In the last three months of 2008, fund managers in many
different sectors were forced into gating or suspending redemptions
by the turmoil in the financial markets, restrictions on certain
investment activities and the Lehman bankruptcy. As funds were
forced to suspend or chose to pay redemption proceeds in specie or
create side pockets, late December and the early months of 2009 saw
fund of funds having liquidity issues, since they relied upon their
underlying portfolio funds to give them liquidity. This in
turn led to some significant pressure on relatively liquid funds
which seem, in some cases, to have been used as ATM machines by
their investors who were unable to realise cash elsewhere.
This general illiquidity, coupled with the forced deleveraging
and massive rush for cash by investors, caused a large number of
funds to suspend redemptions, the calculation of NAV and payment of
redemption proceeds. For many funds, the suspension is giving
them time to restructure with a view to continuing
trading. For others it is part of the process of orderly wind
down. Inevitably these suspensions, however made, have
led to a number of cases coming before the courts.
Developing Case Law
There have been some interesting case law developments in the
major offshore hedge fund jurisdictions, including Strategic
Turnaround, where the Cayman Court of Appeal heard a case which
dealt with the question of the status of a redeemed
investor. In summary, the court worked hard to view a redeemed
investor as a type of creditor from the redemption date which, in
the light of the new Cayman insolvency regime, potentially gives
redeemed investors the ability to wind up the fund, depending on
their circumstances and the fund's constitution.
While litigation is rarely good news, these cases do provide
some guidance when planning strategies to cope with illiquidity and
treating all investors equitably in any plan.
Synthetic Side Pockets
When designing structures for funds to enable them to survive
the crisis we have had to be creative and have come up with plans
which are allowed under the fund's constitution but are not
A good example is the common provision allowing redemption
payments to be made in specie which enables many funds to resume
redemption payments earlier than if they waited for the illiquid
assets to be realised. However, the fund's illiquid assets
are commonly not easily transferable or a direct holding in which
may cause investors legal, regulatory or logistical problems. This
is often surmounted by placing the illiquid assets into a SPV and
then paying redemption proceeds in specie by transferring the SPV
shares to the redeeming shareholders (a "synthetic side
pocket"). The shares in the SPV are not redeemable at the
option of the holder, but can be structured so that they are
redeemed pro rata as and when the SPV receives cash from the
underlying assets, thereby allowing the investors to be paid as if
they were holding the assets direct. This allows a manager to
clean up a fund's balance sheet.
Prevention Is Better Than Cure
What has become very clear over the last 6 months is that funds
which suspend redemptions before they reach a critical redemption
date have more chance of avoiding litigation and liquidation than
funds which find they have to take emergency steps after the
redemption date to limit redemptions.
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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