Claims by funds against investors who have successfully redeemed have hitherto enjoyed limited success in the Cayman Islands. Successful claims have been limited to those where a fairly strict test for fraudulent preference is met. The fund has had to show that there was an intention to prefer the particular creditors over the general body. Today's decision in the Privy Council bucks that trend. The decision overturns decisions of the Cayman Grand Court and Court of Appeal and in doing so opens the door to clawback claims based in constructive trust resulting from the unlawful character of the redemption payment itself.
In a decision1 that overturns the Cayman Islands Court of Appeal and the Chief Justice of the Cayman Islands at first instance, the Privy Council has declared that redemption payments made at a time when a Cayman Islands investment fund was unable to pay its debts as they fell due were unlawful pursuant to section 37(6)(a) of the Companies Law (2007 Revision) and has remitted the matter to the Grand Court to determine whether the recipient investor is accountable for those payments as a constructive trustee.
DD Growth Premium 2X Fund (DD2X) was a Cayman Islands open ended investment fund that invested substantially all of its capital in DD Growth Premium Master Fund (the Master Fund). During the 2008 global financial crisis, the Master Fund suffered severe losses, leaving DD2X unable to pay redemption requests. DD2X went into insolvent liquidation in March 2009.
One investor, RMF, that had received US$23m in redemption payments following redemption requests in late 2008, sought a declaration from the Grand Court of the Cayman Islands that it was not liable to repay the $23m. The official liquidators counterclaimed for a declaration that RMF was liable. The trial came to be heard on the basis of limited agreed facts and discovery. In a ruling on 17 November 2014, Chief Justice Smellie held that DD2X was unable to pay its debts as they fell due at the time of each of the payments to RMF but that they were not voidable preferences as the payments had not been made with the dominant intention to prefer RMF, but rather with the intention of avoiding regulatory and legal action by RMF.
Section 37(6) of the Companies Law (2007 Revision), the version of the Law in force at the time of the payments, provides that "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".
The Chief Justice found that whilst DD2X was insolvent at the time of each payment, the payments to RMF were out of premium, and therefore not unlawful payments pursuant to section 37(6). As a result, he did not consider the liquidators' arguments on remedies.
On 20 November 2015, the Cayman Islands Court of Appeal upheld the decision of the Chief Justice on the basis that the payment was a lawful payment out of premium (the liquidators did not appeal the preference ruling).
In a majority decision handed down on 23 November 2017, the Privy Council overturned the Chief Justice and the Cayman Islands Court of Appeal on the basis that:
Section 37(5) of the Companies Law provides a deeming definition of capital for the purpose of section 37(6), being any payment that was not out of (a) profit; or (b) the proceeds of a fresh issue of shares;
That, as the payment to RMF was made out of share premium, it was not out of profit or the proceeds of a fresh issue and was therefore a payment out of capital for the purpose of section 37(6);
That debts due to redeemed investors were debts that had to be taken into account for the purpose of section 37(6) and therefore DD2X was unable to pay its debts as they fell due at the time of each payment; and
The payments to RMF were unlawful and, as that made them payments in breach of the directors' fiduciary duties, the matter should be remitted to the Grand Court to determine whether RMF was accountable as a constructive trustee and required to repay the redemption payments.
The Privy Council also ruled against a free-standing right of restitution arising from unjust enrichment put forward on behalf of the liquidators. This was on the basis that it was the payment to RMF, and not the redemption itself, that was unlawful, and therefore there was no failure of consideration to form the basis of a claim of unjust enrichment (the liquidators accepted that RMF could have proved in the liquidation for its redemption claim, but not that it should shortcut the liquidation process by retaining the payments). This undermined the proposition asserted for the liquidators that restitution arose by virtue of section 37(6) being for the protection of creditors as a class, requiring the repayment of payments rendered unlawful by the provision.
The matter will now proceed to the Grand Court for further directions and determination of the liquidators' remedies.
Peter McMaster QC and Jeremy Snead of Appleby (Cayman) Ltd instructed Tom Smith QC and Adam Al-Attar of South Square on behalf of the liquidators (Tammy Fu and Gordon MacRae of Kalo Advisors).
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