May 2014 marks the sixteenth anniversary of the Cayman Islands segregated portfolio company ('SPC'). This article takes a look back at the SPC's first decade and a half and in particular at the principles which have emerged from the first reasoned decisions of the Cayman Courts concerning the treatment of insolvent SPCs. The cases have posed some interesting and novel questions for the Courts to resolve and the decisions have put flesh on the bones of the statutory provisions as regards the status, duties and powers of officeholders appointed in connection with SPCs. However there are still some important unanswered questions surrounding the practical aspects of receivership, the rights of shareholders of an SPC and the rationale for the differences in the liquidation v receivership regimes, and these are also explored.
What is it?
An SPC is an exempted company that is permitted to create segregated portfolios in order to legally segregate the assets and liabilities of the portfolios from each other and from the general assets and liabilities of the SPC itself. The utilisation of these innovative legal structures has developed considerably since their first introduction in May 1998. Initially limited to use by licensed insurers, they are now popular investment vehicles employed across the spectrum of financial services' offerings wherever there is a need to set up a statutory ring fencing of assets and liabilities. The SPC structure is widely used by investment funds, captive insurers, and in structured finance transactions.
Treatment in insolvency situations
Part XIV of the Cayman Companies Law (2013 Revision) (the 'Law') sets out the statutory provisions providing for the establishment and operation of SPCs and their treatment in insolvency. Under the Law, the portfolios of an SPC do not constitute separate legal entities; however, in practical terms, they operate like separate limited liability companies and the assets and liabilities of each portfolio are ring fenced, with the effect that shareholders and creditors have recourse only to the assets of the particular portfolio to which their shares are allocated. Liabilities of one portfolio cannot be met by the assets of another; nor can they be met from the general assets of the SPC where this is prohibited in the articles of association (which is the usual position). When a portfolio is insolvent the Court may appoint a receiver to realise and distribute its assets. Official liquidators may only be appointed over the entire SPC. The effect of Part XIV should be that the insolvency of one portfolio would not contaminate the other portfolios of an SPC. As shall be seen below this principle has faced challenge, but has ultimately been upheld by the Cayman Courts.
ABC Company (SPC) v J & Co. Ltd
In 2012, in the matter of ABC Company (SPC) v J & Co. Ltd the Court of Appeal overturned a decision of the Grand Court not to strike out a petition to wind up ABC brought on just and equitable grounds. The SPC, essentially a multi-class fund, had suspended the calculation of Net Asset Value ('NAV') and the payment of redemptions in a number of its portfolios for a number of years; however its remaining portfolios (representing around two thirds of the SPC's NAV) were operating normally and accepting subscriptions and paying redemptions in the usual way. The investment manager was effectively winding down the suspended portfolios so as to make distributions over time before ultimately terminating them.
A shareholder in one of the suspended portfolios, unhappy with the soft wind-down, sought to have official liquidators appointed over the entire SPC on the basis that the SPC had lost its substratum (i.e. that its business purpose had failed) and it was therefore just and equitable that the SPC be wound up. In doing so, the petitioner relied on the line of Cayman cases which consider the issue of winding up funds on a loss of substratum basis, including Re Belmont Asset Based Lending1 in which the Grand Court had laid down the test as to whether a fund had lost its substratum where it is pursuing a soft wind down (and there is no express provision for such an eventuality in its articles). The cases establish that the position under Cayman law is that a fund cannot be said to be carrying on business as an investment fund within the reasonable expectations of its shareholders during a soft wind down as its ability to redeem shareholders and accept subscriptions has been terminated – accordingly the fund has lost its substratum in such circumstances and ought to be liquidated on just and equitable grounds.
