The recent decision of Mr Justice Nigel Clifford in Re Harbinger Class PE Holdings (Cayman) Ltd1 has revisited a line of local authority developed over the past 6 years. Although the case was found to be distinguishable on its facts, Clifford J's analysis has recast the spotlight on an issue that has enlivened debate amongst practitioners in the jurisdiction, leading to calls for clarification on the appropriate test to be applied in the context of just and equitable winding up petitions presented on the basis of a claimed loss of substratum.

The facts in Re Harbinger were straightforward: the Court heard a winding up petition presented by a shareholder whose participating shares in the subject company were received in partial satisfaction of that shareholder's redemption request from a related master-feeder fund structure, where investors subscribed into an offshore feeder which was the sole shareholder in the master fund, through which the investments were made. The company was incorporated in 2008 as a subsidiary of the feeder fund. Although having a general objects clause, the subsidiary company was established as a result of the feeder fund receiving substantial redemption requests which it, and the master fund, had insufficient liquidity to meet. Following a restructuring, the master fund issued a new class of shares, Class PE shares, with various assets allocated to the Class PE shares by the master fund, largely comprising illiquid investments held in a Private Portfolio. The Class PE shares were issued to the feeder fund which in turn transferred the Class PE shares to the subsidiary which issued shares to redeeming shareholders in the feeder fund as partial, in-kind, redemptions. As set out in a supplement to the Confidential Operating Memorandum (COM) of the feeder fund explaining the restructuring, the master fund's investment manager would use 'commercially reasonable' efforts to dispose or otherwise realise assets of the Private Portfolio by the end of 2010, subject to market conditions. Shareholders in the subsidiary would have no right of redemption from the subsidiary, such that it was therefore not considered to be an 'open-ended' mutual fund. Ultimately, this distinction was held to be significant.

Substantial distributions to the subsidiary's shareholders were subsequently made as a result of the master fund realising all but one of the seventeen groups of assets previously held in the Private Portfolio and then making distributions to the subsidiary which was passed through to the subsidiary's shareholders. However, a decision was subsequently taken by the master fund, by way of its investment manager, to reinvest in the remaining illiquid asset in the Private Portfolio to support and protect the investment. The petitioner, one of the subsidiary's shareholders, was dissatisfied with the investment manager's decision to reinvest and presented a winding up petition on the basis that it was 'just and equitable' to do so, the grounds being an alleged loss of substratum, principally on the basis that the master fund's reinvestment in the illiquid asset of the Private Portfolio was said to be contrary to the terms of the COM.

In opposing the petition, the subsidiary countered that its own separate and distinct purpose was simply to hold the Class PE shares in the master fund corresponding to the Private Portfolio and to distribute income attributable to the Private Portfolio assets to the subsidiary as and when they were available. As the subsidiary played no role in managing and/or realising the underlying investments held by the master fund, it argued that it continued to fulfill its purpose and that, accordingly, there had been no loss of substratum. The subsidiary also relied upon supporting conclusions reached by an Independent Monitor, who had been previously appointed by a US bankruptcy court in unrelated proceedings brought against the investment manager by the US Securities Exchange Commission, that actions were being taken to satisfy all outstanding redemption requests and that the relief sought by the petitioner would disrupt the orderly disposition of assets.

Justice Clifford was faced with a choice: apply the modern test for loss of substratum based on a series of first instance decisions in the Grand Court which, although initially the subject of some debate as to its correctness by practitioners in the jurisdiction, was arguably now settled law in the Cayman Islands (at least in the context of open-ended mutual funds), or, follow the centuries-old classic English test for loss of substratum petitions which had in contrast been adopted and followed in another, broadly comparable, offshore jurisdiction. In this regard, the absence of guidance from the Cayman Islands Court of Appeal (CICA) and strongly contrasting judgments from the Commercial Court of the British Virgin Islands (BVI) created scope for disagreement between legal commentators on the 'correct' test to be applied.

Distinguishing the Cayman Islands approach from the BVI; can there be two regimes?

