Victory for Redeeming Investors
There has been a notion floating around the offices of Cayman Islands liquidators that a redeeming investor from a fund is liable to have its redemptions clawed back in favour of the estate in circumstances where it is subsequently shown that the fund was insolvent at the time the payments were made. In a 100-page decision of the Chief Justice in RMF Market Neutral Strategies (Master) Limited v DD Growth Premium 2X Fund (In Official Liquidation), that notion has been demonstrated to have been wholly misconceived.
The judgment represents a victory for common sense and for the Cayman Islands funds industry which is based upon investors' confidence. Investors need to be able to rely upon the Net Asset Value ("NAV") struck and the receipt of payments based on that NAV as being the end of their involvement with the fund. This is especially so where, as in this case, the investor was itself a fund of funds. As the Chief Justice himself said (citing the Privy Council decision in Fairfield Sentry Limited (in liquidation) v Migani & ors.1) "Having had their redemption paid on the basis of NAVs which are also published in keeping with the constitutional documents of the fund, those who have redeemed, would not expect that there could be recourse against them by those who were still members of the fund when it collapsed."
The liquidators' argument was based upon Section 37(6)(a) of the Companies Law which provides:
"A payment out of capital by a company for the redemption or purchase of its own shares is not lawful unless immediately following the date on which the payment out of capital is proposed to be made the company shall be able to pay its debts as they fall due in the ordinary course of business."
In the case before the Court, a NAV had been struck on the basis of a valuation of certain assets which turned out to be worthless so that the NAV had been so overstated that when the assets were realised, there was a shortfall such that the redemptions could not be paid in full. Full payments were made to some redeeming investors, partial payments to others (including RMF) and no payments at all to others. The fund was subsequently wound up and liquidators appointed by the Court.
The liquidators sought to recover the payments made to the redeeming investors on the basis that they were unlawful payments out of capital because, when they were made, the fund could not pay its debts as they fell due.
In a detailed judgment, the Chief Justice examined the capital maintenance doctrine as reflected in Section 37(6)(a) and then considered whether the payments made were payments out of capital. He held unequivocally that they were not.
The mainstay of the Chief Justice's reasoning is that save for a de minimis amount of US$1/1000 per share, the purchase price of the fund's shares represented share premium, and the redemption price of the shares represented share premium plus (or minus) the profit (or loss) on the investment of that share premium (in this case into a similarly named master fund).
Section 34(2) of the Companies Law provides what share premium can be used for and specifically authorises the use of share premium to be used for "Providing for the premium payable on redemption or purchase of any shares of the company" (Section 34(2)(f).
Accordingly, share premium was not to be regarded as having become part of the paid up share capital of the company for the purposes of the capital maintenance rule as embodied in Section 37(6)(a).
The liquidators had sought to argue that under the 2007 Revision of the Companies Law (applicable at the relevant time) Section 37(5)(a), no reference was made to "share premium" (unlike the 2011 Amendment Law which added such a reference). Therefore, the argument went, share premium was by Section 37(5)(b) deemed to be capital for the purposes of Section 37(6)(a). The Chief Justice described this as a "strained and tortuous construction".
The Chief Justice expressly rejected an argument that because changes to the wording of Section 37(5)(a) were made in 2011 to include the words "share premium" in that provision, that a change in the law had been made so that prior to 2011 share premium was to be treated as capital, and after 2011 that was no longer to be so. As the Chief Justice observed, there was no policy change that would justify such a conclusion. The 2011 Amendment served to clarify the existing law and not to alter it.
He held that Section 34(2)(f) was to be read without being limited by Section 37 and that there were in effect two separate regimes: that provided in Section 34 and that provided in Section 37. This conclusion was reinforced by the fact that Section 34(2)(c) provided for share premium to be used "in the manner provided in Section 37" in addition to providing by Section 34(2)(f) that it could be used for providing the premium on redemption. Thus there was no prohibition on using share premium for the purposes of redeeming shares, even if a fund is cash flow insolvent at the time it makes those redemptions.
In the alternative, the liquidators had argued that the payments were a fraudulent preference contrary to Section 168(1) of the Companies Law which requires the payments to be have been made "with a view to giving such creditor a preference over the other creditors". It has been held previously in the Cayman Islands that this requires the liquidators to prove that the "dominant intention of the debtor was to prefer the creditor". On the evidence, the Chief Justice held that the liquidators had failed to prove such a dominant intention; indeed, on the contrary, he held that the payments were made due to the increasing pressure being exerted by RMF (including unannounced visits to offices and threats of reporting to authorities) and a desire to cover up or postpone the discovery of the catastrophic losses suffered by the fund.
Nigel Meeson Q.C. argued the case on behalf of the successful party RMF, leading Ben Hobden and Erik Bodden.
1. UKPC 9
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