Cayman Islands: No Path To Redemption: Privy Council Rules On Pearson vs. Primeo

Last Updated: 29 August 2017
Article by Paul Kennedy

"The path to redemption is not always smooth."

So begins the judgment of Lord Mance in the Privy Council in the case of Pearson v Primeo1 – the latest but almost certainly not the final word on redemption rules in Cayman Islands hedge funds. Indeed, Lord Mance's decision is likely to mean that there is, in fact, no path to redemption for those investors who have not already "redeemed" their shares when a fund is suspended and then goes into liquidation.

This case revolved around section 37(7) of the Cayman Islands Companies Law – a provision which the Grand Court called a "comprehensive code"2 for redeeming investors. Following Pearson v Primeo, that section looks less like a comprehensive code than a dead letter. As Lord Mance says in his judgment, "The likelihood in practice of successful section 37(7) claimants may [...] be slight."3

The Privy Council has upheld the findings of both the Grand Court and the Cayman Islands Court of Appeal to the effect that those shareholders in the Herald Fund (a Madoff feeder fund which is now in liquidation) who had "redeemed"( i.e. property in their shares had passed back to the Fund on the relevant Redemption Day) have a form of creditor claim which is outside the ambit of section 37(7).

A novel point was raised in the Privy Council by the intervention of Reichmuth & Co, a shareholder whose shares had not been redeemed but who had served a valid redemption request prior to the suspension of the Fund. Reichmuth argued that the section must apply to it and to similarly situated shareholders (the "Late Redeemers"). No other party argued that the section applied to them and the Courts have yet to articulate a convincing real world scenario in which the section would apply to any other class of shareholder.

The Privy Council agreed with Reichmuth's submission that the section applies to the Late Redeemers; however, it went on to rule that the effect of a suspension of the Fund was to deny those redeemers (and probably any redeemers) the benefit of the section:

"When as here the suspension continued until the commencement of the winding up, the terms of redemption must be regarded as having provided for redemption to take place at a date later than the date of the commencement of the winding up, within the language of Proviso (i) to section 37(7)(a)"4

What this means is that the section, which is predicated as a means by which shareholders whose shares "have not been redeemed" can enforce the terms of redemption against a fund during the liquidation process, does not bite where the fund suspended redemptions prior to being wound up. In effect, the suspension delays the Redemption Day to infinity and by virtue of the section, renders any late redeemer claims unenforceable.

In Lord Mance's words, the section and the English Companies Act provision on which it was based were "on any view designed to elevate the status of a shareholder where redemption or purchase had not taken place at the commencement of the winding up". It is difficult to reconcile this fact with the Privy Council's conclusion that the Cayman Islands provision does not, in practice, achieve the end it was designed to achieve. Given that suspension of calculation of NAV, subscriptions and redemptions is commonplace for a fund in difficulties and often the precursor to liquidation, and that very suspension blocks the elevation in status which the section was designed to achieve, it is hard to escape the conclusion that shareholders in Cayman funds who have filed valid redemption notices now have no "path to redemption" whatsoever.

The Privy Council also ruled that shareholders who had filed a redemption request after the suspension had been declared5 could not enforce their claims, for the same reason as the Late Redeemers (i.e. they did not have an effective redemption date prior to the commencement of the winding up). So, in the case of Herald, none of the various classes of shareholders or shareholder-creditors in the fund could enforce any claims under the section. The Privy Council posited a number of scenarios in which claims might be enforceable under the section:

"[The situations in which section 37(7) would apply] would exist if the shares had a fixed redemption date, or if notice to redeem had validly been given for a date, prior to the commencement of the winding up, but the company had for any reason wrongly failed to take steps necessary to enable redemption at that date. ...It is also possible to contemplate formalities that a company might be obliged, and might fail, to take in order to complete redemption. It is instructive that the title to section 59 of the English Companies Act 1981 indicated that it was addressing the "effect of company's failure to redeem or purchase its own shares", ie pursuant to terms of redemption or purchase which obliged the company to effect the redemption or purchase at a date prior to the commencement of the winding up."6

However, in such a scenario in the Cayman Islands (where, unlike in England there is no statutory rule against a damages claim by a shareholder in such a case) the shareholder would have a remedy in damages which begs the question what the purpose of the section was in the first place, if not to provide a remedy where otherwise there would be none. Further, the Privy Council's analysis does not address the fact that it is highly unlikely that a fund which could not or did not wish to redeem a shareholder would do anything other than rely on what are commonly broadly drafted suspension provisions. Indeed, whether or not the section ever had a purpose, it may be that the proliferation of such provisions in recent times has rendered this particular section of the Companies Law otiose.

This judgment can be seen as a companion piece to another recent decision of the Privy Council relating to a Madoff feeder fund, Fairfield Sentry Ltd v Migani [2014] UKPC7. There Lord Sumption said:

"It is inherent in a Ponzi scheme that those who withdraw their funds before the scheme collapses escape without loss, and quite possibly with substantial fictitious profits. The loss falls entirely on those investors whose funds are still invested when the money runs out and the scheme fails. Members of the Fund who redeemed their shares before 18 December 2008 recovered the NAV which the Directors determined to be attributable to their shares on the basis of fictitious reports from BLMIS. The loss will in principle be borne entirely by those who were still Members of the Fund at that date."8

As Lord Mance notes in Pearson v Primeo, Fairfield Sentry involved an attempt to recover redemption moneys which had already been paid and it was not necessary to draw the precise line between "those investors whose funds are still invested" and "those who were still Members of the Fund" at the critical date, which is here the commencement of the winding up:

"That line falls now to be drawn, and the Board's conclusion is that the critical moment is when an investor has redeemed and so ceased to be a member of the fund, becoming instead a creditor owed the redemption proceeds."9

The Privy Council in both cases has sought to determine the precise moment when the music stopped and, by extension, who are the winners and losers. That is to be welcomed as it brings a measure of certainty to the rights attaching to redeemable shares, which Lord Mance noted were first introduced only in the 1980s and have not until recent years attracted the same kind of judicial attention as ordinary shares.

What is less clear is what is to become of section 37(7) of the Companies Law; if it does not represent a way for shareholders to cross the line which the Privy Council has drawn in Fairfield and Pearson, then the question must be asked whether it has any purpose. If it does not, then section 37(7) and perhaps section 37 generally10 must be in need of repeal or reform so that the Cayman Islands funds industry has a statutory regime governing redeemable shares which is clear, concise and fit for purpose.


1 [2017] UKPC 19

2 Pearson v Primeo Fund [2015 (1) CILR 482] paragraph 13

3 Pearson v Primeo Fund [2017] UKPC 19 paragraph 35

4 ibid paragraph 26

5 Represented before the Privy Council by Natixis on behalf of the "Later Redeemers"

6 Pearson v Primeo Fund [2017] UKPC 19 paragraph 17

7 An appeal from the BVI

8 Paragraph 3

9 Pearson v Primeo Fund [2017] UKPC 19 paragraph 21

10 The authors note that an appeal is pending before the Privy Council in the case of DD Growth Premium 2X Fund (In Official Liquidation) v. RMF Market Neutral Strategies (Master) Limited [2015 (2) CILR 141] relating to the construction of section 37(6) of the Companies Law.

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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Paul Kennedy
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