In 2010, the first instance decision of Mr Justice Andrew Jones in Re Belmont Asset Based Lending Limited took a new approach to the historic position on loss of substratum under English law by finding that a winding up petition presented against a company operating as an open-ended mutual fund could succeed where the Court could be satisfied that the company's continued operation as a mutual fund was no longer viable, i.e. 'impracticable, if not actually impossible', rather than the higher bar of having to demonstrate that the further conduct of the company's business was impossible.2 Pragmatically, the learned judge questioned whether it was 'sensible to adopt terminology invented in the context of England's 19th century economy'.3 The decision in Re Belmont was followed later that same year in the first instance decision of Mr Justice Angus Foster in Re Freerider Limited which concerned the irretrievable breakdown of mutual trust and confidence in a company which was run as a quasi-partnership. Whilst Freerider was not an open-ended mutual fund, Foster J nevertheless adopted the modern loss of substratum test articulated by Jones J in Belmont in holding that 'I can see no good reason not to adopt the test proposed by Jones J in re Belmont Asset Based Lending Ltd. (1), namely that if the circumstances are such that it is impractical, if not actually impossible, for the company to carry on its business in accordance with the reasonable expectations of its participating shareholders, it will be just and equitable for it to be wound up'.4

Notably differing on its facts from Harbinger, Foster J's reasoning in Freerider appeared to extend the application of the impracticality test formulated by Jones J in Belmont beyond open-ended mutual funds. Interestingly, it would not appear that Foster J was referred to the contrasting decision of the English Court of Appeal in Tower Taxi Technology LLP v Marsden.5 Similarly, the decision in Freerider does not appear to have been specifically referred to Clifford J in Harbinger.

Justice Jones subsequently re-affirmed his approach to the loss of substratum test in his decision in Re Wyser-Pratte Eurovalue Fund Limited.6 This time, following a substantive inter partes hearing at which both parties were represented by Leading Counsel, Jones J was referred to a contrasting earlier decision of Justice Bannister, the sole commercial judge of the BVI, in Citco Global Custody NV v Y2K Finance Inc.,7 which affirmed the traditional impossibility test. Jones J dismissed the fund's reliance on the BVI case as artificial and ignoring the commercial realities of the mutual fund industry in the Cayman Islands, namely that the indefinite suspension of redemptions and the imposition of a management-led wind down, without express mention in the fund's offering documents or shareholder approval, could not be relied upon as being in the ordinary course of business for an open-ended fund. In doing so, Jones J referred to the rights of shareholders to avail themselves of the liquidation provisions contained in Part V of the Companies Law, which, inter alia, provide for the winding up of Cayman Islands registered companies to be carried out by qualified insolvency practitioners.

Jones J ultimately declined to make a winding up order in Wyser-Pratte due to the fact that the petition was largely overtaken by events. However, he was satisfied that it was just and equitable for the fund to be wound up on the basis that redemptions had been permanently suspended and had therefore ceased to be viable by the time the petition was presented. Accordingly, Jones J was satisfied that the Court's jurisdiction to make alternative orders pursuant to section 95(3) of the Companies Law was enlivened and therefore granted the petitioner alternative relief. Relevantly, Jones J also reaffirmed the position previously adopted in Belmont.

Less than two months later, Justice Bannister reaffirmed his more traditional interpretation of the established common law authorities in Aris Multi-Strategy Lending Fund Ltd v Quantek Opportunity Fund, Ltd, and expressly rejected Jones J's adaptation of the classic authorities to the modern fund context. Having reviewed Belmont and Wyser-Pratte, Bannister J considered and returned to the line of nineteenth century loss of substratum company cases beginning with Re Suburban Hotel Company.8 Revisiting his earlier conclusion that loss of substratum had to be founded upon 'impossibility', Bannister J rejected the premise that there could be a separate principle applying to a particular business. Referring to Justice Jones, he determined:

'It appears to me that the learned Judge was confining his reasoning to the position of open ended investment funds. If he was, then I respectfully differ from him. There cannot, in my view, be a separate principle applying only to a particular type of business. While the application of principle to the facts of a particular business, finding itself in a particular situation, may throw up different results in different cases, the principle itself must, I would suggest, be universal'.9

Despite his otherwise thorough analysis of the relevant common law authorities, Bannister J cited no authority on which his universalist view was based.

The issue returned before Jones J in Re Heriot African Trade Finance Fund Limited, in which, coincidentally, the petitioner was the custodian for Aris Multi-Strategy Lending Fund Ltd. Traversing largely the same authorities that Bannister J had in Aris, Jones J nevertheless came to the same view that he had maintained since Belmont. The learned Judge further supported his position as being grounded in public policy, noting:

'The only reason that the English case-law has any relevance at all is that Part V of the Companies Law (2010 Revision) as it then was, and to some extent still is, derived from the provisions of the English Companies Act 1862. Nevertheless, it is incumbent upon this court to apply Cayman law in the context of this country's economy. The fund is one of about 9000 mutual funds currently registered with CIMA and it is not surprising that a very high proportion of the winding-up petitions presented to this court concerns mutual funds'.10

Hedge funds11 are generally credited as having been conceived by Alfred Winslow Jones, a little known sociologist whose novel investment techniques12 remain the archetype for the modern investment manager, in the United States in 1949.13 This date is relevant because the seminal cases referred to by Jones J, Bannister J and now Clifford J effectively have no appreciable connection with modern, open-ended mutual funds i.e. hedge funds.

