Originally published in The Lawyer, November 2007
While ensuring that an offshore investment fund is truly managed offshore has always been an important factor for tax reasons, in these times of turbulent markets the location of the management and administration of the fund is also becoming an important factor for worst-case scenario purposes and the possible liquidation of the fund.
The turmoil brought to world financial markets by the so-called "credit-crunch" has seen several recent cases of cross-border insolvency involving offshore investment funds come into the spotlight. Because these types of funds tend to be vehicles established in an offshore jurisdiction for tax neutrality reasons, but managed and sold to investors onshore, the obvious question is which jurisdictions law should be applied to the liquidation of the assets of the fund? The United States and England have both adopted the UNCITRAL Model Law on Cross-Border Insolvency (the "Model Law") to deal with situations like this. The Model Law introduces the concept of "centre of main interests", or as it is more commonly known, the "COMI". If the COMI of the fund is deemed to be in the offshore jurisdiction then the Court will recognise the offshore liquidation proceedings as foreign main proceedings under U.S. or English law. The importance of this recognition is that foreign main proceedings attract an automatic stay of execution against creditors claims under the Model Law, which is obviously attractive to the manager of the fund.
The two main cases to deal with this issue to date have both arisen in the U.S. The most recent of these, the Bear Stearns cases1, concern two funds which were both Cayman Islands companies with registered offices in the Cayman Islands. A Massachusetts corporation acted as administrator of the funds, and as well as carrying out day-to-day administration services acted as registrar and transfer agent and provided accounting, clerical, shareholder register, investor relations and distribution services to the funds. The books and records of the funds were maintained and stored in Delaware by the administrator. Bear Stearns Asset Managements, a U.S. corporation, acted as the investment manager for the funds and the assets managed by it were located in New York. All other assets of the funds were located in the U.S. (although subsequent to the filing of the liquidation proceedings substantial funds were transferred to accounts in the Cayman Islands).
As is well documented, the funds began to suffer a significant devaluation of their asset portfolios following the volatility in the U.S. sub-prime lending market. The funds boards of directors filed petitions seeking winding up orders in the Cayman Islands and for the appointment of local liquidators. The orders were granted by the Cayman Courts and the liquidators filed petitions pursuant to the United States Code (the "Bankruptcy Code") for orders recognising the liquidation of the funds in the Grand Court of the Cayman Islands as foreign main proceedings in the U.S. The Bankruptcy Code incorporates the Model Law, and provides further that "in the absence of evidence to the contrary, the debtors registered office& is presumed to be the center of the debtors main interests". This is often referred to as the COMI presumption.
The Court in the Bear Stearns case looked to UNCITRAL for guidance on the concept of the COMI. In the regulation adopting the EU Convention the COMI concept is referred to as "the place where the debtor conducts the administration of his interests on a regular basis and is therefore ascertainable by third parties." It was noted that the COMI presumption may be overcome "particularly in the case of a "letterbox" company carrying out any business in the territory of the Member State in which its registered office is situated".
The Court was quick to seize onto the fact that all of the administration and management of the funds took place in the U.S., that the assets of the funds were physically located in the U.S. and that the funds only connection with the Cayman Islands was that they were registered there; in effect they were "letterbox" companies. As a result the COMI presumption was held to be rebutted. In a further blow, the Court rejected an alternative application to recognise the Cayman liquidation proceedings as foreign "non-main" proceedings, deciding that the funds did not even have an "establishment" in the Cayman Islands. One cannot help but think that policy considerations weighed heavily on the Courts decision. With most of the investors located in the U.S. it would have been a brave decision to recognise the Cayman liquidation proceedings, particularly as some commentators have suggested, given the less favourable rights of the funds creditors and investors under Cayman Islands law2.
The judgment in the Bear Stearns case differs from the decision in the other main case to have considered the issue to date, SPhinX. 3 In that case it was stated that if the parties had not objected to the Cayman Islands proceedings being recognised as foreign main proceedings, recognition would have been granted on the sole grounds that no party objected and no other proceeding had been initiated elsewhere. In SPhinX the court refused "main" status largely on the basis of the bad faith motives of those who brought the Cayman Island proceedings.
Another recent case concerns the Basis Yield Alpha Fund, also a casualty of the US sub-prime lending market. Sydney-based fund manager Basis Capital has put the fund into provisional liquidation in the Cayman Islands. The liquidators have taken action in both the US and England to protect the remaining assets of the funds.
It has been reported that an order recognising the Cayman Islands liquidation as the main proceedings was issued by Englands High Court of Justice Chancery Division Companies Court. A possible factor in this decision is that it is understood that the Basis Fund carried out more of its administration in the Cayman Islands. Further, apparently 10.5 per cent of the funds beneficial investors are in the Cayman Islands. However, the fund will have to overcome the Bear Stearns and SPhinX cases in order to succeed in the U.S.
It is interesting to compare the facts of the Bear Stearns and SPhinX cases to the typical investment fund established in Guernsey to see if a similar result would be likely. On the face of it the answer would seem to be no. All investment funds established and authorised in Guernsey are required to appoint a locally licensed Guernsey administrator. The developed infrastructure of Guernseys finance industry means that most of the management and administration of a fund, including all of the services which were carried on in the U.S. in the Bear Stearns cases (with the exception of investment management) is normally carried out in Guernsey, by real entities and real people. Guernseys strong corporate governance ethic and the availability of experienced
Guernsey resident non-executive directors means board decisions, including investment decisions, are implemented in Guernsey. The Guernsey Financial Services Commission (GFSC) does not entertain applications from fund promoters and managers looking to simply establish a "brass-plate" or "letterbox" type vehicle in Guernsey. On this basis it would be unlikely that the COMI of a Guernsey investment fund would be found to be anywhere else other than in Guernsey.
1 In re Bear Stearns High-Grade Structured Credit Strategies Master Fund, Ltd. (In Provisional Liquidation), Case No. 07-12383; In re Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund, Ltd. (In Provisional Liquidation), Case No. 07-12384.
2 For example the online article comment: Bankruptcy court rejects Cayman proceedings of Bears Stearns hedge funds, 21 September 2007, Goodwin Proctor LLP
3 In re SPhinX, Ltd, 2007 WL 1965597 (SDNY July 3, 2007)
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