Source: https://thehedgefundjournal.com/cayman-investment-funds/
Timestamp: 2019-04-23 06:09:22+00:00

Document:
In 2010 the Cayman Islands courts continued to deliver decisions of importance to the funds industry. In particular, the Privy Council delivered its much anticipated judgment in Strategic Turnaround which clarifies a number of important points in respect of suspensions and redemptions by Cayman Islands investment funds.
The decision of the Privy Council makes it clear that powers of suspensions and redemptions and the status of a redeeming but unpaid investor are matters of interpretation of the fund’s articles of association and, to the extent they are incorporated into the articles of association, its offering documents.
An investor had submitted a redemption request to the fund for a 31st March 2008 redemption date and the NAV was duly struck. However, in April 2008, and before the investor had received the redemption proceeds, the fund purported to suspend the calculation of the NAV, redemptions and the payment of redemption proceeds. On this basis the fund withheld the redemption proceeds due to the investor. The investor issued a winding up petition against the fund on the basis of cash-flow insolvency (i.e. it was unable to pay the debt due under its redemption notice) and on other grounds. The fund applied to strike out the petition summarily on the basis that the investor lacked legal standing to bring the petition. The Privy Council refused to strike it out on the insolvency ground and perhaps more importantly, clarified a number of concerns that arose from the Court of Appeal decision.
The Court of Appeal found that on the proper construction of the fund’s constitutional documents, the fund had a power to suspend the payment of redemption proceeds after the relevant redemption date had passed but before the payment of those proceeds. As we will see below, the Privy Council agreed that it was a question of construction of the fund’s constitutional documents but disagreed with the Court of Appeal’s interpretation of them.
• It confirmed that a redeeming investor will become a creditor on the redemption date even if payment of his debt is subsequently suspended in accordance with the fund’s constitutional documents.
The Court of Appeal did not disturb the finding at first instance that redeeming but unpaid investors will rank ahead of other investors but behind “ordinary” unsecured creditors. However, despite this, the Court of Appeal concluded that until the redeeming investor’s name was removed from the register of shareholders, and perhaps until paid, the redemption process is incomplete and the redeeming investor will remain a shareholder of the fund. As such, he would be both a creditor and a shareholder and entitled to use the constitutional machinery of the fund to convene meetings and propose resolutions, even after the redemption date. The Privy Council rejected this unorthodox concept.
• The decision also reaffirms the well-understood and long-standing position that redeeming but unpaid investors rank ahead of other investors who have not redeemed but behind ordinary unsecured creditors.
An additional important point (where it overruled the Court of Appeal) is that it is the terms of the articles that determine whether or not a redeeming investor retains any shareholder rights until payment of the redemption proceeds. In so doing, the Privy Council relied on long-standing authority that whether or not a shareholder’s name should remain on the register depends on the terms of the articles of association. The mere fact that the fund has left a redeeming investor’s name on the shareholder register is not of itself conclusive of the existence of it still having shareholder rights. It held that various nineteenth century cases relied upon by the fund concerning redemptions by members/depositors of building societies were not applicable in these circumstances. It held that each case turns on its own factual framework (i.e. the relevant constitutional document, the subscription/redemption rules and the relevant statutory framework) and that the factual and statutory framework in these cases was not applicable to the articles of association of this particular investment fund or the Cayman Islands statutory framework for investment funds. In the same vein it held that a number of first instance decisions from around the British Commonwealth relating to redemptions turned on the particular statutory and contractual provisions in question.
The fund sought to rely on Article 17: “Subject to these Articles, Shares shall be issued on the terms referred to in the [offering memorandum] …”. The offering memorandum described a power to suspend payments after a redemption has passed which was not contained in the articles of association. It argued that the articles of association should be read together with the offering memorandum, with the articles of association supplementing the terms of offering memorandum where they were not wholly inconsistent.