At first instance in ABC, the Grand Court focused its analysis on the business of the suspended portfolios only, and ruled in favour of the petitioner. It relied on Belmont and found that the SPC had lost its substratum (despite the existence of the other healthy portfolios). The Grand Court considered that it was able to appoint liquidators over or grant unfair prejudice type remedies in respect of individual portfolios under section 95(3) of the Law (such relief includes the ability to order that the petitioner's shareholding be bought out, that derivative action may be pursued on behalf of the company, and more general orders providing for the regulation of company affairs compelling or prohibiting certain actions). This is surprising as there is no mention of such a jurisdiction within the Law, and these remedies are ordinarily only available in respect of entire companies when it has been established that the company should be wound up on just and equitable grounds. It is noted that the Cayman legislature had been invited in 2006 by the Law Reform Commission to amend the Law so as to enable the treatment and liquidation of portfolios as if they were companies, but it had declined to do so.2
On appeal, and despite its success on these issues at first instance, the petitioner accepted that: (i) the liquidation of an individual portfolio is not permissible under the Law; (ii) the appointment of a receiver over a portfolio is only available on the grounds of its insolvency and not on any just and equitable basis; and (iii) its only remedy therefore was to seek the winding up of the entire SPC thereby being required to make out the just and equitable grounds for doing so. The Court of Appeal unanimously held that the petition was bound to fail and clarified, firstly, that liquidators can only be appointed over the SPC as a whole. Should an individual portfolio run into financial difficulties, then the only available remedy is for a receivership order to be made in respect of that portfolio. Secondly, a receiver may be appointed over a portfolio on insolvency grounds only; to do so the statutory test must be satisfied, i.e. that the assets attributable to that portfolio are or are likely to be insufficient to discharge the claims of creditors in respect of that portfolio. Having regard to the facts, and to the detail in the offering documents, the Court of Appeal considered that the petitioner had failed to establish that ABC as a whole had lost its substratum and should be wound up on just and equitable grounds – some of the SPC's other portfolios were carrying on business according to the reasonable expectations of its shareholders.
The Court of Appeal's decision in ABC, although entirely consistent with the general view amongst Cayman practitioners as to the interpretation and application of the statutory regime, is significant in that it was the first case to demonstrate that the segregation principle embodied in the SPC structure will be respected and upheld by the Cayman Courts. It is now firmly established that the insolvency of one portfolio will not necessarily indicate a loss of substratum of the whole SPCs.
The Axiom portfolios
2012 and 2013 saw further welcome clarification of the status, duties and powers of receivers appointed over a portfolio. In the 2012 case of JP SPC 1 and JP SPC 4, winding up petitions were presented by the directors of two SPCs. A feeder SPC had six portfolios, one of which was the Axiom Legal Financing Fund ('Axiom') representing 74% of the SPCs' investors. Axiom's only assets were its shares in Axiom Legal Financing Fund Master SP, the master portfolio. The assets of the master portfolio were receivables from loans made to a number of English law firms conducting class actions. Allegations had been made concerning the activities of the Investment Manager of Axiom and the master portfolio. Initial analysis suggested that the value of the loans had been overstated and further investigations were necessary. Notwithstanding the principles confirmed in ABC, one of the investors original y sought to argue that despite the health of the other unaffected portfolios, the whole SPC should be wound up. The investor ultimately agreed that the appropriate course was for receivers to be appointed over the Axiom portfolios, and receivership orders were made.
The Axiom receivers subsequently returned to the Grand Court to seek directions clarifying their duties and powers so as to bolster an (ultimately successful) application for their recognition in England under the English Cross Border Insolvency Regulations 2006 (the 'Regulations') which have their roots in the UNCITRAL model law on Cross Border Insolvency. Ordinarily, receivers in their traditional role do not qualify for such recognition, but the Regulations take a substance-over-form approach, and require an assessment of the actual status, duties and powers of the officeholder and a consideration of whether the action with which they are involved amounts to a foreign 'insolvency proceeding'. Further hurdles to the application were that SPCs as a concept are unknown under English law, consequently so too are receiverships of individual portfolios, and there has yet to be an onshore bankruptcy case recognising the segregation principle which SPCs embody. In Axiom, the Court removed certain doubts as to what powers would be available to the receivers of portfolios. The decision (unreported 13 March 2013) considered and compared in significant detail the statutory powers available to, and duties owed by, receivers appointed over a portfolio on the one hand, and the powers and duties of liquidators of a Cayman company on the other; and the decision has consequently provided a useful, detailed, and thorough exploration of this area.
