In the current uncertainty of the hedge fund climate, the question is frequently raised by concerned investors as to their position in a liquidation or prospective liquidation of a Fund, if they have outstanding unpaid redemption requests or if they are considering serving redemption requests.
The position of redeeming shareholders varies according to whether the liquidation of the Fund has commenced before or after the redemption date falls due (as provided for in the Fund's Articles of Association). The commencement of the liquidation, for these purposes, is the passing of the special resolution to wind up in the case of a voluntary liquidation, and the presentation of the petition for winding up in the case of a winding up by the Court.
In all liquidations, assets are applied in the following order: (1) liquidation costs; (2) preferential payments, such as taxes, rates and certain wages, and money due to certain depositors in Class A licensed banks (but not including preference shareholders); (3) unsecured creditors who prove in liquidation (which may include secured creditors whose security does not discharge their debt on realisation, and who may prove as unsecured creditors in respect of the shortfall); and (4) any surplus will be distributed among members in accordance with their rights as shareholders.
There are situations where shareholders who have outstanding redemption requests and the redemption date has fallen due before the commencement of the liquidation.
In this case, provided that in the period between the date upon which the redemption was due to be effected, and the date on which the liquidation commenced, the Fund could have properly paid the redemption proceeds in full, then the investor may still (if he chooses) enforce the redemption against the Fund, and his shares will be cancelled, notwithstanding the winding up.
Sums which are payable by the Fund to such a shareholder, will, however, rank behind (1) all other debts and liabilities of the Fund, other than those due to members (shareholders) in their character as members (as described more fully below), and (2) the rights of preference shareholders, whose shares have rights which are preferred to the rights as to capital attaching to the redeemed shares.
Shareholders in this position, who elect to enforce the redemption, will, however, take priority over other members in satisfaction of their rights as members. As their shares are cancelled, however, they will not share in the distribution of any surplus assets, as they will no longer be members.
Where Shareholders whose redemption date falls due after the commencement of the liquidation, the resulting scenario is different.
If the redemption date falls due after the commencement of the winding up, then the redemption cannot be enforced and no redemption proceeds are payable to these shareholders. These shareholders will rank with other shareholders who have not redeemed, and they will have rights in the distribution of any surplus assets in the liquidation, according to their rights as members.
This is the effect of s.37(7)(a) and (b) of the Companies Law (2007 Revision), and is confirmed by sub-paragraph (g) of the proviso to s.49. The effect is that a shareholder with an outstanding redemption request on the date of the commencement of the liquidation will never have priority over unsecured creditors, but may have priority over other members in respect of liabilities due to them in their character as member, but only if (1) the redemption date fell due before the commencement of the liquidation and (2) the Fund could, in the interval between that date and the commencement of the liquidation, have properly paid the redemption proceeds in full.
Liabilities to members in their character as members, mean sums falling due to them by virtue of their rights under their contract with the Fund constituted by the Articles of Association of the Fund and their statutory rights e.g. dividends or (almost certainly) redemption proceeds (Soden v. British Commonwealth Holdings Plc  A.C. 298). Sums which do not so fall due e.g. directors' salary, claims by a shareholder employee sustaining an accident and the like, would not be caught, and would rank with unsecured claims ahead of unpaid redeeming shareholders.
The rationale is (1) to protect the rights of creditors, ahead of the rights of members which attach to members in their capacity as members, and (2) as between members, to protect the rights of those who could and should have been redeemed before the commencement of the liquidation, ahead of the rights of members who have not submitted redemption requests at all, or who have done so, but the redemption date falls after the commencement of the winding up. The corollary is that, in a liquidation with a surplus for distribution among members, after payment of other liabilities, including the redemption proceeds of the redeeming shareholders, the redeeming shareholders are excluded from sharing in that surplus, because their shares will have been cancelled, if they have elected to enforce the redemption.
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.