In 1998, significant amendments were incorporated into the Cayman Islands Companies Law permitting the formation of a segregated portfolio company ('SPC'),1 principally for use in the insurance industry. In 2002, the SPC provisions were extended to apply to exempted companies.
Since 2002, the popularity of SPCs has gradually increased, including their use in other industries: at present, approximately 10% of mutual funds registered in the Cayman Islands are structured as SPCs.
Purpose of an SPC
The purpose of an SPC is essentially to provide an alternative to a typical multi-class company where the separation of assets and liabilities within the company is achieved by the creation of different classes of shares under the articles of association. The major downside for multi-class companies is that although they operate perfectly well while the company is carrying on business, upon an insolvent liquidation, the segregations break down and all company assets are available to meet all liabilities. To address this shortcoming, multiclass companies typically adopt the rather cumbersome safeguard of including limited recourse and non-petition clauses in all contractual documents. As with all contractual safeguards, however, their usefulness is subject to drafting or interpretation issues and potential challenges to their enforceability, and there is the additional risk that a contracting party may assert grounds such as estoppel or misrepresentation to avoid such safeguards.
The SPC provisions in the Companies Law (2011 Revision) ('CL') address these disadvantages of multi-class companies.
Features of an SPC
The salient feature of an SPC is that it gives statutory recognition to the distinction between segregated portfolios such that the assets and liabilities of one portfolio are confined to that portfolio.
SPCs are governed by Part XIV of the CL. To take advantage of the benefits conferred by Part XIV, the SPC must be registered as such with the Registrar of Companies.
The starting point is CL s. 216(1) which permits an SPC to create one or more segregated portfolios in order to segregate the assets and liabilities of the SPC held on behalf of one segregated portfolio from the assets and liabilities of other portfolios and also from assets and liabilities which are not held on behalf of any portfolio.
An individual segregated portfolio does not constitute a legal entity separate from the SPC (CL s. 216(2)). Therefore, in order to vest assets or create liabilities in a segregated portfolio, the SPC must enter in the relevant contract on behalf of such portfolio (CL s. 218(1)). Alternatively, the SPC may contract on its own behalf to acquire what the legislation terms as 'general assets' (CL s. 219). General assets are available to meet liabilities of the SPC which are not attributable to any of its segregated portfolios (CL s. 222), and if the articles of association permit, to meet the liabilities of a particular segregated portfolio to the extent the assets of the portfolio are insufficient to satisfy the liability (CL s. 221).
To protect the integrity of portfolio segregations, Part XIV imposes measures to guard against any intermingling of assets. The directors of an SPC have a statutory duty to establish and maintain procedures to ensure that assets of each segregated portfolio are identifiable from the assets of other portfolios and from the SPC's general assets (CL s. 219(6)).
The central provision in Part XIV which gives statutory recognition to the segregation of portfolios in an SPC is CL s. 220. This section provides an absolute prohibition against the assets of one portfolio being used for any purpose other than to meet the liabilities of that portfolio. It states as follows:
220. Segregated portfolio assets –
- shall only be available and used to meet liabilities to the creditors of the segregated portfolio company and holders of segregated portfolio shares who are creditors or holders of segregated portfolio shares in respect of that segregated portfolio and who shall thereby be entitled to have recourse to the segregated portfolio assets attributable to that segregated portfolio for such purposes; and
- shall not be available or used to meet liabilities to, and shall be absolutely protected from, the creditors of the segregated portfolio company and holders of segregated portfolio shares who are not creditors or holders of segregated portfolio shares in respect of that segregated portfolio, and who accordingly shall not be entitled to have recourse to the segregated portfolio assets attributable to that segregated portfolio.
Insolvency of an SPC
In considering the available remedies should an SPC encounter financial difficulties, Part XIV creates a clear (although perhaps unintended) distinction between individual segregated portfolios and the SPC as a whole.
In relation to the liquidation of an SPC as a single entity, the usual winding up rules prescribed by the CL apply equally to an SPC as to an exempted company. That is, a winding up of the SPC may be petitioned by (CL s. 94):
- the SPC itself;
- a creditor (including a contingent or prospective creditor); or
- a shareholder,
on the grounds that the SPC is insolvent or that it is just and equitable to wind up the company (CL s. 92). If the petition is successful, an official liquidator, who must be a qualified insolvency practitioner, will be appointed to wind up the affairs of the fund.
The difference between winding up an SPC and winding up a multi-class company is that, as noted above, the segregations between portfolios will remain intact. Specifically, CL s. 223(1) provides that in the winding-up of an SPC, the liquidator:
- shall deal with the company's assets only in accordance with the procedures set out in section 219(6); and
- in discharge of the claims of creditors of the SPC and holders of SPC shares, shall apply the SPC's assets to those entitled to have recourse thereto.
As mentioned above, CL s. 219(6) imposes a statutory duty on the directors of an SPC to keep the assets of one segregated portfolio separate from other portfolios and from the general assets of the SPC. On a winding up, this obligation shifts to the liquidator.
The position in relation to individual segregated portfolios however is quite different, and at first glance, the only available remedy upon the insolvency of a portfolio is a receivership order.
