The liquidity crisis of 2008 produced a number of cases in which the Cayman courts resolved the tensions which had arisen between funds which had suffered from reduced liquidity and investors seeking to redeem their investments. The usual vehicle for the resolution of such tensions is the winding up petition. A key question which arises in a number of such petitions is whether the petitioner – a shareholder who has redeemed their investment but has not been paid out – has standing to petition as a creditor of the fund, or whether the petitioner has to rely on the just and equitable ground.
When the waves of the global credit liquidity crisis broke over the beaches of the offshore financial centres, many Cayman funds fought to keep the potentially calamitous consequences of that crisis at bay by suspending redemptions and the payment of redemption proceeds, and using other workarounds such as making distributions in specie to reduce the demands on their own liquidity. The ready use of these tools by funds during the crisis period, and the resultant tensions this created with investors also in need of liquidity, has resulted in a number of decisions which have considered the ability of redeeming investors to petition to wind up the funds in which they are invested or from whom payment of redemption proceeds is awaited.
This feature will look at some of the more recent authorities from the Cayman Islands which have sought to resolve these tensions, including the decision of the Privy Council in Culross Global SPC Limited v Strategic Turnaround Master Partnership Limited and the Court of Appeal's decision In the matter of Camulos Partners Offshore Ltd [2010 (1) CILR 303] which struck out a winding up petition brought by a redeeming investor on the ' just and equitable' ground.
STANDING AND GROUNDS TO PETITION FOR WINDING UP IN THE CAYMAN ISLANDS
The Cayman Islands winding up regime is contained in Pt V of the Companies Law ('Law') and the Companies (Winding Up) Rules. So far as material, the Law provides that a company may be wound up by the court if the company is unable to pay its debts or the court is of opinion that it is just and equitable that the company should be wound up.
The categories of who may petition to wind up include creditors (and by an extension of the Law after the Strategic Turnaround litigation began, includes prospective or contingent creditors) and contributories (shareholders, whether fully or partly paid).
On the hearing of a winding up petition, the court may grant or dismiss the petition, make a provisional order, or make any other order it thinks fit. By an amendment introduced in 2007 which came into force in 2009 as s 95(3) of the Law, the court is also given the power, on hearing a petition brought by contributories on the ' just and equitable' ground, to make an order which provides alternative relief to winding up, including orders which regulate the future conduct of the company's affairs, restrains the company from doing or compels the company to perform an act, authorises the commencement of litigation by the petitioner in the name of the company, or orders the purchase by other members or the company itself of the petitioner's shares.
In Strategic Turnaround the investor ('Culross') subscribed for US$1.84m of shares in the fund. It gave notice to redeem its investment and a redemption date of 31 March 2008 was agreed for the redemption. That redemption was approved for 31 March 2008 and 90 per cent of the redemption proceeds were to be paid within 30 days, with the balance following the fund's audit.
Following the expiry of the redemption notice, the fund's board decided to suspend all redemptions in light of volatility and illiquidity in the US micro-cap turnaround sector. The fund also purported to suspend the payment of redemption proceeds to redeeming investors.
The fund therefore did not pay Culross the redemption proceeds as agreed, and on 10 June 2008 Culross petitioned for the fund to be wound up on the basis that it was a creditor of the fund and that the fund was unable to pay its debts. The fund sought to strike out the petition as an abuse of the process of the court, arguing that Culross was not a creditor because the fund had no present obligation to pay anything to it in light of the suspension of the payment of redemption proceeds.
At first instance the fund's argument was rejected. The court held that Culross was a creditor following the expiration of its redemption notice and that there was no substantial dispute as to the debt because the directors had no power under the articles of association of the fund to suspend the payment of redemption proceeds. The court also held that the redeeming investor remained a member and bound by the articles of association of the fund and would therefore be entitled to petition as a contributory on the ' just and equitable' ground.
The Court of Appeal allowed the appeal in part. It accepted the fund's argument that provisions in its Confidential Explanatory Memorandum ('CEM') formed part of the investment agreement and gave the directors a power to suspend the obligation to pay redemption proceeds. It held also that Culross was a creditor with a future debt which would be due and payable only once the suspension was lifted, and that the fund was entitled to suspend redemptions (including the payment of redemption proceeds) at any time before the redeeming investor's name had been removed from the register of members.
