The Cayman Islands Court of Appeal has provided important clarity on the rights of redeeming investors of Cayman funds in liquidation.
In Michael Pearson (as Additional Liquidator of Herald Fund SPC (In Official Liquidation)) v Primeo Fund (In Official Liquidation)1 the Court of Appeal has confirmed that:
- shareholders who redeem their shares in accordance with a company's articles of association prior to the company being placed into liquidation should be considered as redeemed even though not yet paid, and therefore they rank as creditors;
- redemption creditors' claims are founded on the statutory contract between them as members and the company, and as such their claims are in their "character of a member" and therefore they rank behind the company's external unsecured creditors, but ahead of the company's unredeemed shareholders; and
- as creditors the redeemers are entitled to enforce their right to payment notwithstanding the fund in question being insolvent at the date of redemption.
Herald Fund SPC ("Herald"), was a Madoff feeder fund, registered as a Cayman Islands exempted segregated portfolio company. Primeo Fund ("Primeo"), also a Cayman fund, was a shareholder in Herald.
In late 2008 Herald received redemption requests from a number of shareholders, including Primeo ("the Redeemers"), and in accordance with Herald's Articles of Association, the Redeemers' names were removed from Herald's share register on 1 December 2008.
On 12 December 2008, the day after Madoff's admission and the fraudulent scheme came to light, Herald's board suspended the calculation of the NAV and the issue and redemption of shares until further notice. As a result, the redemption proceeds payable to the Redeemers were not paid.
The Redeemers claimed they were entitled to receive the redemption proceeds as creditors and that their claims to payment were to be treated pari passu with Herald's other creditors and ahead of Herald's other shareholders who had not redeemed their shares prior to the suspension.
The liquidators of Herald took the position that section 37(7)(a) of the Companies Law applied to the claims of the Redeemers and that, under the provisos to that section, they had no entitlement to enforce their claim to the redemption proceeds as creditors, meaning that they would rank as contributories, equally with the un-redeemed shareholders and behind all other creditors.
Section 37(7) states:
(a) Where a company is being wound up and, at the commencement of the winding up, any of its shares which are or are liable to be redeemed have not been redeemed........the terms of redemption ... may be enforced against the company, and when shares are redeemed ... under this subsection they shall be treated as cancelled" (underline added).
The meaning of the underlined phrase was the subject of the appeal, as will be discussed below.
The provisos to this section provide that this right to enforce redemption rights does not apply if:
"The terms of redemption or purchase provided for the redemption or purchase to take place at a date later than the date of commencement of the winding up" ie where the redemption date under the Articles has not passed at the date the company went into liquidation;
"During the period beginning with the date on which the redemption or purchase was to have taken place and ending with the commencement of the winding up the company could not, at any time, have lawfully made a distribution equal in value to the price at which the shares were to have been redeemed or purchased" i.e. the company could not, as at the redemption date, have lawfully paid the redemption because it was insolvent (unable to pay its debts as they fell due).
If the provisos do not apply and the redemption right is enforceable, section 37(7)(b) provides that the redeemed investor ranks behind the company's other unsecured creditors but ahead of unredeemed members.
In at least one previous decision by the Cayman Courts, the lack of clarity of the wording of 37(7)(a) has been noted, and the problematic phrase "shares which are or which are liable to be redeemed [which] have not been redeemed" had been construed2 to apply to the situation where a valid redemption has been made, the redemption date has passed, but no payment has been made prior to the commencement of liquidation.
First Instance Decision
Jones J. in the first instance decision in Primeo rejected the above construction of s37(7)(a). He held that it did not apply to those who had redeemed but remained unpaid. Jones J. found that the phrase "have not been redeemed" could not apply where the redemption date has passed prior to the commencement of the winding up, because, as held by the Privy Council in Culross Global SPC Ltd v Strategic Turnaround Master Partnership Ltd (2010(2) CILR 364), on that date the debt crystallises, the redeemer ceases to be a member and becomes a creditor, and has fully redeemed even though they may still be awaiting payment.
The Importance of the Issue
The application of section 37(7)(a) to unpaid redeemers is important because if it applies, it potentially brings into effect the provisos of 37(7) - the relevant proviso in this case being that if the fund was insolvent at the redemption date (as Herald was), the right to payment of the redemption proceeds falls away.
The Court of Appeal Decision
The appeal focussed on the meaning and application of the words "shares which are or which are liable to be redeemed have not been redeemed".
The Court of Appeal held that:
- at the commencement of a company's winding up, section 37(7)(a) did not apply where redeemable shares had been redeemed according to the company's Articles of Association, notwithstanding that the company was still to make payment of the redemption proceeds; and
- section 37(7)(a) applied where a "holder of redeemable shares" had acquired the right to redemption under the Articles, but where the required steps to complete the redemption had not been completed, such that there was no redemption of the shares prior to the commencement of the winding up.
In holding that section 37(7)(a) did not apply in this case, the Court of Appeal favoured an interpretation of "redeemed" which provides consistency in the application of the term during the life of a company, and on its insolvency. The Court started from the principle that an investor ceases to be a member of a company once the redemption process as set out in the company's articles of association is complete. At that point, notwithstanding the redemption proceeds may not have been paid, the former shareholder is divested of his rights qua shareholder but stands as a creditor of the company, and has a provable claim for the redemption proceeds under section 139(1) of the Companies Law. Such status of creditor invariably gives rise to the question of where former members who are yet to receive redemption proceeds rank on the insolvency of a company.
The judgment of Jones J. at first instance was silent as to whether the Redeemers ranked in the liquidation pari passu with Herald's general unsecured creditors3. On appeal it was contended by Herald that under section 49(g) of the Companies Law the claims of the Redeemers would be subordinate to the claims of Herald's ordinary unsecured creditors, but would rank in priority to the Herald shareholders who had not redeemed their shares. Section 49(g) provides that the claims of a company's ordinary creditors shall have priority over sums "due to any member of a company in his character of a member by way of dividends, profits or otherwise". The Court of Appeal accepted this interpretation and found that the redemption claims of former shareholders are founded on the statutory contract between them as members and Herald, and are properly claims due "in [their] character of a member". While a claim for redemption proceeds is a debt which may be enforced against the company, the debt arises from a prior member/company relationship and the former member remains subject to the interests of the company's external creditors. Interestingly section 49(g) was not referred to in the first instance decision. In practical terms the interpretation of section 49(g) adopted by the Court of Appeal confers on the Redeemers the same priority they would have enjoyed had section 37(7)(b) been found to apply.
It remains to be seen if Mr Pearson on behalf of Herald will be granted leave to appeal to the Privy Council and whether this decision remains the last word on the proper construction of section 37(7).
1. CA unreported 19 July 2016
2. See Re Founding Partners Global Partners Ltd (in Liquidation) (unreported, Foster J., 21 September 2010)
3. The headnote to the report of the first instance decision in the Cayman Islands Law Reports suggests that Jones J held that the non-application of section 37(7) meant that where the redemption date has passed the redeemer becomes a creditor ranking alongside any other unsecured creditor of the company. Jones J does not expressly make such a finding in his judgment but this is perhaps implicit in some of his statements.
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