Part V of the Cayman Islands Companies Law, dealing with the winding up of Cayman companies, has been replaced with effect from 1 March 2009. The new provisions preserve established principles of Cayman insolvency law, clarify some areas of uncertainty and enhance provisions which encourage good corporate governance. This Advisory focuses on the principal effects of these changes for Cayman corporate open-ended investment funds. There may also be implications for certain closed-ended fund structures that use a Cayman corporate vehicle at general partner, fund or portfolio company level1.
Solvency declaration on voluntary liquidation
The amended Law imposes a more comprehensive regime in respect of the voluntary winding up of Cayman companies. Upon a voluntary winding up, all of the directors must sign a declaration of solvency or, failing that, the liquidator must apply to Court for an order that the winding up continue under the supervision of the Court. This does not apply to liquidations in progress prior to 1 March 2009.
The declaration of solvency must state that a full enquiry has been made into the company's affairs and that, to the best of the directors' knowledge and belief, the company will be able to pay its debts in full together with interest within a period not exceeding 12 months from the commencement of the winding up. Knowingly making such a statement without having reasonable grounds could result in a fine and imprisonment.
Additional filing requirements have been imposed in respect of voluntary liquidations. Within 28 days of the commencement of a voluntary winding up the liquidator must, among other things, file a consent to act and any directors' declaration of solvency with the Registrar of Companies, and serve notice of the winding up upon the Cayman Islands Monetary Authority. This latter requirement applies to all companies carrying on a "regulated business", which appears to have the odd consequence of requiring some non-regulated open-ended funds (e.g., most master funds in hedge fund structures) to file such notice with CIMA in certain circumstances.
Companies which had already commenced voluntary liquidation prior to 1 March 2009 need to make all relevant filings now apart from filing of the directors' solvency declaration. Failure to comply with these filing requirements may lead to a significant fine.
Automatic winding up
Closed-ended corporate funds, and a small minority of corporate hedge funds, are expressed to terminate after a certain period. Some other funds are expressed to terminate on the happening of a specified event, for example if the value falls below a certain threshold or a key man event occurs. Where these scenarios are built into the fund's articles of association, the better view used to be that the winding up would nonetheless not commence until an ordinary resolution of the voting shareholders had also been passed. This requirement has been removed, so that the end of such period or the occurrence of such event now automatically triggers the liquidation of the fund.
Managers and sponsors whose investment funds have these circumstances built into their articles of association should discuss this with their regular contact at Walkers.
Enhanced liquidator powers
The amended Law provides significantly enhanced statutory powers in respect of liquidators. In general, the powers relate to the ability of the liquidator to compel the provision of information from individuals associated or connected to the company.
In addition, the new Part V provides that, in the case of a solvent liquidation of a company which has issued redeemable shares at prices based upon its net asset value (e.g., many hedge funds), the liquidator has the power to rectify the company's register of members, thereby adjusting the rights of members amongst themselves. It is anticipated that this provision would only be relied upon in unusual circumstances where there had been miscalculation of the net asset value, and the Law permits any contributory dissatisfied by the liquidator's determination to appeal to the Court. Nonetheless, this power potentially should be disclosed in offering documents. It does not appear to be applicable to funds which always issue shares at a fixed price (e.g., US$100 per share).
Standing to petition for winding up
A contingent or prospective creditor, in contrast to an actual creditor, has historically had no standing to petition for a company's winding up in Cayman. In the recent Cayman Court of Appeal decision in In re Strategic Turnaround Master Partnership, Limited, a case decided based on the Law as it stood before the effective date of the new Part V, it was determined that a redeeming investor has standing to present a petition to wind up a fund on the basis that the fund is unable to pay its debts only once the date for payment of the redemption proceeds has passed without a valid suspension of such payment.
The amended Law extends the category of persons with standing to present a winding up petition to include contingent or prospective creditors of a company, even though there is no actual debt immediately payable. It is not yet clear how this will work in practice. However, the ability to present a petition seeking the winding up of a company does not automatically lead to a winding up order being made. Any petitioner must still establish one of the statutory grounds for insolvency (being cashflow insolvency). The Court retains its discretion and must still be persuaded to make such an order, and this will depend on the particular facts.
One approach to avoid winding up orders being made on the petition of an investor would be to include in subscription documents an agreement by the investors not to present a petition against the fund in particular circumstances. The effectiveness of such a non-petition covenant is expressly recognised in the Law.
Introduction of criminal offences
The amended Law introduces new criminal offences relevant upon a winding up, including fraud committed in the 12 months preceding a winding up; misconduct in the course of winding up; and making material omissions in statements relating to the company's affairs in the course of a winding up. The categories of people who may be liable under each section vary from offence to offence but may include present and former officers, directors, managers, professional service providers (including administrators) and liquidators. For the purpose of certain of these offences, shadow directors are also included. A shadow director is a new concept in the Law, limited to these offences relating to winding up, and is defined as any person in accordance with whose directions or instructions the directors of a company are accustomed to act.
It is common for fund directors or directors of portfolio companies to act broadly in line with the wishes of the investment manager or general partner, or its principals. Importantly, the definition of shadow director states that a person is not deemed to be a shadow director by reason only that the directors act on advice given by him in a professional capacity. This will generally be the case for investment managers advising funds in accordance with an investment management agreement. Advice or instructions given by a general partner to the director of a portfolio company, on the other hand, would probably not be considered to be advice given by the general partner in a professional capacity for these purposes.
In any event, given that the relevant sections are aimed at situations where the person in question has acted with intent to defraud the company's creditors or contributories, the introduction of the shadow director concept is unlikely to cause any particular alarm for managers or general partners. It is nonetheless a timely reminder that directors need to give due consideration to the directions, instructions and requests they receive and should reach (and document) independent conclusions as to the appropriateness of the relevant actions.
The previous rules relating to undue or fraudulent preferences have been modified. The Law now provides for voidable preferences, as opposed to fraudulent preferences, although the word "voidable" is possibly misleading as the Law still provides that any such preference occurring within six months preceding the liquidation is invalid.
The amended Law also introduces the concept of a "related party" in respect of voidable preferences. A creditor is treated as a related party if it has the ability to control the company or exercise significant influence over the company in making financial and operating decisions. A payment to a related party is deemed to have been made with a view to giving such creditor a preference – this is not rebuttable.
The new provisions preserve established principles of Cayman Islands insolvency law and go a long way in improving practices and procedures. They provide tools to protect creditors and investors against fraud and to encourage good corporate governance. There are serious penalties for breach of the Law and fund directors, managers and other industry participants should pay close attention to their obligations at all times prior to and during the winding up of a Cayman corporate investment vehicle.
1.The Law also gives the Cayman Court jurisdiction to make winding up orders in respect of certain non- Cayman companies, including foreign companies acting as the general partner of an exempted limited partnership.
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.