Cayman Islands: Distressed Funds - Synthetic Side Pockets

Last Updated: 1 December 2008
Most Read Contributor in Cayman Islands, September 2018


We are seeing many offshore funds go into distress for a variety of reasons, most commonly where liquidity issues have resulted in an inability to meet redemptions. Devising a solution to manage the fund through its difficulties will always depend on the commercial circumstances and the desired outcome, but crucially any proposed solution must fall within the parameters of the fund's offering document and articles of association. It is also essential that the directors comply with their fiduciary duties in determining an appropriate course of action. The principal duties in a distressed funds context are the duty to act in good faith in the best interests of the fund, the duty to act for a proper purpose and the duty to treat investors fairly.


Most funds are formed with documents which provide the operators of the fund with a variety of defensive measures to provide stability for the fund in times of difficulty. Very few funds have a full complement of such measures, and even those funds that do have a range of techniques at their disposal are finding in the current environment that they do not always cater for every nuance.

The techniques that are most commonly used to manage a distressed fund are, in no particular order:

Side pockets

An ability to segregate illiquid or hard-to-value assets from the remainder of the fund's portfolio allows the fund to continue offering investors redeemable shares while preserving the potential value of the side-pocketed assets. The traditional approach is to permit the manager to identify assets that do not have a readily realisable market value. Upon establishment of the side pocket, a portion of the investors' redeemable shares are immediately converted into a new class of non-redeemable shares, representing the fund's investment in the illiquid asset. When the asset is realised or deemed realised, those investors who participated in the side-pocket are able to participate in the profits (or losses) of the now liquid asset.


Some funds have the ability to impose a gate to enable the fund to delay payment of redemption proceeds. Funds that permit the imposition of a gate usually provide for a particular level of redemptions (on an aggregated basis) to be reached before the gate is triggered. A fund may also have a "stacked gate" which permits gated investors to be given priority over investors subsequently seeking to redeem on the next redemption date.


The articles of association of a fund usually provide that the directors may suspend the determination of net asset value and redemptions. There may be tightly prescribed circumstances which must exist before the suspension may be effected, or the directors may be left with a broad discretion. It may be possible to interpret the articles as enabling suspension of redemptions without having to suspend determination of net asset value, or to partially suspend redemptions. Generally, it is not considered possible to retroactively invoke a suspension of redemptions after the relevant redemption day has passed. It is, however, common for the suspension provisions to enable the fund to delay payment of redemption proceeds to investors after they have redeemed.

Redemption in-kind

Where a fund has insufficient liquid assets to meet all redemptions in cash, it may be possible to pay redemptions partly or wholly in-kind, by the transfer to the redeeming investors of assets of the fund. There must be clear authority in the fund's documents. Securities issued by a company are not considered to be assets of that company, so it is not permissible to create a new class of shares and to use such shares as a redemption in-kind.


Some managers are restructuring funds or moving investors to new funds with different terms, frequently with longer lock-up periods but lower fees. Typically, the fund compulsorily redeems the investors from the existing fund in exchange for an agreement to subscribe for shares in the new fund. The redeeming investor effectively directs the fund to transfer a pro rata portion of the assets in the old fund to the new fund. Unlike some of the other mechanisms, which must be built into the fund's documents, there are no real limits on what can be done with a restructuring because invariably it is done with the consent of the investors.


Side pockets are very effective ways of managing illiquidity but they are commonly not authorised by a fund's documents; on the other hand, redemption in-kind in its pure form is less effective at managing illiquidity, especially where the underlying assets are not transferable, but it is usually permitted by the documents. A synthetic side pocket is a technique which seeks to create the effect of a side pocket where a fund's documents do not contain an express side pocket mechanism, by creating a new subsidiary of the fund and using the power to pay redemption proceeds in-kind to indirectly convey the illiquid assets to the investors.

The best way to illustrate this is with an example. The structure described below is simplified for illustrative purposes but the same principles are being used in typical onshore/offshore master-feeder structures as well.


For the purposes of this example, the key features of the structure (prior to effecting the synthetic side pocket) are:

1. Cayman Islands stand-alone corporate fund.

2. 80% liquid assets, 20% illiquid.

3. Redemption requests received for the next redemption day for 20% of the fund's NAV.

4. Fund documents do not permit the fund to create side pockets, but they do authorise the fund to pay out redemption proceeds in-kind.

5. Illiquid assets are not transferable.

6. Desired outcome is to keep the fund in operation and the manager does not want to suspend redemptions.

7. Manager considers it inequitable to pay redeeming investors 100% out of the liquid assets as this would increase the illiquid exposure for the non-redeemers.

8. Manager does not consider that the investors would consent to the creation of a normal side pocket mechanism.


The synthetic side pocket is effected as follows:

1. A new Cayman corporate SPV is formed.

2. Legal title to the illiquid assets remains with the fund, as they are non-transferable.

3. The fund assigns to the SPV the benefit of the future proceeds (if any) of the illiquid assets, documented in a participation agreement between the fund and the new SPV.

4. In return, the SPV issues shares to the fund which are not redeemable by the holder. The fund now holds an asset (ie the shares of the SPV) capable of being paid out in-kind on a redemption.

5. On the redemption day the redeeming investors are paid out 80% of their redemption proceeds in cash and 20% of their redemption proceeds in-kind by the transfer to them of shares of the SPV.

Non-redeeming investors

One decision to be made is what to do about the non-redeeming investors. It would be possible to leave them untouched: they would continue to hold their redeemable shares, and upon their future redemption they would receive cash and shares of the SPV. However, this would mean that (in our example) 80% of the shares of the SPV would remain as assets of the fund, so any new investors coming into the fund would acquire exposure to the illiquid assets.

An alternative approach is, therefore, at the same time as the fund pays out the in-kind redemption to the redeeming investors, for the fund compulsorily to redeem 20% of the redeemable shares held by the non-redeemers and transfer shares of the SPV to them as well. This may be particularly appropriate where the manager considers that it is the existing investors who suffered the original drop in the NAV of their shares when the assets became illiquid, and so only the existing investors should take the benefit of any upside when and if the illiquid assets are liquidated.

Termination of SPV

From here the process is conceptually simple:

1. Gradually liquidate the illiquid assets, the benefit of which would be received by the SPV under the terms of the participation agreement.

2. Distribute the proceeds received by the SPV, by way of dividend or by compulsory redemption of the shares of the SPV held by the investors.

3. Terminate the SPV.

The concept of a synthetic side pocket is relatively new, and we have already seen certain variations developed. It is too early to tell whether there will be any form of investor backlash against the use of this technique, but its principal advantage is that it relies on the use of mechanisms that are permitted by the fund's articles of association and (hopefully) disclosed to the investors in the fund's offering document.

Cayman Islands
Jonathan Tonge, Partner

David Whittome, Partner

Heather Bestwick, Partner

British Virgin Islands
Richard May

Hong Kong
Philip Millward, Partner

Rod Palmer, Partner

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

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

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
Related Articles
Related Video
Up-coming Events Search
Font Size:
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
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
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 (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

To Use 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.


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.


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