Welcome to Appleby's review of the key decisions handed down in the litigation involving investment funds in the leading offshore jurisdictions during 2012, compiled by members of our Litigation & Insolvency Practice Group in Bermuda, the British Virgin Islands, the Cayman Islands, Jersey, Guernsey and the Isle of Man. Equivalent updates are available in the areas of insolvency & restructuring, company law, civil procedure and trust litigation. Copies may be obtained from our website or from your usual Appleby contact.
During the year we saw further decisions on three classic themes surrounding investors in funds who redeem their investment. Can they petition? What is their status as compared with other creditors? Can money paid to them before the fund's collapse be clawed back? But the courts have also had to grapple with some additional and novel issues, including whether redeeming investors' claims can be satisfied by distribution of assets in kind, rather than cash. The much used device of the side letter has also come in for scrutiny, and we have started to see some cases involving a type of entity now common in most of the offshore jurisdictions, namely the segregated account or portfolio company. Disputes over remuneration arrangements for fund managers have also given rise to judicial decisions.
Status of Redeeming Investors
In the British Virgin Islands, the major written judgments of 2012 have followed one of two strands: either decisions following the Westford line of authority, or decisions in relation to redemption claw back claims. The Fairfield Sentry liquidation (relating to the largest of the feeder funds into Bernard L Madoff Investment Securities LLC) has straddled both.
To recap, Westford Special Situations Fund Limited v Barfield Nominees et al (2011 HCVAP 2010/014) was the decision of the Court of Appeal, handed down in March 2011, which decided that since redemption proceeds are payable to an investor in their character as a member, section 197 of the BVI Insolvency Act 2003 operated to prevent non-payment of redemption proceeds forming the basis of a winding up petition. That section provides that a member may not claim in the liquidation for a sum due to him "in his character as a member of the Fund," but that such amounts should be taken into account for the purposes of the final adjustment of the rights of members.
During 2012, in Spectrum Galaxy Fund v. Xena Investments (BVI HCM 2011/0040), the question arose whether the assignee of redemption proceeds was also caught by Section 197. Predictably in our view, the Court of Appeal held that it was.
Following this logic, Bannister J decided in Somers Dublin Ltd v. Monarch Pointe Fund (BVI HCV 2008/97) that "in this jurisdiction, it is established that unpaid redeeming members of companies are creditors, but not entitled, in their liquidations, to compete with external creditors." This approach avoids what counsel in Westford described as an "unfair and unseemly scramble in the dying days of the company".
Also in the Fairfield liquidation, the case of Krys v. Stitchting Shell Pensionfonds (HCVAP 2011/036) involved a claim submitted by Shell as a redeeming investor in Fairfield Sentry. As well as submitting a claim, Shell had learned that Fairfield held funds with the Dublin branch of Citco and obtained a pre-judgment garnishment order from the District Court in Amsterdam. Following an unsuccessful attempt by Fairfield to challenge the order in Amsterdam, it sought anti-suit relief in the BVI. The Commercial Court Judge held that Shell had submitted to the jurisdiction by making a claim within the liquidation. However, he refused relief on the short ground that it would not be appropriate to restrain a foreign creditor from taking whatever steps were available to it in its home jurisdiction. The Court of Appeal set aside that order and granted anti-suit relief, holding that the ends of justice require the integrity of the Court's process in the supervision and administration of the statutory scheme under the Insolvency Act to be protected.
The Chief Justice made it clear that there is no statement in Westford that an unpaid redeemer is not a creditor. The question in Westford was simply whether the unpaid redeeming creditor is entitled to invoke the insolvency jurisdiction as a petitioning creditor. Apart from this clarification, the decision in Shell is significant in a number of further respects: first, for its finding that the mere submission of a claim within the liquidation process constitutes a submission to the jurisdiction (the liquidators had not yet determined if the claim was valid and would be admitted); next, for its finding that maintenance of the integrity of the statutory scheme under the Insolvency Act is a sufficient ground for granting anti-suit relief; and third for its application of Cambridge Gas [2007] 1 AC 508 with a brief foray into the Universalist v. Territorialist debate. The English Supreme Court in England has since stated in Rubin v. Eurofinance [2012] UKSC 46 that Cambridge Gas was wrongly decided and Shell is currently seeking leave to appeal to the Privy Council.