The Privy Council was keen to point out that it was not addressing a situation in which an investor is claiming the benefit of the effect of the description of the articles of association given in the offering memorandum. The Privy Council said: “[We are] not concerned with a situation in which an investor is claiming the benefit of the effect of the description of the articles given in the [offering memorandum]. Despite the disclaimers in the [offering memorandum], it may be that an investor who had relied upon the description in the articles might have an arguable case for being entitled in one way or another to do so. In the present case, it is the [Fund] itself that is seeking to draw advantage from what appears to [us] to be a discrepancy between its own description of the articles in the [offering memorandum] and the reality; and in this situation [we] see no basis for entitling the [Fund] to rely in its own favour upon its own mis-description of its own articles.” No doubt it will not be long before an investor seeks to persuade a court that a fund’s articles of association incorporate the terms of offering documents and he is thereby entitled to rely on a fund’s mis-description of its own articles of association in those offering documents.
• The rights of investors upon partial redemption of their shares both as creditors for any redemption proceeds due and as shareholders of their remaining shares, and the valuation issues that may thereby arise.
Clear drafting of the fund’s articles of association and offering materials is essential. Although there are a number of old decisions in England and modern decisions in other offshore jurisdictions relating to the rights of investors with respect to redemption notices, considerable care should be taken in assessing whether the factual and statutory framework relevant to those decisions is applicable to the particular articles of association of a Cayman Islands investment fund.
The Privy Council decision underlines a number of very practical points for the many investors and fund managers in the Cayman Islands funds industry. The Strategic Turnaround decision also throws up a number of interesting (and unanswered) questions. There may be occasions where particular funds’ articles of association are not entirely clear as to the investors’ rights and/or where there is, or may be, inconsistency between the articles of association and the offering documents with respect to investors’ rights, powers of suspension, etc. The immediate consequence of the decision is that investors and funds alike will be closely scrutinising the inter-play between their funds’ articles of association and offering documents to establish whether: (i) the articles of association need to be amended to incorporate provisions in the offering documents; and if so (ii) what consents are required in order to effect any changes considered necessary? These are the practical questions that funds are faced with on a daily basis. There will rarely be a “one size fits all” solution to questions such as these. Each is fact specific and requires bespoke analysis relevant to the particular fund’s structure.
Recently, a significant number of investment funds have included express articles of association to provide that a redeeming shareholder rights upon the relevant redemption date are extinguished except for the right to receive redemption proceeds as a creditor, thereby, creating the same outcome as in Strategic Turnaround. The key point from the Privy Council’s decision is that it is the terms of a Cayman Islands fund’s articles of association that determine the rights of the fund and its investors. This is self-evidently practical and common sense. It provides Cayman Islands funds and investors a great measure of flexibility to agree terms for the operation of their funds that are tailored to the specific commercial requirements of the investors.
Colin McKie is a partner, and William Peake an associate with Maples and Calder in the Cayman Islands.
2. The Court of Appeal held that the investor had standing on the alternative ground. The fund did not appeal against this finding, so the Privy Council’s decision is limited to the insolvency ground.
3. Reese River Silver Mining Company Ltd v. Smith (1869) LR 4 HL 64, a principle confirmed as recently as Michaels v. Harley House (Marylebone) Ltd  2 BCLC 166.
4. Re Planet Benefit Building and Investment Soc. (1872) LR 14 Eq 441; Walker v. General Mutual BS (1887) 36 Ch D 777; Sibun v. Pearce (1890) 44 Ch D 354; Pepe v. Cit & Suburban PBS  2 Ch D 311 (notably, the Privy Council declined to express a view as to whether or not this last case was in fact correctly decided).
5. Australia – Basis Capital Funds Management Ltd v. BT Portfolio Services Ltd  NSWSC 76; Bermuda – BNY AIS Nominees Ltd v. Stewardship Credit Arbitrage Fund, Ltd (unrep., 27th Nov 2008), Re New Stream Capital Fund Ltd (unrep., 18th Dec 2009); BVI – Western Union International Ltd v. Reserve International Liquidity Fund Ltd (unrep., 26th Jan 2010), SV Special Situations Fund Ltd v. Headstart Class F Holdings Ltd (unrep., 25th Nov 2008), Re Livingston International Fund Ltd (in liq.) (unrep. 2002).

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