Cayman Islands: Subscription Credit Facilities - Cayman Updates

Last Updated: 23 November 2016
Article by Caroline Barton and Anna-Lise Wisdom

The Cayman Islands Contracts (Rights of Third Parties) Law (Law) grants to a person who is not party to a contract the ability to enforce rights and benefits expressly granted to such third party in the contract, provided the relevant "opt-in" language from the Law is expressly incorporated in the contract in question. The limited partnership agreement (LPA) of a Cayman exempted limited partnership (ELP) may attempt to either (i) exclude a lender as a beneficiary or (ii) provide for a lender to be a third party beneficiary of its provisions. However, since the Law does not (nor was it designed to) grant rights to persons who are not accorded such rights by virtue of the relevant contract, such provisions may not necessarily have the desired impact.

Language in LPAs providing for a lender to be a third party beneficiary of its provisions may be of limited enforceability unless the lender is expressly made a delegate of the rights of the general partner (GP) in the LPA and the LPA then incorporates the required opt-in language to trigger the operation of the Third Parties Law. This is uncommon. However, the lack of such express delegation is not fatal to a lender's enforcement rights – it simply means that such rights, rather than being capable of direct enforcement pursuant to the LPA, will instead arise (as they have done historically) under its security package, which will typically include step-in rights via the power of attorney granted to the lender to enforce the contractual rights of the GP to make capital calls.

The express exclusion of a lender as a third party beneficiary in the LPA will ultimately have no impact on a lender's enforcement rights granted by virtue of a well-constructed security package, because the lender, rather than enforcing its rights as a third party beneficiary, will exercise the rights of the GP under the LPA that have been assigned to it as part of the security package.

Set-off

Lenders to Cayman ELPs do not benefit from laws which enshrine the obligation of an investor to contribute cash to a fund in statute. Accordingly, lender's counsel will generally look for affirmative language in the LPAs outlining the funding obligations of investors and the right of the ELP/GP to make capital calls on the investors. The obligation of an investor set out in the LPA to commit funds up to the amount of its unpaid capital commitment is generally recognised as a legal, valid and enforceable obligation which can be sued upon by a lender who steps into the shoes of the GP pursuant to its security package. However, under Cayman law, where investors do not expressly waive the right of set-off in the LPA, there is a presumption that the parties intend for set-off to apply. Absent express waivers of set-off in the LPA, investors will remain entitled to set off amounts payable by them in respect of their uncalled capital commitments against any amounts which become due and payable by the ELP/GP to the investor. In the context of subscription financing, absent such express waivers, the lender's security could potentially be subject to set-off of claims accruing to investors prior to the service of an investor notice under the facility, which might be deducted from amounts payable to the fund pursuant to a capital call issued by the GP or a lender on an enforcement event.

Importantly, the service of notice on investors of an assignment of capital call rights to a third party lender will prevent set-offs from arising after the date of service of such notice. This rationale is based on the common law principle that set-off works between the same parties in the same right. If there is notice to one party of the assignment of a right to a third party (i.e., lender), set-off will no longer continue to work in the same manner. As investor notices are routinely delivered in deals involving Cayman ELP borrowers, this should give some comfort to lenders as far as the potential for new set-offs to arise is concerned. However, the service of notice on investors does not have the same effect with respect to claims which might have arisen prior to the date of service of the notice. Most LPAs and/or the accompanying subscription documents, will now incorporate express waivers on the part of investors confirming that they will not rely on any right of set-off of in order to reduce their obligations to make their capital contributions. Usefully, these contractual waivers survive the insolvency of the ELP. The insolvency provisions of the Companies Law of the Cayman Islands (which apply to ELPs by virtue of Section 36 of the Cayman Islands Exempted Limited Partnership Law), expressly provide that the collection in and application of property on the insolvency of a company is without prejudice to and after taking into account and giving effect to any contractual rights of set-off or netting of claims between the company and any person or persons and subject to any agreement between the company and any person or persons to waive or limit the same. Certain LPAs that do not incorporate express waivers on the part of LP's may instead incorporate an agreement by investors to deliver such waivers if requested by lenders to do so in the future. If obtained, this is as effective as a waiver embedded in the LPA.

Credit facility agreements will also typically incorporate representations and warranties to the effect that there are no existing claims of offset which would or could diminish or adversely affect the investors' obligations to fund their capital commitments. Diligence around these representations would likely reveal any existing claims of substance or circumstances which would warrant further investigation, such as non-payment of capital calls by investors.

LLC Law

The Limited Liability Companies Law, 2016 came into force on 8 July 2016 creating a new type of Cayman vehicle similar to a Delaware LLC.

We have begun to consider the potential impact of the use of a Cayman LLC in the subscription credit facility and, in particular, how effective security over the capital call rights of such a vehicle might be obtained.

As the Cayman LLC is essentially a hybrid between the ELP and a Cayman exempted company, we must consider how (i) the contractual obligations of members to fund the Cayman LLC and (ii) the security over such obligations, will be documented.

LLC agreement and subscription documentation

The LLC Agreement as the main constitutional document of the Cayman LLC will set out a member's rights, much like the Memorandum and Articles of Association of an exempted company and the LPA of an ELP. As industry players are aware, taking security over the capital call rights of a Cayman exempted company presents certain challenges however such issues are not expected to arise with respect to an LLC Agreement.

Separately, each member in the Cayman LLC would enter into a subscription agreement setting out the terms on which it agrees to be a member and fund the Cayman LLC.

In order to ensure that a Cayman fund may participate in a subscription financing, the constitutional documents and subscription agreement must contemplate the related collateral arrangements. A Cayman LLC is no exception. If the adoption of the Cayman legislation results in the use of Cayman LLCs as the new vehicle of choice then the following items must be included in the formation documents of a Cayman LLC:

  1. Express and broad wording as to the ability to incur indebtedness in connection with a subscription credit facility as borrower or guarantor;

  2. Express ability to assign the rights to call for and enforce capital contributions and apply the proceeds towards the satisfaction of the Cayman fund's secured liabilities; and

  3. The acknowledgement by members of such assignment.

Conclusion

Appleby remains fully informed of the latest developments in the fund finance market and will continue to provide timely updates on general areas of interest. For more specific advice, we invite you to reach out to any of the authors or to your usual Appleby contact.

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.

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Authors
Caroline Barton
 
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