Claw Back Claims
The Fairfield liquidation in the BVI has dominated the area of redemption claw back claims. In Quilvest & others v. Fairfield Sentry Limited (In Liquidation) (BVICVAP 2011/041), the Court of Appeal delivered its decision in an appeal against the decision of Bannister J on the trial of preliminary issues in "claw back" actions brought by the fund against redeeming investors. The Court of Appeal upheld the decision of Bannister J, albeit by a slightly different route, by accepting that the Articles of Association created a debt in favour of the redeeming investor, and that the investor (in complying with the requirements of the Articles to complete the redemption process and surrendering/cancelling their shares) had given good consideration for the redemption sum, which in turn precluded a claim for mistake.
The fund met with more favour on the secondary question which came before the Court, namely whether a "certificate" within the meaning of the Articles had been given by the fund which was conclusive in relation to the calculation of the Net Asset Value.
Other redemption claw back claims were also brought in Steinberg v. Swisstor & Wise Global Fund Ltd (HCVAP 2011/012) when the US Court-appointed receivers of two BVI funds, Lancer Offshore Inc and the Omnifund, brought proceedings against some 45 defendants. However the case is mainly of interest for the issues of civil procedure that it raises, and is commented on further in our round-up on that topic.
Redemptions in Kind
In the Cayman Islands, the ability of an investment fund to effect a redemption in kind to investors, and its effect on their standing to petition for a winding up of the fund, was considered by the Court for the first time. In the matter of FIA Leveraged Fund (18 April 2012, Smellie CJ), the investors who petitioned for the winding-up of the company were three US pension funds that were owed redemption proceeds of US$144,500,000. Rather than meeting the redemption request in cash, the company sought to satisfy those requests by issuing promissory notes. The company's offering memorandum permitted redemptions in kind and provided that the value of the assets paid out "shall be determined by the Board of Directors in consultation with the investment manager in its sole discretion." The petitioners were unsatisfied with the purported in kind redemption. They issued a winding-up petition on the insolvency ground and also the 'just and equitable' ground on the basis that the company had lost its substratum. In the face of the petition, the company transferred certain assets into a new Delaware company and asserted that there was a genuine dispute as to whether the petitioners had been properly redeemed by way of an in kind distribution.
The Court held that since the redemption in kind did not realistically represent the value of the petitioners' entitlement in relation to the redemption proceeds, it did not discharge the debt owed to the petitioners. The court also found that it would not be reasonable to conclude that the company's contractual documents vested in the directors of the company an exclusive and absolute discretion to effect an in kind distribution which would not give effect to the obligations owed to the investors by virtue of the contractual documents of the company. The facts justified a winding up order being made on the just and equitable ground as well as the ground of insolvency.
The question of redemptions in kind also came before the Royal Court in Jersey in 2012. In Euro Value Investment Company 1 v. Greater Europe Deep Value Fund II Limited [2012] JRC 146 EVIC sought to have the defendant fund wound up or alternatively sought remedies under Articles 141 and 143 of the Companies Law (Jersey's minority shareholder protection provisions). EVIC was a 27% shareholder in the fund. It was an expert fund established for investing in Russia and former Soviet Union related countries. Its life was stated in the prospectus to be for 5 years – the first 3 years being the investment period and the last 2 being the wind-down period. Much of the fund was invested in Russian real estate and it became apparent that it would take more than 2 years to achieve a fair value for the sale of that land. The fund accordingly sought the shareholders' approval to the extension of the fund's wind down period by 3 years. Alternatively it suggested a redemption in kind proposal whereby a new subsidiary of the fund would be established which would hold the fund's unsold real estate plus a reserve of $10m for follow up investments. Shareholders could then apply for cash or shares in the subsidiary. Those who opted for cash would be given a pro rata share of cash held by the fund and additional costs to compensate for their interest in the unsold real estate assets (which were discounted by 30%). The cash option was only available if no more than two thirds opted for it.