Culross appealed against the decision that it had no present debt. The Privy Council allowed the appeal. It held that the cardinal principle is that the capital subscribed by shareholders in a company may not be returned to investors otherwise than as prescribed by statute. Under Cayman law this is a matter to be determined by the articles of association of a company. With respect to redemptions, the manner in which redemptions were to be regulated was a matter on which the fund and the investors were free to make any agreement they pleased. On a proper construction of the articles in this case, the Privy Council found that the fund did not have the power to suspend the payment of redemption proceeds once the relevant redemption day had passed. The Privy Council also considered that the way in which the articles of the fund were framed meant that Culross ceased to be a member in respect of those shares at the close of business on the redemption day. Culross therefore had standing to petition as a creditor to wind up the fund and also had a present debt.
IMPLICATIONS OF THE STRATEGIC TURNAROUND DECISION
The Privy Council's decision makes it clear that how a fund protects itself in a crisis in terms of its ability to suspend redemptions and/or the payment of redemption proceeds is a matter for agreement with the investor. This is a welcome clarification. It means that, provided the agreement makes express provision, the fund can take those measures necessary to protect itself, including suspending the payment of redemption proceeds.
Where in the documents comprising the investment agreement should such measures be recorded? Another welcome confirmation given by the Privy Council is that while the articles of association of the fund will usually be looked to first for what powers the fund has and how they may be exercised, the parties are free to agree in which documents such matters will be set out. This is welcome because as funds well know many potential investors never review anything other than the Offering Memorandum, and in some cases it may give rise to injustice for the investor to seek to avoid the exercise of a power which was set out in the Offering Memorandum because it is not also included in the articles. That said, if a fund wishes to ensure that the terms of the Offering Memorandum prevail over those in the articles, it will likely need to ensure that the articles conform and refer to the Offering Memorandum and make it clear that the articles are subject to anything set out in the Offering Memorandum.
CREDITOR OR CONTRIBUTORY? DOES CLASSIFICATION MATTER?
The fact that the redeemed investor was held to be a creditor is important under Cayman law. The redeemed investor has standing to petition to wind up the fund as a creditor and thus enjoys certain advantages over other investors (ie those whom have had their redemptions notices suspended prior to the redemption date) who are not. For one thing, the creditor's petition is advertised unless the court orders otherwise, which can lead to support from other creditors for the winding up. Further, the petitioner does not need to show that there are no other remedies which it could pursue. Even in a case where the creditor has some future debt (eg he is due the payment of redemption proceeds once a suspension is lifted), he can still petition on the basis that he does not expect the debt to be paid in the future because the fund is now or will by the time the suspension is lifted be unable to pay its debts. In this regard the investor can seek to prove to the satisfaction of the court that the fund is insolvent.
One concern is the effect on the redeeming investor who awaits payment of its redemption proceeds of an insolvency arising between the date of the presentation of the petition and the winding up order. Under ss 37(6) and 37(7)(a)(ii) of the Law an unsatisfied redemption notice can be enforced against a liquidator only if, in the period between the redemption date and the winding up date, a fund was able to pay its debts as they fell due. In such case (especially if the fund made a payment out of its capital in order to redeem the shares), a liquidator might well reject the investor's proof of debt in a liquidation, effectively depositing the investor back in the pool with other shareholders who had not redeemed (ranking behind all creditor claims).
This point was argued in Re Matador Investments Limited. The court declined the fund's invitation to determine the effect of these provisions on the petitioner's claim, holding that the petitioner had done enough to show that it had standing and was prima facie entitled to a winding up order.
The ability of an investor faced with a suspension of redemptions to wind up on the ' just and equitable' ground is more restricted. In particular, as the decision in Camulos shows, an investor may be denied the remedy where there is no issue which affects the members as a whole.
In Camulos the investor issued a redemption request for its entire investment, effective 30 September. On 3 September the investment manager of the fund proposed a restructuring to investors, including the investor, in which investors could exchange shares in the classes of the fund in which they were invested for shares of a new class. The offer provided that those who did not accept the offer would receive 15 per cent in cash for the value of their shares and the balance would be paid by way of a distribution in specie of unspecified assets.
The investor rejected the proposal and received no cash at all, either in respect of the redemption notice it had submitted and which expired on 30 September or pursuant to the terms of the restructuring, and no distribution in specie. In November the investment manager purported to suspend the cash payments due under the exchange offer. The investor issued proceedings in the Grand Court by way of an originating motion rather than a winding up petition. It sought declarations as to the redemption price payable in respect of its investment and as to the value and type of assets to be transferred pursuant to the (now suspended) in specie distribution, and payment of 15 per cent of the amount of the redemption price. It alleged that there were no grounds justifying the exercise of the power to suspend payment of the redemption price or that the power had been exercised for an improper purpose.
