By Jonathan Tonge and Alan Craig
A Segregated Portfolio Company ("SPC") is a single corporate legal entity with the benefit of statutory segregation of assets and liabilities between segregated portfolios established within the company.
When first introduced in 1998, the use of SPCs was restricted to licensed insurers. SPCs were utilised by insurers to segregate liabilities arising from different insureds or lines of business within a single company. The SPC structure allowed distinct business to be conducted within one company without the risk of losses in one area compromising the overall solvency of the company, its ability to continue in business and to meet its other obligations. The segregation also allowed insureds to better assess the risk profile of the insurer as they required only to review the business of the segregated portfolio through which they were to be insured and to ascertain the sufficiency of the reserves of such segregated portfolio with reference thereto as opposed to conducting an assessment based on the overall business and reserves of the company.
An amendment to the Companies Law in late 2001 removed the restriction on the use of SPCs for insurance purposes only and we have since seen the development of their use in various other sectors. In Mutual Funds SPCs have been utilised to allow for the establishment of segregated portfolios to segregate the assets relating to classes of shares with different investment criteria, thus protecting shareholders from the potential of cross liability arising from the adverse investment performance of other classes of shares. The SPC structure also has application in multiple tranche debt issuing vehicles, securitisation and derivative transactions.
Advantages over traditional methods of creating legal divisions between asset pools (such as setting up underlying special purpose vehicles and negotiating limited recourse provisions with third parties) include greater legal certainty, reduced complexity and administrative cost savings.
CONSTITUTION OF SEGREGATED PORTFOLIO COMPANIES
The SPC concept, under a variety of different names is now familiar in offshore, and some onshore, jurisdictions. The SPC is a single legal entity within which may be established various segregated portfolios. Cayman Islands law provides that assets and liabilities of each segregated portfolio are legally separate from those of the other segregated portfolios. Creditors of a segregated portfolio have recourse to the assets of the segregated portfolio and to any general assets of the company (being assets not comprised with any segregated portfolio) to the extent that the segregated portfolio assets attributable to such portfolio are insufficient and the segregated portfolio general assets exceed any minimum capital amounts required by any regulatory body in the Cayman Islands (so as to allow the continued operation of the company). A recent legislative amendment allows the company to completely remove the recourse of creditors of segregated portfolios to the general assets of the company. With insurance structures it is sometimes preferred that creditors have the ability to make a claim against the general assets so as to establish a degree of risk sharing, hence the ability to completely "protect" the general assets is optional.
In common with other Cayman Islands companies an SPC will be constituted by its Memorandum of Association which will be supplemented by Articles of Association which set forth specific regulations concerning the operation of the company and the rights of shareholders to govern the operation of the company (these are akin to the Issuer Charter and Bylaws of a US corporation).
Shares can be issued with rights related to specific segregated portfolios but it is not necessary that shares be issued in respect of segregated portfolios and third party participants who prefer, for tax reasons or otherwise, not to have a direct shareholding in the company can participate in the business of a segregated portfolio on a purely contractual basis.
The provisions applicable to SPCs are to be found in the Companies Law (2003 Revision) (the "Law").
KEY FEATURES OF AN SPC
The main features of an SPC are as follows:
- An SPC may create one or more segregated portfolios in order to segregate its assets and liabilities.1
- Although a segregated portfolio must be separately identified it will not be a separate legal entity from the company.2
- The law provides that to be binding on, or to enure to the benefit of a segregated portfolio, contracts should be executed by the directors of the SPC on behalf the relevant segregated portfolio which must be named. It is important to note that directors incur personal liability if they fail to satisfy these requirements. The Court may relieve a director of all or part of his personal liability if he satisfies the Court that he ought fairly to be relieved because (a) he was not aware of the circumstances giving rise to his liability and, in not being so aware, he was not fraudulent, reckless or negligent, and did not act in bad faith; or (b) he expressly objected, and exercised such voting rights as he had as a director, whether by way of voting power or otherwise, so as to try and prevent the circumstances giving rise to his liability.
- Assets of the SPC are either segregated portfolio assets or general assets. The Directors of an SPC have a duty to establish and maintain the segregation of each segregated portfolio’s assets from those of other segregated portfolios and the general assets of the SPC and to ensure that assets and liabilities are not transferred between segregated portfolios other than at full value. 3
- Shares may be issued in respect of a particular segregated portfolio the proceeds of which are included in the assets of such segregated portfolio and which may carry the right to distributions from that segregated portfolio.
- Segregation of assets and liabilities
(i) a creditor of a segregated portfolio only has recourse to the assets of the segregated portfolio with which it contracted and (thereafter) the general assets of the SPC (to the extent that the segregated portfolio assets attributable to such portfolio are insufficient and to the extent that the segregated portfolio general assets exceed any minimum capital amounts required by any regulatory body in the Cayman Islands and such right of recourse has not been excluded in the Articles of Association of the company).4
(ii) a creditor of a segregated portfolio has no recourse to the assets of other segregated portfolios of the company.5
(iii) where a liability of a segregated portfolio company to a person arises or is imposed other than in respect of a particular segregated portfolio or portfolios such liability shall extend only to, and that person shall, in respect of such liability, be entitled to have recourse only to, the company’s general assets.6
WINDING UP AN SPC/RECEIVERSHIP
If, upon the application of:7
the SPC itself,
any creditor of a specific segregated portfolio,
the holder of any segregated portfolio shares, or
CIMA (if the SPC carries on a regulated business),
and the Grand Court of the Cayman Islands (the "Grand Court") is satisfied that:
- the assets attributable to any particular segregated portfolio are or are likely to be insufficient to discharge the claims of the creditors of that segregated portfolio; or
- there is a desire for there to be an orderly winding down of the business attributable to the specific segregated portfolio and it is proposed to distribute those assets to those entitled to have recourse to the segregated portfolio,8
the Grand Court may make a receivership order and appoint a receiver over that segregated portfolio’s assets.