At an EGM to consider these proposals, the necessary 75% majority required to extend the wind-down period was not achieved, but the ordinary resolution required to pass the redemption in kind proposal passed. EVIC then obtained an interim injunction to prevent the redemption in kind taking place.
As a preliminary matter, the Royal Court concluded that the redemption in kind proposal was in breach of the Articles and the prospectus, which breach could not be cured by 62% of the shareholders voting in favour. This was largely because that proposal was designed to achieve exactly the same as the extension of the wind-down period which had been rejected. Also because, if more than 2/3 of the shareholders elected for cash, some would by necessity have to go down the redemption route and would thus be locked in for a further unexpected period of time.
The Court then considered the allegation of unfair prejudice. EVIC alleged that the fund's affairs were being conducted in a manner which was unfairly prejudicial to the interests of those members who did not support the ordinary resolution carried at the AGM. The Court held that the fund effectively sought to over-rule EVIC's decision to withhold its approval to the extension of the life of the fund. Given that, and the finding that the redemption in kind proposal was in breach of the terms of the articles and the prospectus, the court was satisfied that the application under Article 141 was well founded and enjoined the fund from proceeding with the redemption in kind.
Segregated Account/Portfolio Companies
On 25 May 2012, the Court of Appeal in the Cayman Islands in Re ABC Company (SPC) delivered judgment in respect of an appeal by ABC against Jones J's decision not to strike out a petition to wind up ABC on the 'just and equitable' ground. The petition had been brought by an investor in a segregated portfolio of ABC referred to as the German fund, who alleged that ABC had lost its substratum, following a decision by ABC in 2008 to suspend redemptions in the German fund for three years, to enable ABC to effect a 'soft wind-down.'
ABC applied to strike out the petition on the grounds that two thirds of the portfolios of ABC were carrying on business as usual and it could not possibly be said that ABC had lost its substratum. The Court of Appeal, allowing the appeal of ABC, unanimously held that the petition was bound to fail. Important statements of principle were delivered, in particular that the Grand Court does not have jurisdiction to wind-up individual segregated portfolios of an SPC. The only remedy afforded by legislation is the appointment of a receiver and that was only available if the portfolio was insolvent, and not also on the 'just and equitable' ground. Further, in determining whether the substratum of the company had failed, it was necessary for the petitioner to establish that ABC (as a whole) had ceased carrying on business according to the reasonable expectations of the shareholders. Those expectations would be taken from the Articles and the relevant offering documents of ABC which permitted the directors in their absolute discretion to suspend redemptions and subscriptions. On the facts of the case and having regard to the offering documents, it was impossible for the petitioner to contend that ABC had ceased to carry on business in accordance with the reasonable expectations of its shareholders or the shareholders in the German fund (which constituted only 1 of 82 segregated portfolios and a fraction of ABC's combined NAV).
The Court of Appeal also took the opportunity to comment on the court's decision in re Belmont Asset Based Lending Ltd [2010(1) CILR 83] when it reformulated the test for loss of substratum as follows: if it has become impractical, if not impossible, to carry on the company's business in accordance with the reasonable expectations of its participating shareholders, it will be just and equitable for the company to be wound up. The decision in Belmont has been followed in a line of cases in Cayman, but the Commercial court in the BVI has expressly declined to adopt the test as formulated in Cayman: see Aris Multi-Strategy Lending Fund Ltd and Quantek Opportunity Fund Ltd (Claim No BVIHCOM 2010/0129). The Court of Appeal noted the alternative approaches and without endorsing one over the other hinted that the correct approach should lie somewhere between the two. The issue is likely to fall for judicial determination in the near future.
The Bermuda Court handed down its first reasoned decision in relation to the apportionment of civil costs ordered against segregated accounts companies. In Gottex et al v New Stream [2012] SC (Bda) 66 Civ (15 November 2012), a segregated accounts company had unsuccessfully contested substantial litigation. The plaintiffs were investors in certain segregated accounts of the unsuccessful company. The company was subsequently placed into receivership and liquidation. The question before the Court was first, whether only those segregated account classes or investors which were not connected to the plaintiffs should bear the economic burden of the costs order. Second, whether the liability for a costs award was sufficiently linked to the segregated accounts or whether the liability could only accrue to the general account of the company. On the facts of the case, the Court determined that the costs liability was in fact "linked" to all the segregated accounts of the company. The question then arose whether the successful plaintiffs' own accounts were liable to contribute to paying their own costs. The Court applied the principles developed in relation to the traditional corporate model in the context of the scheme of the Segregated Accounts Companies Act 2000 and answered the question in the affirmative. The judgment includes a full discussion of the principles applicable in relation to apportionment of litigation expenses between segregated accounts.
