Cayman Islands: Winding Up Solvent Funds Loss of Substratum

The Issue

An issue arising with increasing frequency in connection with Cayman Islands domiciled investment funds is the circumstances in which an investor in a solvent fund can bring an informal wind down initiated by management of the fund to an end and have the board replaced by a liquidator appointed by the Grand Court of the Cayman Islands ("the Court"). Recent case law in the Cayman Islands has shed light on the circumstances in which the Court might intervene, and the factors which may militate against such intervention.


It has been approximately two years since the unprecedented economic environment of 2008 began severely impacting investment markets. Due to the tight credit markets and resulting liquidity issues, many open ended investment vehicles took steps to manage liquidity issues and to protect their investors' interests, for example by suspending the ability of investors to redeem shares or interests in order to prevent a fire sale of assets at severely depressed prices and/or maintain the solvency of the investment vehicles.

In the context of taking these steps, some funds determined that their investment strategy was no longer viable and informed investors that they would be conducting an informal wind down of operations by realising their assets and returning the proceeds of realisation to their investors over a particular timeframe, depending upon the profile and liquidity of the portfolio.

An issue arising in a number of recent cases is whether investors unhappy with an informal wind down can ask the Court to appoint a liquidator even though there is no suggestion of lack of probity on the part of the fund's directors or managers or no express need for independent investigation. Circumstances in which investors might wish to have a liquidator appointed include perceived delay in the realisation of assets or return of realisation proceeds, or the continued receipt by managers of a management fee equivalent to that charged when the investment vehicle was actively trading.

Just and Equitable Petitions

There is no doubt that the Court has jurisdiction to wind up an insolvent fund. In the case of a solvent fund, the Court has jurisdiction to make a winding up order on the petition of a shareholder where it is 'just and equitable' to do so.

The circumstances in which it will be just and equitable to wind up a solvent fund are not limited, but they tend to fall within certain well defined categories including lack of probity on the part of directors, the need for an independent investigation of the fund's affairs, deadlock, or the oppression of minority shareholders. It is also well established that it is just and equitable for a fund to be wound up by the Court, and a liquidator appointed, if a shareholder can establish that the purpose for which the fund was established can no longer be achieved, i.e. that the 'substratum' of the fund has been lost. However, the issue of when a fund can be said to have lost its substratum is open to debate.

Substratum – Funds

There are different views as to when a fund has lost its substratum. If the purpose of the fund is only to pursue a particular investment objective, then once the decision is taken by the fund that that objective can no longer be achieved (for example, by suspending all voluntary redemptions and implementing an informal wind down process), one can see that it is arguable that the substratum has been lost. That was the view taken by Jones J in the Grand Court of the Cayman Islands in Re Belmont Asset Based Lending, (January 2010), ICP Strategic Credit Income Fund Ltd (August 2010), and followed in his recent decision in Re Wyser-Pratte Eurovalue Fund Ltd (November 2010). It was the view of Jones J in these three decisions that the mere fact that a fund has ceased to be viable as an open ended mutual fund is sufficient justification to make a winding up order.

On the other hand, there is an alternative view that the purpose of a fund is wider than merely pursuing a particular investment strategy. The purpose of the fund could be said to include realising investments and returning the proceeds to shareholders prior to a formal liquidation and dissolution of the fund. If that view is right, then while the fund is continuing its commercial functions and returning the proceeds of investment to shareholders it would not be accurate to state that the substratum has gone. This somewhat broader view of the fund's substratum seems to have been adopted by Foster J in Re Steel Partners II, (November 2009) another first instance decision of the Court. Also, in the Eastern Caribbean Supreme Court (British Virgin Islands) Bannister J seems to have taken a broad view of what constitutes a fund's substratum, holding in Citco Global Custody NV v Y2K Finance Inc (November 2009) that where directors are carrying on the business of the fund (returning proceeds of redemption to shareholders), albeit for the last time, it is not just and equitable to wind the fund up and it is not the proper exercise of a court's discretion to step in and unilaterally shut the fund down.

We think that the alternative view has considerable force, namely that the mere fact that an open ended mutual fund has ceased to be viable should not be regarded, without more, as sufficient justification to make a winding up order. We expect the question of which view is to be preferred will be taken to the Court of Appeal in due course.

Pragmatic Approach

Notwithstanding the divergent views as to when it might be said to be just and equitable to wind up a fund on the basis that its substratum has been lost, the Court has considerable flexibility with regard to the remedies available even where it decides that there is jurisdiction to wind up. It does not necessarily follow that the Court will appoint a liquidator and make a winding up order simply because it takes the view that the substratum has gone. If the informal wind down is proceeding at a reasonable pace and there appears to be no particular advantage in appointing a liquidator, the Court may instead give directions and allow the directors to continue the informal wind down of the fund. In the most recent decision (Wyser-Pratte) the Court took advantage of the flexibility afforded by the Cayman Islands Companies Law (2010 Revision) and allowed the directors to continue the informal wind down of the fund. This pragmatic approach is to be welcomed, and suggests that even if the Court takes what might be regarded as a narrow view as to what constitutes the substratum of a Cayman Islands investment fund, it is alive to the commercial realities and will strive to arrive at a solution which is in the interests of all the shareholders in a solvent fund.

New Funds

With respect to new funds yet to be launched, the argument that the fund has lost its substratum (upon the commencement of a future informal winding down) can be pre-empted to a large extent by careful and considered legal drafting. For example, investment management agreements and offering memoranda can be tailored explicitly to contemplate a winding down process within the ambit of the manager's services and the fund's purposes. In addition, since March 2009 the Cayman Islands' Companies Law requires the Court to dismiss or adjourn a winding up petition brought by an investor who is contractually bound not to present such a petition against the fund. Accordingly, funds should consider including appropriate non petition language in subscription documents or other agreements with investors. These legal tools should provide a solid answer to an allegation of loss of substratum and may be supplemented by regular and clear communication with investors at times when the fund faces liquidity issues.

Petitioning for Winding Up – a High Risk Strategy

In the Cayman Islands the general principle is that a successful party recovers its costs from the other party to the litigation. The Court of Appeal decision in Camulos Partners Offshore Limited (the hearing took place on 2 December 2009, judgment was delivered on 18 March 2010) made it clear that a shareholder in a Cayman Islands fund needs to ensure that it does not have a more suitable alternative remedy before presenting a winding up petition on the just and equitable ground.

Presenting a winding up petition against a solvent fund can be a high risk strategy. Winding up petitions must not be used to put maximum pressure on a fund and, where a winding up petition is used for this purpose, it is liable to be struck out as an abuse of process with the shareholder liable to meet the legal costs of the fund.

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.

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