Hedge funds then, as they are now, are driven by the investment manager promoter and it is their reputation and strategies that attract investors. The corporate vehicle, determined by the particular investment structure (suited to the needs of the on-shore investment manager), is the conduit which enables their investment. Open-ended mutual funds are a designation under the Mutual Funds Law of the Cayman Islands, not the Companies Law, with the most popular vehicles for open-ended funds being exempted companies, exempted limited partnerships and unit trusts, the requirements under the Mutual Funds Law for each being the same. Whilst it would be overly simplistic to equate the hedge fund to the investment manager, given the vehicle's both complex and necessary corporate governance structure, the vehicle's operators are expected to delegate any investment decisions to the investment manager.

However, the most telling reasons for Justice Jones' modern rationale can be distilled from his judgments. As he considered significant in Wyser-Pratte, a further hallmark of an open-ended mutual fund, is the fluidity of its investors, such that 'by definition, a company cannot be said to be carrying on business as an open-ended mutual fund if its ability to redeem shareholders in cash and its ability to accept new subscriptions has been terminated permanently'.14 This is to be contrasted with closed-ended mutual funds, which are not regulated by the Cayman Islands Monetary Authority (CIMA) and for which the investment objectives for investors are usually longer-term asset growth strategies, more commonly pursued in the private equity sphere.

The learned Judge also considered the representations of the investment manager and the statutory filings required by the Mutual Funds Law in Heriot, where he noted:

'To translate these statements into a modern context, it can be said that it is just and equitable to make a winding-up order in respect of an open-ended corporate mutual fund if the circumstances are such that it has become impractical, if not actually impossible, to carry on its investment business in accordance with the reasonable expectations of its participating shareholders, based upon representations contained in its offering document'15.

However, the Judge went on to draw a distinction between circumstances in which a fund was specifically set up, for example as a limited duration company in order to liquidate distressed assets, as opposed to a typical open-ended mutual fund whose directors embarked on an 'ad hoc' liquidation which was 'forced upon its management by a combination of extraordinary events outside their control'.16 Put another way, Jones J was clearly contemplating certain circumstances in which a fund's constituent documents could be drafted so as to expressly permit a management-led soft wind down (and in such circumstances a petition founded on loss of substratum would be bound to fail):

'However, I do recognize that there may be circumstances in which it can be said that a liquidation is being carried out in the ordinary course of a company's business, as contemplated by its articles of association and offering documents. A fund may be set up for the very purpose of liquidating distressed assets. A fund may be set up as a limited duration company, in which case its articles of association will set out when, how and by whom the company is to be liquidated at the end of its pre-determined life. In these circumstances, it may be said that the liquidation is itself part of the company's business, in which case it would not be appropriate for the court to interfere in the process by making a compulsory winding-up order, at least in the absence of serious breach of duty or serious mismanagement on the part of those responsible for the company's liquidation.'17

Despite the force of the conflicting views, practically speaking, as a matter of general principle there is inherent difficulty in overturning winding up orders (not least due to funding issues of appeal costs). Accordingly, as of the date of this article, only one appeal has been heard by the CICA, in 2012, which touched upon the issue, namely ABC Company (SPC) v J & Company Limited. In that case the CICA heard an appeal arising in respect of a winding up petition presented against a segregated portfolio company, a Caymanian adaptation of a Delaware concept, on the basis of a purported loss of substratum. However, despite remarking on the divergent approaches to loss of substratum petitions adopted in the Cayman Islands and the BVI, the facts of ABC Company meant that the Justices of Appeal were not required to determine which approach was correct. Notably, in delivering his judgment, The Rt. Hon. Sir John Chadwick, President, observed:

'It must be anticipated that an appeal will come before this court in which it will be necessary to choose between the approach of Jones, J in Belmont and Heriot on the one hand, and that of Bannister, J. in Aris v. Quantek on the other hand: or, perhaps, to decide that the true approach in this jurisdiction should lie somewhere between the approaches respectively adopted in those cases. But this is not that appeal.'18

