Cayman Islands: Lancelot: Investor Side Letters – Still A Gap In Cayman Between Legality And Reality

Last Updated: 13 May 2015
Article by Jeremy Snead

In 2012 and 2013 first instance decisions of the Cayman Islands Grand Court1 restricted the efficacy of side letters which may be routinely entered into between investors and investment managers of the fund they are investing in, seeking to vary rights attached to their issued shares (see Investor Side Letters: Mind the Gap). The Cayman Islands Court of Appeal (CICA) has now given its first judgment on the topic.2

Summary

In the Matter of Lancelot Investors Fund, Ltd, the beneficial owner of shares in a fund had sought to agree a shorter lock-up period for redemptions with the investment manager. At first instance, the Grand Court found that the side letter was not enforceable for want of authority or standing on both sides of the side letter:

  1. side letters attaching rights to shares could only be enforced if entered into by the registered owner, the beneficial owner could not directly enforce its rights; and
  2. there was a lack of authority for the investment manager to bind the fund.

In its judgment, the CICA has narrowed the gap to enforceability – accepting that in certain circumstances the beneficial owner could directly enforce a side letter attaching rights to its beneficially owned shares, although holding that the particular side letter in question still failed because the investment manager did not have actual or ostensible authority to sign it on behalf of the fund.

Whilst the appeal was unsuccessful, the CICA's purposive reasoning strengthens the position of a beneficial owner in pursuing recovery of its investment. Although the CICA expressly explained its reasoning in the context of a liquidation, it could also be logically extended to the situation of a company on the brink of insolvency and form the basis for arguments in cases where beneficial owners may otherwise be restricted from presenting a winding up petition – such as where a beneficial owner is forced to change its custodian which is then unable to present a winding up petition for six months from the date of registration.

The ruling also gives an indication of how the gap to enforcement can be further reduced. The CICA considered that, based on the documents and the "world's view" of investment managers, the investment manager did not have actual authority to bind the fund or transmit the decisions of its directors. The CICA's narrow view of the role of the investment manager was correct on the basis of that fund's documents, but may surprise many in the investment community, who view an investment manager as their primary point of contact and capable of negotiating binding commitments on behalf of the fund it manages.

An investment manager must therefore have actual authority (which could be contained in the fund's investment management agreement or a separate board resolution regarding a particular transaction) or have the agreement ratified by the directors after the fact – a transaction acknowledgement by the administrator in response to a redemption request was held by the CICA not to be sufficient ratification.

The Background to the Lancelot Case

From 2005 to 2007 KBC Investments Limited (the Investor) invested periodically in redeemable shares issued by Lancelot Investors Fund, Ltd (the Fund, and the Shares). The Shares were subject to a lengthy lock-up period stated in the Fund's Confidential Information Memorandum (the CIM). The Investor sought to vary the lock-up period by entering into a side letter (the Side Letter) directly with the investment manager of the Fund (the Investment Manager). The Shares were registered in the name of Fortis Bank (Cayman) Ltd as custodian for the Investor (the Custodian).

In October 2007 the Custodian submitted a redemption request for $29m in accordance with the terms of the Side Letter (the Redemption Request). The administrator of the Fund (the Administrator) confirmed a partial redemption of the Shares effective as of the next quarter date. The Administrator then made a partial payment in respect of the Redemption Request having redeemed those Shares which were outside of the standard CIM lock-up period, but indicated that the balance (the Balance) of the Redemption Request could not be satisfied as the remaining Shares held by the Custodian were subject to the standard CIM lock-up period and so could not be redeemed (the Remaining Shares). The Administrator accordingly revised the transaction acknowledgement.

The Remaining Shares were not redeemed and the Balance was not paid by the time the Fund suspended share redemptions. The Fund subsequently became the subject of an order for winding up, whereupon an official liquidator was appointed (the OL).

The Custodian duly submitted a proof of debt for the Balance (the POD). The OL gave notice of rejection of the POD on various grounds, including that the Redemption Request was correctly refused in relation to the Remaining Shares and the Balance were still subject to the standard CIM lock-up period because the amended lock-up period set out in the Side Letter was ineffective in respect of the Remaining Shares.

The Investor, not the Custodian, appealed to the Grand Court against the rejection of the POD. The Judge at first instance held that:

  1. the Remaining Shares still vested in the Custodian and unless and until the Remaining Shares were transferred to the Investor, the Investor had no standing to appeal the rejection of the POD
  2. in any event, the Side Letter was not binding on the Fund: it was not executed with the Fund's authority and had not been ratified by the Custodian; and even if duly authorised, amounted to an invalid variation of class rights; and
  3. the Redemption Request did not amount to a request to redeem at the first available date, and once it had failed, no longer stood effective.

The Investor appealed to the CICA. The judgment of the CICA was written by Justice of Appeal Martin (Martin JA) and supported by the rest of the CICA.