The receiver is deemed to be the agent of the SPC and does not incur personal liability unless he is fraudulent, reckless, negligent or he acts in bad faith.9 The making of a receivership order by the Grand Court creates a stay of proceedings against the SPC in relation to the segregated portfolio in respect of which the receivership order is made. This will not however prevent a secured creditor from enforcing its security against the relevant segregated portfolio. Once a receivership order has been made, the powers of the SPC’s directors cease in respect of the business of or attributable to the specific segregated portfolio’s assets.10
The court cannot make a receivership order if the SPC is in liquidation and any receivership order made ceases to be of effect upon the commencement of any liquidation of the SPC.11 An SPC may not commence a voluntary winding up without the prior leave of the Grand Court if any of its segregated portfolios are the subject of a receivership order.12 The remuneration and expenses of a receiver are met from the assets of the specific segregated portfolio in respect of which the receiver was appointed in priority to all other claims.13
Winding up or Liquidation
Save for a voluntary winding up requiring leave of the Grand Court if a segregated portfolio is in receivership, an SPC may be wound up or liquidated in the same manner as any other company incorporated under the Law. However, any liquidator appointed must continue to maintain procedures to segregate and keep segregated particular portfolio assets from other portfolio assets and the general assets of the SPC.14 Further, he must only discharge specific segregated portfolio creditors’ claims from the assets of the specific segregated portfolio. If the creditor has only a claim against the general assets of the company (ie., assets that are not part of a segregated portfolio) he must pay that general creditor out of the general assets only.
THIRD PARTY DEALINGS WITH AN SPC
When dealing with an SPC a third party should clearly establish which segregated portfolio of the SPC it is dealing with (and therefore which of the relevant segregated assets it has recourse against).
INTERNATIONAL RECOGNITION FOR CLAIMS AGAINST AN SPC’S ASSETS
The concept of statutory segregation of accounts is now well developed and recognised in jurisdictions such as Delaware, Guernsey and Bermuda. However, it may be prudent to seek legal advice from an insolvency practitioner in those jurisdictions where a segregated portfolio’s assets are located outside the Cayman Islands. Furthermore, to reinforce the legal position it is advisable that Cayman Islands Law be selected to govern contracts to which an SPC is a party and to ensure that such contracts provide that the Cayman Islands courts shall have jurisdiction to determine any disputes.
REQUIREMENTS TO REGISTER AN EXISTING EXEMPTED COMPANY AS AN SPC
The benefits of operating segregated portfolios are not restricted to new companies first incorporated as SPCs. An amendment to the Law permits existing exempted companies to apply to be re-registered as Segregated Portfolio Companies. To be re-registered as an SPC an existing exempted company must satisfy the following requirements:
1. It must file a declaration made by at least two directors of the company setting out an accurate statement:-
- of the assets and liabilities of the company as at a date within three months prior to the date of the declaration;
- of any transaction or event which, as at the date of the declaration, has occurred or is expected to occur, between the date of the statement of assets and liabilities prepared pursuant to subparagraph (i) and the date of registration of the company as an SPC which if it had occurred before the date of the declaration would have caused material changes to the assets and liabilities disclosed in the declaration;
- that the company intends to operate as an SPC and the assets and liabilities which the company proposes to transfer to each of the segregated portfolios to be established on registration;
- that on registration as an SPC, the company and each segregated portfolio will be solvent;
- that each creditor of the company has consented in writing to the transfer of assets and liabilities into the segregated portfolios being established (or alternatively that adequate notice has been given to all creditors of the company and that ninety-five percent by value of the creditors have consented to that transfer of assets and liabilities into segregated portfolios);
2. It must pass a special resolution of voting shareholders (ie. a two-thirds majority (or such higher majority as may be specified in the Articles of Association of the company) vote of those present at a meeting, in person or by proxy, and entitled to vote, or a unanimous resolution in writing) authorising the transfer of assets and liabilities into segregated portfolios; and
3. Where the company is licensed by the Cayman Islands Monetary Authority ("CIMA") it must obtain CIMA's written consent.
Examples of use of the re-registration process have included mutual funds wishing to bring the benefit of statutory segregation to existing class structures and insurance companies looking to introduce new lines of business (whether by client or risk area) within an existing licensed insurer without the risk of cross liability affecting the performance of the separate business lines. The use of an SPC structure can bring substantial costs and administrative savings as against structures where multiple entities are established to create segregation, particularly in relation to licensed entities.
Cayman Islands’ Segregated Portfolio Companies are an innovative structure with a wide range of commercial applications. The structure is now used by a substantial portion of licensed insurers, to which the use of SPCs was at first restricted, and the SPC structure is now being rapidly adopted in the Mutual Funds sector and is likely, over time, to become the preferred vehicle for multi-class Mutual Funds. We are also now seeing the use of SPCs in the debt issuing and other financing vehicles.
The SPC structure provides new opportunities for advisors in transaction structuring and a reason to revisit some well established structures to determine if they can benefit from the incorporation of features available to SPCs.
1 Note requirement to file an annual notice stating the name of each segregated portfolio see s233(6) of the Law.
2 See s235(2).
3 See s238.
4 See s240(1).
5 See s239.
6 See s240(2).
7 See s244.
8 See s243.
9 See s245(3).
10 See s245(6)(a).
11 See s243(4).
12 See s243(5).
13 See s247.
14 See s242(1).