims where the plaintiff had failed to comply with Order 15, Rule 12A of the Grand Court Rules (which requires a plaintiff to seek the leave of the Grand Court to bring a derivative claim against a Cayman Islands company), noting that compliance with the rule is a substantive (rather than procedural) condition precedent to the continuation of a derivative action in New York.

This decision is consistent with the position taken by courts in Hong Kong and England and means that US shareholders, some of whom bring nuisance suits in the US hoping to extract a settlement, will first have to show the Grand Court that there is a case to answer.

In contrast, the Grand Court could see fewer winding up applications for companies with significant Hong Kong based subsidiaries following the decision of the Final Court of Appeal of Hong Kong in Kam Leung Sui Kwan v Kam Kwan Lai and Ors. The FCAHK determined that it could wind up a BVI holding company with a 'sufficient connection' to Hong Kong, which connection could be established though the holding company's shareholders and subsidiaries (its shareholders and directors were resident in Hong Kong and its underlying assets and the business carried on by its sub-subsidiaries were located in Hong Kong).

Increasing awareness of regulatory developments

On 9 February 2016, the Cayman Islands Monetary Authority issued the first edition of its bi-annual Supervisory Issues & Information Circular to Licensees. The Circular aims to raise awareness of common regulatory issues and highlight regulatory developments for the financial sector, and "to emphasise regulatory matters which might not be particularly problematic at this time but are important to [CIMA's] regulatory objectives".

While the overriding focus of the Circular was Anti-Money Laundering and Countering Terrorist Financing, it also identified data security as an area that CIMA expects licensees to consider in conducting business and developing business strategies. The Circular states that Cayman Islands based firms "are exceptionally vulnerable to data breaches" and that CIMA "will review licensees' approaches to data security risk management".

Although the Cayman Islands is yet to enact data protection legislation (The Data Protection Bill, 2016 was released on 1 April 2016), CIMA's interest in data security is not surprising, nor is it unprecedented. Data security has caught the attention of other financial regulators. For example, the Australian Securities and Investment Commission has indicated in that it intends to play a role in the cyber risk management of its regulated population. We expect that CIMA's focus on data protection will continue to intensify following the recent Mossack Fonseca data breach.

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