The beneficial/registered owner issue

Martin JA concluded that it was no bar to enforcement that the Investor was the signatory to the Side Letter:

  1. whilst in general only a registered shareholder may bring proceedings to vindicate shareholder rights, once a company goes into liquidation, all provable claims against the company rank for dividend, which may be assigned by virtue of CWR 18, r9(1);
  2. if the Custodian had validly assigned the benefit of the POD to the Investor, then the Investor would have been entitled to appeal its rejection as creditor;
  3. the agreement between the Custodian and the Investor was such that the Custodian was a bare trustee, but once the Custodian became a proving creditor then there was no obstacle to the Investor maintaining an action as equitable assignee, even while the custodian agreement continued in effect, but once it came to an end, the provisions of the agreement contained a separate equitable assignment (which would include the benefit of the POD);
  4. accordingly, the Investor was an equitable assignee with the benefit of the POD and so was entitled to be regarded as a creditor for the purpose of CWR O.16, r17 and as such entitled to maintain an appeal, subject to joinder of the assignor – the evidence being such that there was no good reason to refuse permission for its joinder; and
  5. under the circumstances the Side Letter could only be construed as made on the Custodian's behalf, and the Custodian's Redemption Request and proof of debt were explicable only on the basis that it had the benefit of the Side Letter, which it had accordingly ratified by its conduct.

The CICA's approach strengthens the position of a beneficial owner seeking to recover in a liquidation, raising the prospect that otherwise unenforceable contracts may be ratified by the conduct of the beneficial owner's custodian/nominee. Although the CICA did stress that "there is no doubt that in ordinary circumstances the rights attaching to shares may only be pursued by the registered shareholder" there are not many steps between the logic adopted by the CICA in this situation and a situation whereby a beneficial owner needs to secure the winding up of a company but is prevented from doing so because of some procedural irregularity. One stark situation is the blanket provision in the Companies Law preventing any shareholder from presenting a winding up petition if it has not held some or all of its shares for at least the six months immediately preceding the presentation of the winding up petition3 – which catches administrative transfers from custodians back to long-standing beneficial owners or changes of custodian necessitated by circumstances beyond the beneficial owner's control (such as the insolvency of the custodian) which are made in the period prior to a winding up petition being presented. Investors in such a position should be in a stronger position to enforce their rights prior to insolvency and may now be emboldened to present petitions with some expectation that the Grand Court of the Cayman Islands will take a similarly pragmatic approach.

Authority of the Investment Manager to act on behalf of the Fund

Martin JA went on to conclude that the Side Letter was not binding on the Fund because:

  1. whilst the CIM expressly contemplated a variation of lock-up periods, the Investment Manager did not have actual authority to make such an arrangement;
  2. none of the documents or actions of the Fund gave any ostensible evidence of the Investment Manager having such authority;
  3. the outside world would not generally regard an investment manager as having authority to transmit decisions of the board of directors and any investor would be aware that the Investment Manager was merely one of a number of persons dealing with the Fund's affairs– the fact that the Investment Manager had "been let loose on the investors" did not in the circumstances give it ostensible authority to make representations as to the Fund's decisions about share redemption; and
  4. a transaction acknowledgment from the Administrator could not amount to a ratification of the Side Letter by the Fund because the Administrator was similarly not authorised to transmit the decisions of the Board.

Those looking to enter into side letters should ensure that they are negotiating with those who have the authority to agree the compromise sought, the safest solution being to contract directly with the Fund. Martin JA's comment about the "outside world's" view of the general authority of investment managers to bind an investment fund is an interesting proposition. It suggests that, when contracting with an investment manager, authority to bind the fund should be explicit in the fund's documentation. However, Martin JA's comments do not reflect the practical reality of the alternative investment industry: in our experience, the majority of fund promoters and onshore counsel will expect investment managers to have the requisite authority to enter into binding side letters. The CICA's findings suggest that this practicality is not reflected in legality. For this practice to continue, investment managers should build authority into their investment management agreements or seek director resolutions appointing the investment manager or delegating authority to agree side letters (and reflect this in the offering documentation so that the authority is apparent to the contracting counterparties).

Those seeking to enforce side agreements already entered into by an investment manager should seek confirmatory evidence of that authority or obtain express ratification of the agreement by the directors of the fund. Those who have yet to rely on their side letters should seek assurance that they have been entered into with the appropriate authority, the best solution being to seek ratification by the board of the relevant fund.

Postscript

The question as to whether the Side Letter was invalid as an unlawful variation of class rights did not fall to be determined by the CICA, so the thorny issue of class right variations still remains to be tackled by the higher Courts.

Footnotes

1. Namely Medley Opportunity Fund Ltd v Fintan Master Fund Ltd & Nautical Nominees Limited 2012 (1) CILR 360; Lansdowne Limited & Silex Trust Company Limited v Matador Investments Limited (In Liquidation) & Ors. 2012 (2) CILR 81; Swiss-Asia Genghis Hedge Fund v Maoming Fund (24 July 2013, unreported); and KBC Investments Limited v Geoffrey Varga (12 August 2012, unreported)

2. In the matter of Lancelot Investors Fund, Ltd (in official liquidation), KBC Investments Limited v Geoffrey Varga, 27 April 2015 (unreported)

3. s94(3) Companies Law (2013 Revision)

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Jeremy Snead
Similar Articles
Relevancy Powered by MondaqAI
Appleby
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Appleby
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions