A recent decision of the Supreme Court of Bermuda provides a fascinating foretaste of what may be to come as two Bermuda funds registered under the Segregated Account Companies Act 2000 (the "2000 Act") work their way through a compulsory winding up process. The case In the Matter of CAI Master Allocation Fund Ltd & In the Matter of CAI Allocation Fund, Ltd [2011] SC (Bda) 45 Com, concerns a master fund and a feeder fund ("the Funds") that were ordered to be wound up in late 2010 on the petition of the Bermuda Monetary Authority on the basis of "regulatory concerns".
The Joint Provisional Liquidators ("JPLs") recently sought directions from the court on a number of questions, including whether a Quistclose trust had arisen in favour of potential investors who had paid subscription monies but to whom no shares had been issued. Also of interest was the court's response to the question of whether, if the Funds had been used as vehicles of fraud, the separate legal status of the segregated accounts might be "pierced", so that the liability for liquidation costs in respect of one account might fall across the entire range of accounts. Before dealing with these questions, the Judge made clear that the winding-up regime applicable to Bermuda companies in general also applied to segregated account companies. This is subject to any special statutory provisions for segregated account companies, for example that each segregated account must be wound up on an individual basis. However, as the Judge put it "the starting assumption will generally be that the umbrella principles which inform the modus operandi of a traditional winding-up will apply".
Turning now to the Quistclose trust question, this was relevant in respect of segregated accounts with a deficiency. If potential investors' monies were held on a Quistclose trust, those monies would be returned in full whereas if they constituted assets of the Funds, the investors would be entitled to a pari passu share. In giving general guidance to the JPLs on this question, the Judge accepted that where monies were received but no shares were issued and the monies were held on deposit pending a decision whether or not to accept the investment, those monies could be regarded as held on trust for the investors in question. Once the monies were "actively invested" and even when no share certificates had been issued, those monies would in general not be impressed by a trust but would form part of the assets of the Funds. The judge referred with approval to the recent Court of Appeal decision of Kingate Global Fund Ltd v. Knightsbridge (USD) Fund Ltd et al [2009] Bda L.R. 59. In that case it was held that a Quistclose trust arose on the somewhat complex facts in respect of subscription monies for a fund even where there was no legal or de facto segregation of the monies. It is therefore not surprising that the Judge found that such a trust existed in the case of these segregated account companies.
Liquidation Cost
Perhaps of more interest is that part of the Judge's decision dealing with liquidation costs and the suggestion that the corporate veil should be pierced in the event that the Funds had been used as an instrument of fraud. This question arose in the context of one of the segregated accounts which had no assets, and in respect of which there was an allegation that improper payments had been made to the manager and affiliates of that segregated account. The suggestion from the JPLs was that the separate legal status of the segregated accounts might be pierced so that the liability for liquidation costs incurred in respect of one account might fall across the entire range of accounts.
In what amounts to a robust defence of the general principle of segregation the Judge held that there was a "statutory iron curtain" separating the various segregated accounts. The Judge held that:
"... absent agreement on the part of the investors, or a binding variation of their share rights ... the separate status of segregated accounts in companies registered under the 2000 Act is sacrosanct, particularly in the event of insolvency".
In the context of the liquidation of a segregated account company, the Judge pointed to section 25(1) of the 2000 Act. This provides that the liquidator of such a company must deal with the assets and liabilities of each segregated account in accordance with the 2000 Act and in the absence of contractual terms to the contrary, not apply the assets of one segregated account to the liabilities of another segregated account or the general account.
Segregated Accounts
However, just as the "iron curtain" turned out to be not entirely impenetrable, so too did the Judge make clear that a challenge to the segregation of accounts may be possible depending on the facts, and within the express terms of the 2000 Act. The Judge relied on section 18(16) of the 2000 Act which excludes the application of rules of law relating to trusts save that nothing in that section is to deny:
"(a) the remedy of tracing in law and in equity the assets or proceeds of the assets of any segregated account where such assets or proceeds have been commingled with the assets of any other segregated account or the general account; or
(b) any remedies available under the doctrine of constructive trusts or similar equitable remedies where those remedies would otherwise be available".
The Judge concluded by stating that the scheme of the 2000 Act is inconsistent with departing from the segregated account scheme in the absence of investor agreement or "compelling equitable grounds for so doing". It remains to be seen whether the JPLs intend to argue that such "compelling equitable grounds" exist on the facts of this case. The Judge was clear that on the evidence before him at this stage at least, there was nothing to support even an arguable case to go behind the "iron curtain".
Originally published in Resolution, Offshore – Winter 2011/12.
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