The investor then became aware that the fund was proposing to pay the 15 per cent cash payment to every other investor except itself. As a result of this discovery it threatened to issue a petition to wind up the fund on the ' just and equitable' ground; the fund applied to restrain the presentation of the petition as an abuse of the court's process. The judge refused this application and a winding up petition was presented (by this time the fund had already made cash payments to the other investors and had indicated that it was prepared to segregate some US$27.4m in cash, which exceeded the sum in dispute, from its assets). The fund then applied to strike out the petition, for stays, validation orders and for leave to appeal. The court made validation orders on condition that the US$27.4m was paid into court.
The Court of Appeal struck out the petition. It held that it was relevant, in considering whether to restrain the presentation of or to strike out a winding up petition on the just and equitable ground to consider two questions: (i) Is there an alternative remedy available to the petitioner?; (ii) Is it unreasonable of the petitioner not to pursue that alternative remedy? If the court was satisfied that the answer to those two questions was yes, then it could be expected to restrain the presentation of the petition or strike it out as an abuse of process or that it would not be just and equitable to wind the company up.
On the facts, there were alternative remedies available to this investor: the relief which it sought could be obtained either in a fresh writ action or in the originating summons proceedings which the investor had already issued. The court was also satisfied that the investor's conduct was unreasonable: it had refused to give an undertaking to the fund that no petition would be presented without notice and had acted precipitately in presenting the petition. The court had no doubt that the investor's objective was to apply maximum pressure to the fund to accede to its demands (which were already in issue in the originating summons proceedings).
It may be thought that the Camulos decision narrows access to winding up relief on the just and equitable ground. In fact, this is not so. Where the investor is claiming that powers to suspend redemptions have been exercised for an improper purpose this will usually be a matter which affects the shareholders as a whole. In Camulos the investor was seeking to use the just and equitable ground to vindicate its own position. By the time the petition was presented the fund had already paid the cash amount due to the other investors, and the investor knew this so it could not be said that the investor was acting on behalf of all members. In addition, the investor was also seeking in the petition the same relief it claimed in the originating summons proceedings, so there was little question that there was an alternative remedy and that it was already being pursued. The fund had also suggested an arrangement whereby the amount in dispute would be segregated from its own assets and paid into escrow. There was no question that the fund had the funds available to meet the claim. There was also no question that the fund was solvent. It is also clear that the investor did not need, nor would it likely have been entitled to, any of the relief which is available as an alternative to winding up by reason of s 95(3) of the Law.
The traditional grounds for seeking winding up relief on the just and equitable basis, namely loss of confidence in management, oppression of members and inequitable enforcement of strict legal rights are all matters which affect the members as a whole and are all matters where the court is able to make alternative orders regulating the fund's affairs or compelling the company to do something (like lift suspensions and start restating NAVs) which it is more likely that the investor actually wants. Where such issues arise it is unlikely that Camulos will be applied stringently.
LOSS OF SUBSTRATUM
One important ground which it is open to both members and creditors to invoke is the loss of substratum ground. The Cayman court has shown an increasing willingness to use this ground as a basis for a winding up order where the calculation of a fund's NAV or the suspension of redemptions has been in place for a prolonged period.
In an unreported decision of the Grand Court, Jones J held in Re Belmont Asset Based Lending Ltd (January 2010) that it was possible to wind up a fund on the single ground that it had lost its substratum. The judge held:
'[I]t can be said that it is just and equitable to make a winding up order in respect of an open ended corporate mutual fund if the circumstances are such that it has become impractical, if not actually impossible, to carry on its investment business in accordance with the reasonable expectations of its participating shareholders, based upon representations contained in its offering document. If such a company, organised as an open ended mutual fund, has ceased to be viable for whatever reason, the Court will draw the inference that it is just and equitable for a winding up order to be made.'