Side Letters
In two cases, in the context of winding-up petitions brought against investment funds in the Cayman Islands, the Grand Court has been asked to determine the effectiveness of side letters entered into by funds with particular investors which those investors sought to argue granted them preferential rights in relation to redemptions of their investments in the funds.
First, in Medley Opportunity Fund Ltd a US$45 million investment in Medley had been made by Fintan Master Fund Ltd, acting through its nominee. Fintan had agreed to two restructuring proposals which limited and altered its redemption rights but later sought a full and prompt cash redemption pursuant to a side letter entered into before the investment. The litigation concerned whether Fintan was still entitled to preferential treatment under the side letter or whether the restructuring agreements meant that Fintan had waived its redemption rights as embodied in the Articles and/or the side letter.
On 21 June 2012, the Court (Quin J) found against Fintan since Fintan was not itself a shareholder in Medley (the shareholding being held by its nominee). The side letter was therefore not effective as the nominee shareholder was not a party to it. The side letter was superseded by the nominee agreement with the registered shareholder, who had since exercised its rights under the Articles. Any right to rely on the terms of the Articles was also subsequently altered by the restructuring agreements which had been approved by Fintan's nominee as registered shareholder.
Then, on 23 August 2012, Quin J handed down a further judgment dealing with an investor seeking to enforce its rights in accordance with an alleged oral side agreement. In the case of Lansdowne Limited and Silex Trust Company Limited v Matador Investments Ltd, Englefield Holdings Corp. and Martine Guerrand-Hermes, the petitioners were investors in Matador Investments Ltd. It was alleged that a principal of Matador had made representations to the ultimate beneficial owner of the shares to the effect that the gating provisions and other restrictions on the redemptions would not apply to their investments. Quin J held that any such agreement between the principals of Matador and the ultimate beneficial owner of the shares could not be said to be between Matador and the petitioners. Applying the principles in the Medley case, the agreement could not be binding. The Court also reiterated that the Articles of a company comprise an agreement that creates collective rights and obligations as between the company and all of its shareholders and between the shareholders themselves (and by virtue of the Companies Law the terms and manner of redemption must be set out in the Articles).
Fund Managers
The interpretation of contractual documentation between fund managers was in issue in the Cayman Islands case of Ennismore Fund Management Limited v Fenris Consulting Limited (7 February 2012). The dispute concerned a claw back claim by Ennismore in respect of bonus payments made to Fenris by virtue of it acting as a fund portfolio manager for Ennismore. This arrangement was contained in written contractual documentation between the parties which had not been drafted or reviewed by lawyers.
Following the global financial collapse, there had been a significant loss in the value of portfolio assets managed by Fenris in 2007 and 2008: Ennismore claimed this entitled it to claw back certain assets held on Fenris' behalf pursuant to the claw back arrangements. However, the parties disagreed as to the manner in which the terms of contract between them operated and as a consequence Fenris sought to redeem certain investments that Ennsimore argued were subject to claw back (which resulted in an interim injunction being granted by Quin J over the disputed assets pending determination of the dispute at trial).
At trial, the Grand Court followed the English Supreme Court judgment in Rainy Sky SA v Kookmin Bank [2011] UKSC 50: this confirms that the Court should consider what a reasonable man who had all of the background information would have understood the contract to have meant, but is also authority for the proposition that if there are two possible interpretations of a contract, the one which is consistent with common business sense should prevail. Taking this into account, Foster J found that Ennismore's interpretation was correct and his decision is now a leading Cayman authority on contractual interpretation. Fenris has appealed to the Court of Appeal and judgment is currently awaited.
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.
