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10 March 2008
Changes in the restructure and insolvency of hedge funds has led a defining period for lawyers in the Cayman Islands, explains Peter Hayden.
The fallout of the credit crunch and its impact on hedge funds continues to keep legal practitioners and the courts busy in the Cayman Islands.
Recent decisions have helped to clarify the approach under Cayman law and provide some useful guidance on frequently arising issues.
This has been particularly important in the current climate, where many funds are facing an increasing volume of redemption requests at a time when their assets have become increasingly illiquid, and when liquidations and litigation arising out of failed funds and frauds in the US have become much more prevalent.
Funds have adopted different strategies to deal with the difficulties they face, with the restructuring of illiquid assets into side pockets a commonly used technique. Some funds are also looking to pay redemptions in kind rather than in cash, but a large number have suspended redemptions to give them more breathing space to liquidate assets or restructure.
The only case so far to have reached and been decided by the Cayman Islands’ court of appeal on investor redemptions is in the matter of Strategic Turnaround Master Partnership Limited.
This case dealt with the ability of a fund to suspend redemptions and the effect of a suspension on redeeming shareholders.
It was held that the position should be determined by reference to the articles of association of the relevant fund. In that case, the articles were found to provide for redemption to be a process which started with a redemption request and was not completed until the redeeming investor had been paid and removed from the register of members.
The suspension of redemptions applied to redeeming investors at any stage of the process. After the redemption date (ie the date given in their notice), investors became creditors and ranked in priority to other investors whose redemption date had not passed at the time of the suspension coming into effect.
However, based on the common law authorities and section 37(7) of the Cayman Companies Law (2007), they ranked behind all other debts and liabilities of the company.
The position adopted in the case is a pragmatic one. It ensures that suspensions are given wide effect providing funds with more breathing space to liquidate assets or restructure.
It also removes some of the incentive for investors to submit redemption requests by increasing the risk that such requests will be caught by a suspension. At the same time, it preserves the distinction between creditors and shareholders.
The extent to which the Cayman courts will co-operate with the courts of other jurisdictions in relation to cross-border insolvencies was considered by the grand court in re Lancelot Investors Fund. The case arose out of a pyramid fraud scheme carried on by the Petters Corporation in the US.
The key issue was whether or not the Cayman court should allow the Cayman registered fund to be wound up by a Chapter 7 trustee in the US or whether a Cayman liquidator should be appointed.
The Cayman Islands have not implemented the UNCITRAL Model Law on Cross-Border Insolvency so the matter was determined on common law principles.
The court expressly adopted the decisions of the House of Lords in re HIH Insurance Ltd (2008) and the Privy Council in Cambridge Gas Transportation Corporation v Unsecured Creditors of Navigator Holdings PLC (2007), accepting the general principle that insolvency should be unitary and universal (ie one insolvency that receives worldwide recognition).
In Lancelot the ourt found that, on the particular facts of the case, the place of the principal liquidation was clearly the US. This was perhaps unsurprising because the Cayman entity was only one of a group with the other 18 companies being incorporated in the US and it had invested in the Petters Corporation through loan notes governed by US law which had been assigned to it by one of the US entities in the group.
The only real connection with Cayman was that its registered office was located in Cayman, with the investment manager being based in Illinois, there being no Cayman based directors and the administrator being based in the Bahamas. Unfortunately, the court did not elaborate on the test to be applied at common law to determine the place of the principal liquidation so some uncertainty remains in this regard.
Although deciding that the US was the place of the principal liquidation, a Cayman liquidator was appointed to take custody of any Cayman assets because it was thought impractical for them to vest in the court, pending any application for recognition by the US trustee.
The Cayman winding up was stayed to allow the US trustee to complete his initial investigations and the Cayman liquidator’s role was limited to negotiating a protocol with the US trustee defining their respective roles.
The court stressed the desirability of cooperation and actively encouraged the US trustee to consider taking up a joint appointment in Cayman with the Cayman liquidator.
The decision illustrates the importance placed on judicial comity by the Cayman courts and contrasts starkly with the approach taken by the US courts in the Bear Stearns (Basis Yield) and Sphinx cases.
Peter Hayden is a senior associate at Mourant du Feu & Jeune.