The justification for winding up in such cases is that:
'An investor's decision to subscribe for shares will be based upon the reputation and past performance of the investment manager. So long as a fund's assets are being invested and managed in accordance with investment criteria and guidelines set out in the offering documents, shareholders cannot and do not expect to have any say in the investment decisions. The position changes if the fund ceases to be viable with the result that the calculation of NAV is suspended and the principal or only function left for management is to realise the assets for the benefit of creditors and shareholders. This exercise may involve an investigation and pursuit of claims against the investment manager and other professional services providers which can only be undertaken by professional independent liquidators. Even if a fund is solvent on a balance sheet test and there is no apparent cause of complaint against any of its service providers, its investors should still not be deprived of the advantages of having the task performed by professional independent liquidators. Nor should they be deprived of the protections provided by the Companies Winding Up Rules, simply because the investment manager (who may not have been at fault) chooses to undertake the task itself.'
This novel decision has been followed in others in Cayman where the fund was in a wind-down and the investors had a legitimate expectation that the fund would by wound up by liquidators (Re Wyser- Pratte Eurovalue Fund; Re Heriot African Trade Finance Fund). The key part of the judge's reasoning is that the continuation of the fund's investment business is impractical or impossible. Such an argument will likely prevail if the fund has suspended redemptions or the payment of redemption proceeds for a long time.
BVI AND CAYMAN CONTRASTED
The difference of approach between the BVI and Cayman with respect to the issue of standing will be considered shortly. As to the issue of winding up on the loss of substratum ground the Commercial Court in the BVI has not followed the reasoning of the Grand Court in Re Belmont Asset Based Lending Ltd. In Re Quantek Opportunity Fund the BVI Court was presented with the same argument which was before the Cayman Court but declined to make a winding up order. He regarded Jones J's analysis as a departure from principle. Unsurprisingly perhaps, when the BVI decision was argued before the same judge re Heriot African Trade Finance Fund the Grand Court declined to accept the BVI Court's reasoning, holding that the position in Cayman and the BVI were different.
Strategic Turnaround holds that the investment agreement will determine whether a redeeming member is also a creditor under Cayman law. If the agreement provides that the redeemer's name is to remain on the register until the redemption proceeds are paid in full then this will likely be construed as meaning that the member remains a member until that date as well as a creditor for the redemption proceeds. Is it possible for the redeeming investor to be fish and fowl? The Privy Council did not take the opportunity to address in any detail the views expressed at fi rst instance in Bermuda (BNY AIS Nominees v Stewardship Credit Arbitrage Fund, In re New Stream Capital Fund) and in the British Virgin Islands (In re Livingston International Fund, SV Special Situations Fund v Headstart Class F Holdings, Western Union v Reserve International Liquidity Fund) that once a redemption date passes a redeeming shareholder is 'transmuted' into a creditor. The judgment of the Board merely noted that:
'These decisions all turn on the particular statutory and contractual provisions in question in them, and they are as stated first instance decisions. They do no more than lend some comfort that the view which the Board takes of the present contractual scheme is unlikely to be regarded as unusual or surprising.'
While the 'transmutation' theory has some superficial attraction (it is a clean solution to a potentially knotty problem), the point is whether or not a redeemed investor is a creditor depends on the contractual scheme and the bargain which has been made by the investor and the fund. Although it may present some difficulties in terms of accounting treatment, there seems no reason in principle why a redeeming investor cannot be a creditor for the redemption proceeds and a member at the same time.
As a recent decision of the BVI Court of Appeal shows, standing is also dependant on the relevant legislative scheme. In Westford Special Situations Fund Ltd v Barfield Nominees Ltd and others (reasons handed down 28 March 2011) the Court decided that as s 197 of the Act provides that a member or past member cannot claim in a liquidation a sum due to him in his character as a member, and the provision goes on to expressly include a claim to payment of redemption proceeds as such a claim, the investor was a creditor in a general sense but was not a creditor with standing to petition to wind up the fund:
'... a member relying on a debt due from a company arising in his character as a member is not a creditor of the company for the purposes of winding up the company ...'
Strategic Turnaround is a useful decision for Cayman investors and funds alike. It provides clarification for investors as to the resolution of existing disputes and certainty for funds as to what they need to do in the future. For investors awaiting the payment of redemption proceeds it is likely that the enforcement of those rights has become easier. Funds will also be pleased that they can choose which terms of which investment documents will prevail.
It is submitted that, despite the decision in Camulos the just and equitable ground remains available for the majority of cases in which class rights are in issue and are sought to be enforced and will be available where complaint is made that a power has been exercised improperly or that there has been a loss of confidence in management. The ready use of the loss of substratum ground in Cayman is also welcome and is consistent with the Cayman Islands' desire to remain as a jurisdiction which above all is designed to suit the needs of investors.
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.