28 July 2008
Current market conditions are driving numerous offshore reconstructions, mergers and liquidations of investment funds, portfolios and structured finance products.
Declining investment returns and the refocus of some listed investment funds has also led to increasing and organised shareholder agitation, with hostile attempts to appoint independent board members and the requisition of members’ meetings of significant listed entities.
The popularity of Guernsey as a home for such structures means that Guernsey’s insolvency and regulatory regime has come into sharper focus. On 1 July, Guernsey introduced new companies legislation that, despite remaining broadly based on English company law, also retains some important differences, for example the inability of Guernsey law administration to effect any form of moratorium over potential enforcement by creditors against secured assets.
The way that Guernsey legislation interacts in cross-border insolvency or reconstruction is often a paramount consideration, as are overlapping regulatory considerations for listed or regulated investment schemes.
Cross-border issues: investment funds
Guernsey investment funds are regulated and authorised either as closed-ended or open-ended funds and fall under different levels of regulatory supervision according to this classification rather than by asset class or hedge strategy.
Guernsey funds must be administered by a licensed administrator regulated by the Guernsey Financial Services Commission. When a fund is in trouble, it is increasingly common for conflicts to arise between the regulatory duties of an administrator as a licensed entity, the directors of the fund (some of whom may be directors of the administration firm) and its promoters and investment advisers.
Of particular relevance are the potential overlaps in regulatory regimes that do not become apparent until liquidation, particularly where they are listed outside the Channel Islands. For example, contrary to AIM or the London Stock Exchange, the NYSE Euronext Amsterdam exchange does not suspend or delist the shares of companies that are in compulsory liquidation provided that adequate market information is given to the public. This arises from a basic conflict of laws between the concept of liquidation in common law and civil law jurisdictions. This causes significant problems for liquidators when trying to wind up the affairs of an investment fund while its shares remain actively traded.
Compounding such issues, regulatory authorities may themselves misunderstand the boundaries of their responsibilities in respect of an offshore fund that is listed or being marketed to the public in their jurisdiction, leading to potential conflicts of regulatory duty, which are often further compounded by the different residential domiciles and duties of administrators, directors or investment advisers.
Overseas assets, leverage and security
The careful drafting of dispute resolution and forum clauses when creating offshore funds is critical if matters take a turn for the worse. These considerations are particularly relevant to contracts of ownership of underlying asset classes of a fund, the related borrowing and the jurisdictions in which those assets are held, together with the proper law and prior ranking basis of any security over assets and their valuation.
Many funds operate with leveraged strategies that require security to be provided over a block of assets, usually overseas. A key issue is the situs of fund assets and how contract valuation mechanisms match and track borrowing levels. Highly leveraged strategies have quickly found themselves at the mercy of margin calls that squeeze their liquidity and ability to trade, and some types of funds are currently finding themselves over-secured, with lenders reticent to recalibrate risk. These issues are not limited to the offshore world, but the cross-border issues and conflicts that they create in a potential offshore insolvency require careful analysis.
Taking early advice
Timing is crucial in insolvency and restructuring. There has been a noticeable trend towards a few City firms alone advising on reorganisations, regulation and liquidations of offshore structures, or bringing offshore counsel in at the last moment and attempting to squeeze advice into a preconceived plan of action. Whether this is arising from pressure on costs, pure oversight, or is a reflection of reduced dealflows in the City is difficult to ascertain.
Notwithstanding that giving advice on foreign law probably leaves a solicitor uninsured, it often creates costly problems when it is discovered that the primary law and regulation applicable to a structure will not accommodate a settled plan of action, often leaving the offshore lawyer with the show-stopping ‘don’t shoot the messenger’ advice. A simple telephone call at the earliest opportunity can save mutual clients much potential frustration and cost.
Mark Helyar is managing partner of Bedell Cristin, Guernsey