The Cayman Islands Court of Appeal (the "Court" 1) recently delivered a judgment (the "Judgment") in the case of In re Strategic Turnaround Master Partnership, Limited. The Court considered a number of points of interest to hedge funds and their service providers, particularly in relation to redemptions and suspensions and the timing of various steps in the redemption process. This Advisory considers the implications of the Judgment for Cayman Islands hedge funds.
Strategic Turnaround Master Partnership, Limited (the "Fund") received from an investor (the "Investor") a timely redemption request for 31 March 2008 (the "Redemption Day"). The Fund's confidential explanatory memorandum (the "PPM") provided that, except as otherwise described in the PPM, redeeming investors would receive at least 90% of the redemption price no later than 30 days following the date of redemption.
On 17 April 2008, before the Fund had either removed the Investor from the register of members or paid the redemption proceeds to the Investor, the directors of the Fund resolved to suspend all redemptions. The ability to suspend was set out in the Fund's articles of association (the "Articles") and the PPM. The Articles provided that "The Directors may, from time to time ... declare a suspension of the determination of the Net Asset Value of shares and the issue and redemption of the shares." The PPM used a slightly different formulation, but gave the Fund express power to suspend the payment of redemption proceeds.
On the basis of the suspension, the Fund refused to pay redemption proceeds to the Investor. The Investor proceeded to petition the court for the winding up of the Fund on the basis that (a) the Fund was unable to pay its debts (which is a statutory ground) and (b) that it was just and equitable that the Fund should be wound up (which relies on the court's discretion). The Fund's application to strike out the petition was refused. The Judge who heard the application ruled, among other things, that (i) the Investor's shares had effectively been redeemed as at the Redemption Day, (ii) until payment of the redemption proceeds, the Investor remained a member of the Fund bound by the rules of the Fund, and (iii) on the Redemption Day the Investor became a creditor of the Fund, in its capacity as a member, in the amount of the redemption proceeds, ranking ahead of other shareholders, but after third-party creditors.
The Fund appealed. The Investor challenged the Judge's ruling on point (ii) above and also contended that the Fund's obligation to pay the redemption proceeds fell due on the Redemption Day, and not 30 days later.
Key Features of the Court's Judgment
The Court made clear that the Judgment related to questions of construction of the Fund's Articles, the PPM and certain matters of law. The Court further confirmed that its conclusions would not be the same in relation to every dispute concerning the redemption of shares in every fund and accordingly the decision needs to be read in that context. The principal points arising out of the Judgment are considered below.
When does a redeeming shareholder become a creditor?
The Court held that, on the Redemption Day, the Investor became a creditor of the Fund despite the fact that (a) the redemption proceeds to which it was entitled had yet to be determined and (b) the date upon which the payment of the redemption proceeds was due under the Articles and the PPM had not yet arrived. This accords with the view taken by Walkers.
What can a redeeming shareholder do as a creditor?
A creditor whose debt is presently due and payable has standing to petition the court for the winding up of a company. However, until the day due for payment of the redemption proceeds passes without any suspension having been invoked, the debt is not due and payable.
Where a shareholder submits a timely request for the redemption of shares and the date for payment of some or all of the redemption proceeds has passed, the redeeming shareholder will have standing to present a petition to wind up the fund on the basis that the fund is unable to pay its debts. A redeeming shareholder will not have standing to present a winding up petition on this basis if either (a) the date for payment of the redemption proceeds has not passed, or (b) the date for payment of the redemption proceeds has passed but the fund has resolved prior to that date to suspend payment of the redemption proceeds. By extension, from a legal perspective there is little to be gained by a fund in suspending payment of redemption proceeds after the date on which payment is due.
It is important to note that although a redeeming shareholder may be described as a 'creditor' for the purposes of making a claim against the fund, such claim will still be made in its capacity as a shareholder and not as an outside creditor. Thus, although a redeeming shareholder will rank ahead of shareholders who have not served notice to redeem, it will rank behind unsecured creditors.
When does a redeeming shareholder cease to be a member?
The Court held that even though the Investor became a creditor in respect of the redemption proceeds on the Redemption Day, this did not mean that the redemption process was at an end. Rather, the Investor remained a member of the Fund until it received payment and its name was removed from the register of members. In support of this holding, the Court drew on the general principles recognised by the English cases to this effect and the Articles, which provided that the process of redemption was not complete until the Investor's name was removed from the register of members and the shares made available for re-issue.
The Court held that after the Redemption Day, the Investor was still bound by "the majority of the Articles and the PPM." It is presently unclear how a redeeming shareholder could be bound by some, but not all, of a fund's articles of association and how to determine which provisions would continue to apply and which would not. The Court did not address the question of whether, in these circumstances, a redeeming shareholder would be entitled to exercise any rights as a shareholder (such as voting rights) following the redemption day, but pending its removal from the register of members and receipt of redemption proceeds. In our view, it would be a curious result if in these circumstances a redeeming shareholder would be entitled to requisition, participate and vote as a shareholder, for example.
Many fund articles provide that once a share is redeemed the shareholder ceases to be entitled to any rights in respect of it (other than the right to receive a dividend declared prior to such redemption and the right to receive redemption proceeds). In the present case, the Articles relating to voluntary redemptions contained a substantially similar provision. However, on a compulsory redemption, the Articles provided that a shareholder would have "no Member rights with respect to the Shares to be compulsorily redeemed after close of business on the Redemption Day, except the right to receive the redemption proceeds therefore..." The Court concluded that, in the case of the Fund, members' rights were lost after the Redemption Day for compulsory redemptions but only at the end of the redemption process for voluntary redemptions.
In our view, there is no particular reason for distinguishing between the rights of a shareholder who voluntarily redeems and one who is subject to compulsory redemption. It follows, in our view, that in the case of both voluntary and compulsory redemptions of shares, a fund's articles should specify the effective date on such redemption occurs and whether or not the redeeming shareholder is entitled to exercise any rights as a member from such date.
When can a fund suspend payment of redemption proceeds?
The Court concluded that the Fund had power to suspend the payment of redemption proceeds prior to the scheduled payment date. It is noteworthy that (unlike the PPM), the Articles said nothing about suspending payment of redemption proceeds. The Court concluded that the reference to redemption in the Articles must have been a reference to "the entire process of redemption" including payment of redemption proceeds. While the Articles incorporated the PPM's redemption provisions, it is not entirely clear whether, in the absence of the express power in the PPM to suspend payment of redemption proceeds, the Court would have reached a different decision on this point.
Going forward, to avoid any doubt on the subject, it is advisable that a fund's constitutive documents contain clear power, both in the articles of association and in the offering document, to suspend payment of redemption proceeds.
This case is interesting because it addresses the redemption process as one which involves various stages, ending with the removal of a redeeming shareholder from a fund's register of members and the payment of redemption proceeds. It also suggests that a fund may be able to suspend payment of redemption proceeds prior to the scheduled payment date (relying on the suspension of redemption provisions) even if there is no express power to do so in the fund's articles.
For Walkers' analysis of the recent decision of the Supreme Court of Bermuda in BNY AIS Nominees Limited & Ors v Stewardship Credit Arbitrage Fund, Ltd. click here.
1 The Cayman Islands Court of Appeal is the second highest appellate court for Cayman Islands cases. If leave to appeal is granted by the Court of Appeal, the ultimate court of appeal is the Privy Council in London. Decisions of the Cayman Islands Court of Appeal are binding on lower courts in the Cayman Islands.
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.