24 February 2009
Yeats’ The Second Coming perhaps describes best how some lawyers and financiers are feeling about the world economy at the moment: “The best lack all conviction, while the worst are full of passionate intensity.”
However, for those who can remember it (and only one of the authors of this article can), many law firms made it through the recession of the 1990s only on the back of strong litigation performance. In simple terms, when there is no money to be made tomorrow, people try to recover the money they lost today from the person they think caused them to lose it
– the counter-cyclical economy. The recession in which we now find ourselves is no different.
The most obvious impact on the Channel Islands has been in the world of funds, and in particular redemption requests. The scenario is relatively straightforward. A family office or private or corporate investor has a wide range of investments, some of which are performing better than others. The investor also has its own gearing and liquidity issues and may be keen, in the current climate, to realise some of its assets into cash. Accordingly, the funds industry has seen a significant rise in redemption requests over the past six to 12 months. However, the wave of redemptions has brought about a number of distinct legal issues, some of which are set out below.
The tsunami redemption request
In most well-drafted fund instruments, there is provision for the ‘gating’ of redemption requests. In other words, where redemption requests in excess of, say, 10 per cent of the fund’s value are submitted all at the same time, not everyone’s request will be allocated in full. There will be a pro rata allocation, and it may be that a number of investors are not redeemed fully until after two, three or sometimes four redemption days.
However, some funds have not had gating provisions. Those funds have been put into immediate meltdown and have had to be wound up or restructured. Self-evidently, where funds are pushed into a fire sale position, the value of their assets have tumbled even more significantly. In some circumstances investors have been prudent and have participated in an orderly winding up of the company. In some, they have not.
The overwhelmed administrator
Faced with a flood of redemption requests, and even with gating provisions, fund administrators have nevertheless found it difficult to deal with all the necessary paperwork. In most fund particulars there are specific timetables within which redemption requests have to be honoured. However, with such a glut of redemption requests, there has been a rise in the amount of administrators failing to process redemption requests in time.
In times of stable or rising markets, it may not have been significant that a redemption request that ought to have been processed on 1 September was not, in fact, processed until 1 October. In the context of September/
October 2008, however, significant value was wiped off investment funds during that time, which unsurprisingly investors might seek to recover from either the manager or the administrator of the fund. In those circumstances the wording of the fund documentation becomes critical. However, where there are words, there are lawyers pouring over them and litigation usually follows.
Oddly, we have seen cases in this scenario where, because of extreme volatility of the markets, the value of the fund has in fact bounced up again by (in the above example) November 2008, and so the loss has been negligible.
The suite of documentation put in place for funds is necessarily complex.
Even in the simplest structures there are still scheme particulars, a management agreement, an administration agreement, a custodian agreement and the Articles of Association of the fund vehicle. Hitherto it has been rare that the internal consistency of the documentation has been examined closely.
In more recent times, however, inconsistencies have been exposed. If, for example, the scheme particulars provided for a 30-day notice period on redemptions, but the Articles of Association for a shorter period, which should prevail? One of the consequences of the longer period could be that it falls outside a particular redemption day and that the value of the fund is significantly lower on the following redemption day. More catastrophically, it might be that the fund is in liquidation by the time the longer period has expired.
In these counter-cyclical times, it is also not just the administrators or managers who are in the line of fire. Fund advisers, lawyers, accountants and other professional advisers are also potentially on the receiving end of claims arising from inconsistent documentation.
Investment strategy disputes
Some funds are made up of many small investors, all represented by a single broker or investment adviser. In such troubled times, the strategic approach of investment advisers may well differ, and where a minority shareholding takes a different view from that of the board, the potential for litigation against the directors for the position that they have taken (even on third-party investment advice) is significant.
Even if it would be difficult to impose individual liability on the directors, that does not prevent investors from threatening it and thereby undermining the confidence of many boards to take difficult decisions.
There has been a rise in emergency extraordinary general meetings where directors seek to gain ratification of their strategies by shareholder majorities, often in order to extinguish the protestations of minority groups. One particular issue that can arise is the nature of the resolution to be passed at that meeting. If the resolution is effectively to wind up the company, a special resolution is required. Accordingly, the minority group may seek to present its resolution as merely a change in investment strategy (requiring only a 50 per cent majority in respect of an ordinary resolution).
The reader might be forgiven for thinking that we are in apocalyptic times. Certainly, Ozannes has seen unprecedented levels of enquiries in relation to these types of disputes. However, what is perhaps different from the recession of the early 1990s is that, at least until now, many of these disputes are being resolved without the need to trouble the courts. Such pragmatism on the part of investors and fund managers is to be commended. It perhaps means that Yeats’s fears about the “blood-dimmed tide” are not quite as great as some may have first thought.
Robert Shepherd is a managing partner and Anthony Williams is an associate at Ozannes in Guernsey