The decision in Harbinger

Faced with the competing interpretations, it was perhaps unsurprising that Clifford J would return to the decisions of Jones J and Bannister J, and the leading authorities they considered, in determining whether the impossibility test would apply to the facts of that case. However, like the Court of Appeal before him in ABC, on analysis he also determined that he needed to make no decision on the correctness of Jones J or Bannister J's respective approaches, because the facts of the case made plain that the subsidiary company was distinguishable as a close-ended fund:

'By common consent the Company here is not, and never has been, an open-ended corporate mutual fund, one that issues shares to, and redeems the shares of, investors at any time investing the net investment proceeds in investments for the benefit of shareholders ... the test to be applied in this case in determining whether there has been a failure of substratum is founded upon the established underlying principle of the line of authorities referred to which requires the Court to determine whether it has become impossible for the company to achieve the purpose for which it was formed. It is a question that must be determined by ascertaining the principal or main objects of the company and then deciding whether it has become impossible for the company to attain those objects.'

The learned Judge later continued:

'it is clearly established, in my view, that the principal or main object for which the Company was formed was indeed limited to holding the relevant Class PE shares issued by the Master Fund and receiving through the redemption of those shares the net cash flow from the realization of the Master Fund of the assets in the Private Portfolio for onward payment to its own shareholders. There can be no reasonable expectation on the part of its shareholders for the Company to do anything else. Furthermore, the evidence demonstrates that the Company has fulfilled this purpose and continues to do so.

That really is the end of the Petitioner's case. It cannot possibly be said that the attainment of the Company's principal or main object has been rendered impossible in some sense resulting in a failure of substratum. Accordingly, there is no jurisdiction to make a winding up order.'19

It might nevertheless be said that in coming to the view that he reached (i.e. without departing from the Belmont approach), Clifford J was, in effect, contravening Bannister J's view that there should be a 'universal approach'. However, it remains unclear why Justice Bannister would consider it undesirable for there to be a separate test with respect to open-ended mutual funds, given the importance of hedge fund industry to both the Cayman Islands and the BVI. To the contrary, it is suggested that, in principle, there would not necessarily be anything objectionable or untoward in having a modified test which applies to open-ended mutual funds.

However, as a result of the decision in Freerider, there does appear to be some scope for debate as to what the appropriate test for the loss of substratum is in the Cayman Islands with respect to an entity that is not an open-ended mutual fund (i.e. whether or not Foster J's acceptance of the Belmont line of authority applying equally to all other Cayman companies was right, or whether Clifford J was correct to adopt the old English test of impossibility (in the context of an entity which was not an open-ended mutual fund)). This potential dichotomy will not be conclusively determined unless and until the CICA has occasion to specifically consider the position.20 In the meantime, it is suggested that the Belmont line of authority is unchallenged and remains good law with respect to open-ended mutual funds.

Recent developments

We are aware that the loss of substratum issue was recently argued again before Madam Justice Ingrid Mangatal of the Grand Court in Re The Washington Special Opportunity Fund, Inc. The judgment, which is expected imminently at the time of writing, promises to once again put this issue into the spotlight (regardless of the outcome of the decision). The judgment of the Court of Appeal in Harbinger will also be eagerly awaited (although it may not necessarily determine the issue once and for all, at least with respect to open-ended mutual funds).


1 (unreported) 10 November 2015; Grand Court Cause No FSD 80 of 2015.

2 Such test representing the traditional common law approach to loss of substratum cases since the nineteenth century.

3 [2010] 1 CILR 83 at [12].

4 [2010] 1 CILR 486 at [71].

5 [2005] EWCA Civ 1503.

6 [2010] 2 CILR 194.

7 [2009] 11 JBVIC 2502.

8 (1867) LR 2 Ch App 737, followed notably by Re Diamond Fuel Company (1879) 13 Ch D 400 and Re Haven Gold Mining Company (1882) 20 Ch D 151.

9 [2010] 12 JBVIC 1501 at [34].

10 [2011] 1 CILR 1 at [34].

11 The better-known and more colloquial term which is often used to encompass many open-ended mutual funds.

12 P. Astleford and D. Frase, Hedge Funds and the Law (Thompson Reuters (Legal) Limited, 2010) p. 49.

13 D. Gabbert, Hedge Funds (LexisNexis, 2008) p.1.

14 Supra at [21].

15 [2011] 1 CILR 1 at [34].

16 Ibid at [42].

17 Ibid at [41].

18 [2012] 1 CILR 300 at [67].

19 Supra at [57 to 58] and [83 to 84].

20 We understand that the decision in Harbinger is presently the subject of appeal.

This article first appeared in International Corporate Rescue.

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