If a fund is insolvent, it is either not able to pay its debts as they fall due, or its assets are less than its liabilities. An investor/creditor will have the ability to put the fund into a formal insolvency procedure and, in most cases, appoint an independent third party to take control of the assets and investigate the conduct of the fund’s directors, managers and other controlling functionaries. Defined terms in this article are the same as the terms which were defined in the potential causes of action article.
Insolvency procedures in Guernsey in respect of investment funds vary considerably depending on the legal structure of the investment fund (i.e. whether it is a corporate body, a trust or a limited partnership) and are summarised in brief below.
This is a collective court-driven procedure derived from the customary law of Guernsey which results, ultimately, in the distribution of the debtor’s personal property amongst its creditors.
This court based statutory procedure (which applies to corporate structures only) provides protection from creditors and a breathing space for the fund, whilst the fund continues to trade and do business under the management and control of an administrator. The administrator is appointed by the Court which will only make an administration order if it is satisfied that the fund is insolvent (either on the cash flow or balance sheet test) and that one of the two statutory purposes can be satisfied, namely either the survival of the fund’s business as a going concern or a better realisation of assets than would be effected if the fund was simply wound up.
Administration is not intended to be a terminal process and in that regard an administrator has no power to make a distribution to creditors. From an investor’s point of view, if the fund is insolvent but could continue to trade (and possibly become solvent) in order to maximise realisations to both creditors and investors, then administration may well be the most appropriate route to adopt.
- Winding up/Liquidation:
A voluntary or compulsory winding up (also known as liquidation) could take a number of forms depending on the legal structure of the fund. A voluntary winding up can be prescribed by the fund’s constitutional documents and the relevant legislation applicable to it. A compulsory winding up is a court-driven process that can be directly instigated by a creditor or other prescribed parties (such as a company director or member, a partner or general partner of a limited partnership, a trustee of a unit trust, or the GFSC) and may be related to the solvency of the fund and/or its inability to pay debts as they fall due. A corporate structure can also be wound up on just and equitable grounds. In all cases, a liquidator will be appointed to realise the assets of the fund and distribute these to creditors after scrutiny from the main stakeholders (in a voluntary liquidation) or a Commissioner of the Court (in a compulsory winding up).
The fund does not necessarily have to be insolvent in order for it to be wound up voluntarily, and accordingly, by definition, if it is solvent then there would be a return to members once the assets have been realised.
- PCCs and ICCs:
In respect of an ICC, winding up can be carried out in such a way as to not prejudice the affairs, business and property remaining of any of its remaining ICells, and accordingly, during the winding up, the ICells shall continue to carry on business to the extent necessary for the continuance of business of the ICC.
The liquidator of a PCC must ensure that the cellular assets are kept separate from those of the core assets, and must only apply those core assets in discharge of creditor claims in relation to the PCC and not the PCells.
In respect of PCCs, further relief may be sought through either a receivership order or a recourse agreement. A receivership order (an order in respect of a PCC directing that the business and cellular assets of or attributable to a particular cell be managed by a receiver) may be made if the Court is satisfied particular grounds are met (as set out in the Companies Law) including the cell’s insolvency. The effect of a receivership order is to create a moratorium in respect of the cell, leaving the receiver to perform his functions which are similar to that of a liquidator.
A recourse agreement can be entered into by the PCC with a third party and it will provide that, pursuant to an arrangement effected by the fund, its protected assets may be subject to a liability owed to that third party. The cellular assets attributable to the fund may only be available to such creditors who are creditors in respect of a particular cell and such assets are protected from other creditors who are not creditors in respect of the same cell.
The distribution process in a liquidation is relatively simple in Guernsey. In respect of secured debts, if a secured party has a valid security interest in accordance with Guernsey law without title to the collateral, to the extent the collateral is sufficient, it has priority to all other claims for the amount due to the secured party. If the secured party has title to the collateral, then it may realize or otherwise deal with the collateral notwithstanding the fund’s insolvency. Any debts which can be set off by an insolvent corporate fund will (following a recent decision of the Court) also fall outside the insolvent estate. From the unencumbered assets, the liquidator takes his costs and expenses and pays preferred creditors. The balance of the funds will be distributed equally amongst the unsecured creditors of the fund, and if there is anything remaining then these will be distributed either pari passu or in accordance with a stakeholder agreement, amongst the members/partners. Where a Guernsey fund has assets in other jurisdictions, the insolvency and security interest laws and regulations of those jurisdictions may impact on those assets. .
- Powers and Functions of Office Holders
A liquidator has the power to commence insolvency specific actions against third parties under the Companies Law for preferences (where the fund has preferred a third party creditor over other creditors), misfeasance (where a director or former director has misapplied or misappropriated company funds, or where they have acted in breach of their fiduciary duty so as to cause loss to the company) and fraudulent and wrongful trading. An administrator has no such power, although a creditor or member may also bring misfeasance actions against the directors of a company in liquidation without recourse to the liquidator.
Wrongful trading is becoming more relevant in today’s climate where directors may try to continue to trade ailing funds, but with the result that creditors suffer further losses. If the directors knew or ought to have known that the fund could not avoid insolvent liquidation in those circumstances, then they are liable to contribute to the insolvent estate for the losses incurred. The directors’ knowledge will be based on their own skills and experience. For example in the funds industry most company officers are professionals who act in this capacity frequently, and will therefore be deemed to have a high level of knowledge and skill. Whilst wrongful trading carries only civil liability, fraudulent trading, where a fund is carried on with the intent to defraud creditors or for any other fraudulent purposes, carries both criminal and civil liabilities which a liquidator can prosecute.
Both the liquidator and the administrator have the power to bring actions against third parties in the name of the company. Accordingly, if a third party has breached a contract or a duty owed to the fund resulting in a loss to the fund, then the office holder can commence proceedings in the name of the fund against that third party. On that basis, for example, an administrator appointed by the Court could procure the fund to sue a director of the fund, or its manager or custodian, for negligence and breach of fiduciary duty.
Under section 426 of the Companies Law, liquidators and administrators also have a general power to apply to the Court for directions on the performance of their functions. Whilst there are no specific powers in Guernsey entitling the officer holder to seek information or documents from third parties in relation to the fund, its affairs, property or management, the Court has jurisdiction to make such an order, if it considers that such information and documentation would assist, and be beneficial to, the liquidator or administrator in the performance of their functions. Accordingly, section 426 can operate so as to enable officer holders to obtain information and documentation from parties connected to the management or operation of the insolvent corporate fund.
The fund investor has a number of options in relation to a Guernsey investment fund which has been mis-managed and/or is insolvent. The ability to pursue the parties involved in the management or formation of a fund, through civil or derivative actions, has been enhanced by the insolvency regime in Guernsey that enables office holders to maximise realisations for the benefit of all creditors and investors in that fund.