Originally published in Captive & ART Review Guernsey supplement, May 2007
Guernsey introduced a new segregated cell company structure in May 2006 – the incorporated cell company (ICC). The introduction of the legislation followed soon after the creation of the structure in Jersey in February 2006. In January 2007 my team performed the first conversion of a mutual PCC fund to an ICC (creating the world's largest ICC mutual fund).
Segregation: A Potted History
As most readers will be aware, Guernsey pioneered the protected cell company (PCC) concept in 1997, modelled on similar but less formal and enforceable provisions in the Caribbean. Some 10 years on, the Guernsey PCC concept has been adopted by many major offshore jurisdictions. Far from its origins in the management and structuring of insurance risk, it is now used extensively in many areas of offshore financial structuring, including single purpose vehicle (SPV) cells for securitisation purposes and particularly for multi-strategy umbrella funds. Until 2006, practitioners in Jersey and a number of other jurisdictions had viewed the PCC concept with some scepticism. After some 10 years of essentially secure operation in Guernsey and elsewhere, the scepticism finally seems to be dwindling.
None of the original criticisms of the PCC as being unreliable in insolvency have been reflected in court proceedings, indeed many of the practical problems encountered since 1997 have been more subtle and related primarily to ordinary negligence and errors in administration. In other words the PCC has displayed the same characteristics in use as any "normal" company or trust structure. Without doubt one of the reasons for the smooth operation of the structure has been the restriction in Guernsey on the use of the PCC for non-regulated purposes until recent times. This means a much higher level of regulation, compliance and independent corporate governance has been applied to the Guernsey PCC until 2006.
As more and more legislatures adopt the PCC concept or an analogue by a different name, the less likely it becomes that a court in such a foreign jurisdiction would fail to recognise the reciprocal legal principles imposed by segregated cell company legislation.
However, despite all the flexibility and benefits, the PCC structure does currently pose some challenging (and therefore potentially expensive) legal issues for the purposes of achieving certain results, particularly where a credit rating might be a pre-requisite; and this has to date limited to some extent the use of the PCC for certain types of reinsurance and structured finance transaction, when its characteristics would otherwise perfectly suit such uses.
Jersey therefore introduced the ICC in February 2006 in response to lingering (albeit unsubstantiated) doubts about the PCC structure to create a hybrid of the PCC and a conventional company group. Many people are now asking what possible benefit such a structure could have over a simple group of separate companies?
The key points of the new ICC structure are:
- Additional comfort regarding inter-cell security in the event of insolvency;
- The ability to create binding contractual relations between cells without eroding cellular insolvency protection;
- More formalised and less radical structure than the PCC, enabling an easier route to cell rating;
- Very significant flexibility;
- Opportunities for use of mixed "hybrids" and multiple-regulated cells.
Insolvency Protection & Rating
The key difference between the PCC and the ICC are that each ICC cell is a separate legal entity with a separate registration, as opposed to a single entity in the case of the PCC. This separation of corporate legal entity is generally respected in most jurisdictions and for that reason the ICC can provide more comfort in the event of insolvency of one cell; a foreign court would be less likely to use the assets of another cell to satisfy creditors' claims. It has always been the most important risk associated with a PCC that a foreign court might not recognise the inter-cell protections afforded by the Guernsey legislation.
For that reason it has generally been the case that counsel have advised a PCC to retain its assets in Guernsey to absolutely avoid any risk associated with foreign courts ignoring such inter-cell protections. Although, as indicated above, many other jurisdictions now have the same or similar legislation and are therefore less likely to ignore the similar provisions of another jurisdiction, the foreign asset risk is likely to be reduced for an ICC and its cells. This might, for example, allow increased access by ICC cells to investment markets where PCC boards have been reluctant to venture on a multiple cell basis.
The PCC cell has proved a difficult structure for which to obtain a credit rating, mainly because of the possibilities for the creation of recourse agreements and the fact that a large structure might require considerable and expensive due diligence to ensure a clean and high standard of limited recourse and insolvency protection. The ICC, because of the individual legal personality of each cell, is likely to be a considerably easier structure for which to obtain a credit rating.
The additional benefit of having a separate legal entity at the cell level in an ICC is that cells are able to enter into binding contractual relationships with one another. This is not possible with a PCC and in particular has caused problems for rent-a-captive operations where there may have been a commercial case to provide financial guarantees or letters of credit, for example, between cells. Combined with the flexibility of having different memorandum and articles in each cell, complex but binding commercial arrangements can be created between cells which could not be created in a PCC without creating subsidiaries or involving third parties interposed between cells at additional expense. Cells in an ICC can buy and sell assets to one another, provide guarantees and borrow and lend from one another, adding a whole level of flexibility which has at times been a limiting factor with the PCC.
Erosion Of Insolvency Protection
Although the PCC has been re-engineered in 2005 and 2006 to enable "arrangements" in connection with the transfer of assets between cells, the inevitable result of excessive transfer of assets between the cells of a PCC must be to endanger the insolvency protection provided by law. There has been considerable debate and confusion in the past about what constitutes a transfer of assets in the ordinary course of business. This in turn has led to misapplication of the law and transfers of assets between cells having the potential effect of causing prejudice to creditors of the cell from where the transfer has been made. Since the ICC enables the usual principles of corporate benefit and contract law to be applied between separate ICC cells, the ICC is likely to be far less susceptible to erosion of insolvency in similar fashion.
The Guernsey ICC legislation was created on the model of that introduced in Jersey. Guernsey has the benefit of detailed familiarity with the concept of the segregated cell company and has been able to make certain improvements. Guernsey, for example, crucially included the ability to convert a conventional company into an incorporated cell and vice-versa. A PCC can also be converted to an ICC. Utilising other useful offshore legislation such as that enabling migration, it is now possible to migrate companies from all over the world to Guernsey and put them under one "roof" and vice versa. This has considerable benefits and attractions for private wealth management, where the structure is already being used for property holding and management.
Flexibility – Accounts
The ICC structure also allows accounts to be restricted to the individual cell shareholders in comparison to a PCC where all shareholders have a right to consolidated accounts. This is particularly useful for structures with mixed third party ownership (such as a rent-a-captive) or a private client structure where there may be a need for privacy in connection with the operations of different cells.
Multiple Use ICCs - The Future?
One opportunity is the potential for the use of the ICC for multiple/mixed regulatory purposes, for example, a licensed captive insurance cell and other cells providing employee benefits, holding structures for intellectual property assets, efficient royalty streaming, structured finance (including the issue of debt taking advantage of beneficial foreign company listing rules), hedging operations, private and tax transparent treasury fund management and so on. By establishing contractual relationships, the profits of one operation could also be used to fund or capitalise another. The Guernsey captive industry has an established relationship with the financial directors and CEOs of many of the world's largest corporations. Guernsey also has a sophisticated financial services infrastructure which is very well suited to provide a diverse mixture of beneficial financial products and structuring in a well regulated, low tax environment.
In the areas where, in particular, there is increasing convergence between the insurance and capital markets, there is likely to be a need for a new regulatory approach. This multiple use is one to which the ICC is well suited in terms of security and flexibility.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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.