In general terms, an application for a receivership order in respect of a segregated portfolio may be made by the SPC, a director of the SPC, or a shareholder or creditor of the segregated portfolio (CL s. 225(1)), on the grounds that the segregated portfolio assets are or are likely to be insufficient (after taking account of the SPC's general assets) to discharge creditor claims in respect of that portfolio (CL s. 224(1)(a)).
If a receivership order is made, the role of the receiver is to manage the assets of the segregated portfolio for the purpose of closing down the business the portfolio and distributing the assets to those entitled to have recourse to them (CL s. 224(3)). In undertaking this role, the receiver has all the functions and powers of the directors of the SPC as regards the particular portfolio (CL s. 226(1)).
It is difficult to understand why the Cayman Islands legislature saw fit to immunise individual segregated portfolios from being wound up when the main focus of Part XIV is centred around absolutely isolating one portfolio from other portfolios and from the SPC itself. It makes little sense for the legislation to provide for a portfolio to be closed down and its assets distributed via a receivership order, and then stop short of the final step of winding up and dissolving the portfolio. Indeed, the report of the Law Reform Commission recommending the creation of Part XIV stated that it was intended a segregated portfolio should be liquidated in exactly the same way as if it were a company. That intent, however, did not carry through to the final amendments to the CL.
Further, CL s. 225(1) allows a receivership order to be applied for by a shareholder of the segregated portfolio. This is inconsistent with CL s. 224(1)(a), which cites insolvency as the only basis upon which a receivership order can be made against a segregated portfolio. However, it is consistent with the premise that some wider range of remedies was at some point contemplated by the legislature, and this may be a partial answer to the anomaly which appears in the CL.
The ABC case
This anomaly was exposed in a recent case, ABC Company (SPC) v. J & Co Ltd (unreported, May 2012). It is significant because for the first time since the introduction of the SPC provisions in 1998, the Cayman Islands Court of Appeal has delivered a decision which considers in some detail the remedies available to an investor in a segregated portfolio where that portfolio (but not the whole SPC) is insolvent.
ABC was an open ended investment fund registered in the Cayman Islands as an SPC with 82 segregated portfolios. In 2008, ABC suspended redemptions for a number of portfolios which together represented 32% of the fund's net asset value. In 2010, ABC's articles of association dealing with suspension of redemptions were amended by the passing of special resolutions by each class of participating shareholders. Later in 2010, a disgruntled investor in one of the suspended portfolios petitioned to wind up ABC, or in the alternative, to wind up the segregated portfolio in which the investor was a shareholder, on the grounds that either or both were unable to carry on the business for which they were incorporated and had therefore lost their substratum.
The Court of Appeal held that both petitions were bound to fail and should be struck out for the following reasons:
- The Court had no jurisdiction to wind up an individual segregated portfolio. Further, there was no provision in Part XIV allowing for the making of a receivership order in respect of an individual segregated portfolio at the suit of a shareholder on just and equitable grounds. The petition to wind up the segregated portfolio itself must fail.
- The directors of ABC acted bona fide in resolving to suspend redemptions in the segregated portfolios. – To determine whether the substratum of ABC had failed, it must be established that ABC had ceased carrying on business according to the reasonable expectations of its shareholders. To ascertain those expectations, regard must be had to ABC's articles of association and offering documents.
- An informed investor reading ABC's articles of association and offering memorandum could not fail to understand there was a risk of share redemptions being suspended.
- It was impossible to contend that ABC had ceased to carry on business in accordance with the reasonable expectations of its shareholders. As a result, the petition to wind up ABC must fail.
The decision of the Court of Appeal confirms that the only remedies available to a disgruntled investor in a segregated portfolio are to:
- apply for a receivership order on the grounds that the portfolio is insolvent: a receivership order is not available on the just and equitable ground, nor can a portfolio be wound up on any ground whatsoever; or
- subject to the operation of any enforceable non-petition clause, petition to wind up the SPC itself on the grounds of insolvency or on the just and equitable grounds should the circumstances of the case permit.
On the facts of the ABC case, the result is unsurprising. Indeed, it would have been rather startling had the Court ventured outside the plain wording of Part XIV, as the petitioner sought to do, so as to put the fund at risk of liquidation in circumstances where two-thirds of its portfolios were carrying on business as usual, and a substantial majority of shareholders had (albeit implicitly) ratified the directors' decision to suspend redemptions.
Nonetheless, although the outcome was a fair and predictable one, the decision does serve to highlight the fact that Part XIV needs to be overhauled as regards the liquidation of segregated portfolios. Not only is it illogical that an individual portfolio cannot be liquidated when liquidation of the entire SPC is not feasible (in cases like ABC), the receivership remedy is not an adequate alternative. The CL and the Companies Winding up Rules 2008 give various protective rights and entitlements to creditors and shareholders of a company in liquidation, but those statutory rights and entitlements are not afforded to creditors and investors in a portfolio in receivership. Both of these issues need to be addressed by the legislature amending Part XIV to permit individual portfolios to be wound up on the same grounds and in the same manner as SPCs and exempt companies.
1. Also known in other jurisdictions as a protected cell or segregated account company.
Article first published in International Corporate Rescue, September 2012
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.