A review of Cayman Islands hedge fund corporate governance and best practice, including in times of distress
It may be business as usual for hedge funds as they seek to weather the market storm caused by Covid-19. However, the true economic effects are perhaps yet to be seen.
This five-part series considers some of the guiding principles that apply to corporate governance in a Cayman Islands hedge fund context and some of the best practices that boards of directors should be implementing as a matter of course, which may need to be re-visited and adapted in times of distress.
To access part 1, part 2 or part 3 please click here, here and/or here.
Part 4: Distressed Situations
If a fund becomes distressed and liquidity issues arise, an emergency meeting of the board of directors will almost certainly be required. While the constitutional documents of most modern funds permit ad hoc meetings at short notice and by telephone/video conference, the constitutional documents will still need to be checked to ensure any stipulated requirements relating to the holding of board meetings, e.g. the requirement for prior notice (including the ability to waive notice and any other formalities), are satisfied.
In addition, depending on the circumstances, the location of the directors may make attendance difficult (in light of current restrictions/limitations on travels), e.g. in the event the location of a director has adverse consequences on the fund from a non-Cayman legal/tax perspective. It will be important to engage relevant local (tax) counsel on this issue.
Assuming the board of directors is able to validly meet, at the outset of the meeting it will be essential for the board of directors to:
- manage conflicts of interest. For example, if a real (or ostensible) conflict arises, a director may wish to recuse themselves from relevant discussions and/or resolutions, or even step-down as a director to ensure the integrity of the board is not, in any way, compromised. In particular, if the investment manager is represented on the board of directors (which is typical), then conflicts as regards "their" director may quickly become apparent, e.g. in the context of discussions around NAV calculation/hard-to-value assets and fee terms. The directors have, amongst others, a duty to avoid conflicts of interest and a duty to act in what the director bona fide considers to be in the best interests of the fund. It is therefore imperative that any conflicts of interest are suitably identified, disclosed, monitored and managed. Any conflicts of interest should be noted in the board minutes (or documented in written resolutions);
- establish if the fund is insolvent or 'in the zone of insolvency', i.e. is the fund able to pay its debts as they fall due (including any crystallised redemption payments). This analysis will also include any debts which are prospective in nature1. This is because, where the fund is insolvent, the directors must have regard to the interests of the fund's creditors when discharging their duties to the fund, rather than (in a solvent situation) having regard to the interests of the fund. The fund's financial position needs to be verified by the board of directors undertaking a full assessment of the fund's financial position and consistently with the valuation of assets principles discussed above. Such cash flow assessment should be undertaken regularly by the fund to allow the board of directors to make appropriate decisions; and
- consider whether they have sufficient and relevant knowledge and experience to carry out their duties as directors in a distressed situation. It might be the case that the appointment of additional or replacement directors who specialise in distressed situations is appropriate.
Once these basic, but essential, issues have been addressed, the board of directors may then seek to manage liquidity in consultation with the investment manager. In doing so, it is strongly recommended that the board of directors consults with its legal counsel (and, in particular, insolvency and dispute resolution teams), as, amongst other matters, there can be significant personal implications on the directors. In particular, the law in this area often evolves quickly and there are restructuring tools available to funds in the Cayman Islands that can facilitate a restructuring of the fund whilst providing a 'safe harbour' for the directors and a stay on claims against the fund. However, it may be the case that certain discussions between the board of directors and legal counsel take place independently; that is, away from the investment manager, in light of the potential conflicts of interest that may arise in a distressed situation.
As ever, detailed minutes of all meetings, including the matters considered and decisions made, and the information requested from, and provided by, service providers and advisors, should then be prepared for the review and sign-off by the directors. Where permitted, a meeting accompanied by detailed written resolutions may be preferable. It is always possible that the resolutions of the board of directors could be scrutinised at a later date, and accurate record-keeping may assist the directors in demonstrating that they discharged their duties as directors.
Part 5 - the final part - will consider relations with the Cayman Islands Monetary Authority and investors.
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.