Statutory Powers Available under Part XIV of the Law
Section 224(3) – A receiver appointed over a portfolio is tasked with the 'orderly closing down of the business of or attributable to' the portfolio and the distribution of its assets to entitled persons.
Section 226(1) – A receiver is conferred with a general power to do all such things as may be necessary to complete that task, and has all the functions and powers of an SPC's directors in respect of the portfolio's business and assets.
Section 226(6)(b) – The receiver may attend SPC board meetings, and he may vote at board meetings on matters concerning the SPC's general assets where creditors of the portfolio over which he is appointed have an interest in those general assets.
Section 226(3) – A receiver is deemed to be an agent of the SPC and 'shall not incur personal liability except to the extent that he is fraudulent, reckless, negligent, or acts in bad faith'.
Section 226(2) – A receiver may apply to the Court for directions in relation to the extent of or exercise of his functions or powers.
Section 226(5) – An automatic stay of proceedings against the SPC in relation to a portfolio comes into force as soon as an application for a receivership order is made and any would be litigants are compelled to seek the Court's permission to commence any claims.
Section 228 – Finally, a receiver's remuneration and expenses are payable only from the assets of the portfolio over which he is appointed.
The case confirmed that the receiver of a portfolio will be considered as possessing duties akin to those of a liquidator of a Cayman company, and, for most purposes, a receiver is to be attributed with the appropriate powers of a liquidator (confined in their application to the portfolio and its assets, shareholders or creditors). In particular the following practical points emerge: It is now clear that a receiver may be granted any of the powers usually conferred on liquidators by Part V of the Law, with appropriate modifications, to suit the particular circumstances of the receivership. Such powers range from the ability to conduct investigations into the affairs of the portfolio and the ability to seek to unravel transactions on the basis that they are a preference, an undervalue transaction, or constitute fraudulent trading.
It is notable in the Axiom case that the Grand Court granted the receivers all the powers of liquidators exercisable under Part I (exercisable with sanction) and Part II (exercisable without sanction) of the Third Schedule to the Law. Such powers, particularly those exercisable with sanction, are considerable and include the power to carry on the business of the portfolio, to compromise any claims with creditors or shareholders, to deal with or sell portfolio assets, to obtain credit, and to engage staff, attorneys, or other professional advisors.
More generally, the Court confirmed that the basic duty of a receiver appointed over a portfolio is to collect in and realise the assets of the portfolio and to make distributions in accordance with the statutory regime, with any surplus being returned to shareholders (which is the fundamental duty of a liquidator of a Cayman company), to exercise any necessary corporate powers to fulfil their duties, to convene meetings of creditors and/or shareholders, and even to appoint a receivership committee.
A receiver of a portfolio is considered by the Court, to have the power to commence legal proceedings on two grounds. Firstly, on the ground that this is a power exercisable under Part I of the Third Schedule to the Law. Secondly, on the basis of the proper construction of Part XIV, the Court considered that whilst a portfolio's assets are segregated from the assets of other portfolios and the general assets of the SPC, the portfolio's assets are nonetheless 'company assets', and the receivers, in displacing the SPC's directors in respect of the particular portfolio's assets and business, and being deemed an agent of the SPC, are entitled to bring proceedings in name of the SPC in respect of and on behalf of the portfolio over which they are appointed.
In subsequent proceedings to wind up the investment manager of the Axiom portfolios (Re Tangerine Investment Management Limited (unreported 25 April 2013) it was argued that the Axiom receivers were not entitled to appear on another creditor's petition to wind up Tangerine, on the basis that a portfolio had no separate legal identity to its SPC, and any debt would therefore be owed only to the SPC. The Grand Court firmly rejected these arguments. Despite the Axiom portfolios lacking separate legal personality, the Court considered that the receivers had sufficient standing to be heard. Its reasoning relied on the significant statutory powers afforded to, and duties owed by, the receivers, and particularly their effective displacement of the portfolios' directors' functions and powers as regards the particular portfolios, the fact that there was no liquidator appointed over the Axiom SPCs (who would have had standing to appear in the proceedings on the opposing creditor's analysis), and also that the nature of the receivers' powers was such that they could procure the SPC to act (such as in respect to the commencement of legal proceedings). Interestingly, in Tangerine, the Court went on to appoint one of the receivers jointly with the opposing creditors' choice of appointee as an official liquidator of the Axiom portfolios' former investment manager.
Finally, in the case of Calibre SPC, a case concerning the winding up of an entire SPC and its two portfolios on the insolvency basis, the Grand Court provided guidance as to which requirements of the Companies Winding Up Rules ('CWR') would apply as regards the individual portfolios (as technically only the SPC would be caught by the CWR). This was helpful as the Law does not address the finer administrative details of what needs to be done in the liquidation of a portfolio. The Grand Court clarified that liquidators were to perform their statutory obligations contained in the Law (and thus the CWR), in respect of each Portfolio separately.
This meant, amongst other things, that each portfolio would require separate certificates of solvency, liquidation committees, reporting and accounting, and that there would need to be an appropriate apportionment of expenses, including liquidation fees, between the SPC and its individual portfolios.
The Cayman Islands' jurisprudence in respect of SPCs has developed significantly during their teen years providing greater certainty in the treatment of SPCs and their portfolios in insolvency situations, which will be of great assistance to practitioners and their clients deriving benefits from the SPC structure. However, some interesting questions remain as do possible differences in treatment between receivers appointed over portfolios and liquidators appointed over Cayman companies.
Axiom made it clear that receivers appointed over portfolios, like a liquidator, possess the power to bring legal proceedings in the name of the SPC on behalf of the portfolio over which they are appointed. Liquidators have the benefit of seeking litigation funding from creditors (or, less commonly but increasingly, from unrelated third parties) to assist their recovery efforts; but a receiver's ability to obtain funding from third parties is less clear. Confronting any recipient of third party litigation funding is the problem of whether these arrangements can be attacked as falling foul of the archaic, but still applicable, doctrines of maintenance or champerty. The former is the assistance or encouragement of proceedings by someone who has no interest in the proceedings or any motive recognised by the law as justifying interference; and champerty is an aggravated form of maintenance, whereby the assistance is provided in exchange for a share of any fruits of the action. Should a litigation funding contract be found to involve maintenance or champerty it is treated as contrary to public policy and unenforceable. Creditors providing a fighting fund for a liquidator need not fear falling foul of the doctrines (provided that they do not seek to usurp the liquidator's control of the action) as they are considered to have a legitimate interest in actions which may have the effect of swelling the size of the liquidation pot for ultimate distribution. The difficulty arises when the proposed litigation funder is an unrelated party.
An exception or safe haven has developed over time which protects liquidators and other office holders from the application of the doctrine of champerty. It provides that a liquidator is able to sell legal claims belonging to the entity in liquidation to unrelated third parties for a share of the recoveries of the litigation.3 The exception has been rationalised by the English Courts to arise as a result of the liquidator's statutory empowerment to sell an insolvent entity's assets coupled with their duty to realise the assets comprised in the insolvent's estate.4 It is plainly arguable that the receiver of a portfolio ought to benefit from this safe haven in the same way as liquidators may – on the basis, as established in Axiom, that a receiver possesses an almost identical duty to realise the portfolio's assets and statutory power to sell those assets. However, the issue has yet to be tackled by the Cayman Courts.
Test for insolvency
The test for the appointment of a receiver over a portfolio is in effect a balance sheet test for insolvency:- an order may be made where the assets attributable to that portfolio are or are likely5 to be insufficient to discharge the claims of creditors in respect of that portfolio. In contrast, the insolvency test applied to any Cayman Islands' company on an application for its winding up is the traditional cash flow test: can the company meet its debts as they fall due? A receiver could therefore be appointed over a portfolio which would otherwise be considered solvent were it an individual company. In Axiom the portfolios were not insolvent on a cash-flow basis, but they were likely to be insolvent as a result of imminent future lending obligations, and so, because of the lower insolvency threshold, the Axiom portfolios were able to be put into receivership. The reasoning behind this apparent difference in treatment is unexplained;6 but the wider gateway may perhaps go some way to mitigating the fact that a shareholder in a portfolio is not entitled to petition to wind up the portfolio on just and equitable grounds.
Remedies for portfolio shareholders
Where a shareholder of a company is able to demonstrate that it would be just and equitable that a company be wound up, the Court has jurisdiction to grant 'unfair prejudice' type relief under section 95(3) of the Law (discussed above). The ABC case has confirmed that it is not possible to appoint a liquidator or receiver over an individual portfolio on just and equitable grounds, even if such grounds exist and this therefore leaves stakeholders without any ability to seek the alternative remedies that would be available to a shareholder of a company where grounds to wind up exist. Again, in our view there does not appear to be any basis for this distinction and this may well be the subject of future legislative reform.
Schemes of arrangement
Like any Cayman company, SPCs can enter into a scheme of arrangement on behalf of the entire company. A scheme is a court supervised compromise made between a company and its creditors and/or members whereby an arrangement can be made binding on such persons provided that certain safeguards are met. Schemes are commonly used in the Cayman Islands but it remains unclear whether a portfolio would have standing to enter into a scheme in its own right or whether an SPC could enter into a scheme on behalf of one or more of its portfolios. Interestingly, the cell of a Jersey 'Protected Cell Company' (similar to an SPC) has recently been found by the Royal Court in Jersey to possess such standing, although unlike in Cayman, the relevant Jersey company statute provides that a protected cell is to be treated, for all purposes, as if it were a company and it can be liquidated independently of its cell company (See Re Ashburton Global Funds PCC January 2014). In Cayman it is probable, relying on Axiom principles, that an SPC could enter into a scheme on behalf of one or more of its portfolios (which was the position in Jersey prior to the Royal Court's decision in Ashburton).
SPCs are a firmly established and mature corporate offering in the Cayman Islands, and it is now clear that the segregation principle will be upheld and that receivers of insolvent portfolios are to be considered as possessing the standing and powers of a liquidator as regards their portfolio and it's affairs. Further innovations are to be expected (such as Portfolio Insurance Companies, when the Insurance (Amendment) Bill 2013 comes into force – these are subsidiary companies held by a portfolio in regulated structures established to carry on insurance business without the need for a separate licence). As discussed above, there has yet to be any real onshore test or confirmation of the SPC segregation principle; however, given the recent recognition of the Axiom Receivers in England, the first significant steps in this direction have now been taken.
1  1 CILR 83.
2 Report of the Law Reform Commission Review of the Corporate Insolvency Law and Recommendations for the Amendment of Part V of the Companies Law (2004 Revision), April 2006.
3 Seear v Lawson (1880) 15 Ch D 426 and more recently in Norglen Ltd v Reeds Rains Prudential  1 All ER 218 HL and ANC Ltd v Clark Goldring & Page Ltd, The Times 31 May 2000.
4 In ICP Feeder Fund & ICP Master Fund (unreported 4 April 2014), the Cayman Court recently reviewed the applicable principles regarding litigation funding for liquidators and re-affirmed that the position in the Cayman Islands was the same as in England.
5 Although there are no Cayman authorities on this issue, we consider that the degree of probability necessary to satisfy this test is likely to be 'more probable than not' following Re AA Mutual International Insurance Co. Ltd  EWHC 2430 (Ch).
6 The Cayman test for the appointment of a receiver over a portfolio is similar to the English test for the appointment of an administrator under the Insolvency Act 1986, where an administrator may be appointed if the company in question 'is or is likely' to become unable to pay its debts and the administration order is reasonably likely to achieve the stated purpose of the administration. The rationale for the wider gateway in the case of administrators arguably stems from the fact that administration (which is the UK equivalent of the US Chapter 11) is intended to give a company breathing space and allow for the possibility that a corporate rescue, scheme of arrangement, or an otherwise more advantageous outcome can be achieved for creditors should the company eventually be wound up. There would not appear to be any similar justification justifying the broader gateway afforded to portfolios as the process of administration does not exist in the Cayman Islands.
Previously published in International Corporate Rescue
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