The pace of regulatory developments in the offshore arena means that change is now constant. But while a significant proportion of the media focus has been on either new or reformed rules on the compliance side such as the Common Reporting Standards, registers of beneficial ownership and the Base Erosion and Profit Shifting agenda, there are also industry-driven developments of significance.
A fine example is the introduction of the Cayman Islands Liability Companies Law, 2016 which was enacted in June 2016 and which came into force on 8 July 2016. The introduction of the LLC is a response to demand from the investment funds and financial services industry, and Ogier worked closely with the Cayman Islands Government and was centrally involved with the development of the Law.
As we approach the 12-month mark since the beginning of the Cayman LLC regime, it is a good time to take stock of how it has been received.
In a nutshell, an LLC is a hybrid entity incorporating characteristics of a partnership and a company modelled on the Delaware Limited Liability Companies law, but with subtle and key differences, and drawing also from the well-recognised features of Cayman’s successful exempted company and exempted limited partnership. Unlike a partnership, it has separate legal personality. The members of an LLC, like the shareholders of an exempted company, will have limited liability and will not be required to make any contribution to the LLC exceeding the amount such member has undertaken to contribute pursuant to the LLC Agreement constituting the LLC. It is similar, but not the same, as its Delaware counterpart.
Potential uses for Cayman LLCs identified prior to the laws introduction underline its flexibility. Among the options considered at its inception were; incorporated joint ventures (i.e. ventures where the JV participants carry on the JV business through a corporate vehicle); securitisation SPVs as an alternative to the existing option of a Cayman exempted company in which all of the shares are held by a Cayman STAR trust; a holding entity for a corporate group; or an investment feeder fund. That final option has sparked the interest of the hedge and private equity industries.
Given the LLCs hybrid nature it has far greater flexibility than a company, particularly in two key areas: in respect of its management and organisation and in the manner in which it can allocate profits and losses.
Unlike an exempted company, an LLC does not have a share capital. Instead, members are issued interests or classes of interests. This allows for flexible internal accounting and record keeping whereby an LLC member may have a capital account and make capital contributions in accordance with the LLC Agreement (in a manner similar to a partnership).
The members of an LLC may agree amongst themselves how the profits and losses of the LLC are to be allocated and how and when distributions are to be made, which may be on a non-pro rata basis. This might be useful where, for example, the LLC Agreement provides for tax distributions that would be on a non-pro rata basis given that distributions are made at different times to meet tax liabilities of the members. This is difficult to mirror in a corporate structure where distributions on shares of the same class would need to be made pro rata.
No board of directors needs to be appointed. An LLC may be managed by some or all of its members or by one or more appointed non-member managers. Furthermore, the LLC agreement can provide for classes or groups of managers with differing rights, powers, and duties, which may be useful where different managers are managing different assets within the same LLC. Finally, any person acting on any board or committee of the LLC may act in a manner which the person believes to be in the best interests of a particular member even though this may not be in the interest of the LLC.
The potential hybrid tax status of a Cayman LLC can also be an advantage. However, whether the LLC will be tax transparent or tax opaque will be a matter for the relevant onshore jurisdiction. There may be a degree of flexibility under the onshore jurisdiction’s tax law to treat a Cayman LLC as either depending on the drafting of the LLC Agreement. It will be necessary to check with relevant tax advisors that the desired tax treatment will apply.
How popular has the model proven?
Within the first six months, close to 200 Cayman LLCs were registered, as practitioners – particularly in the hedge and private equity spaces - saw the potential advantages of the new structure over the older, and more established options such as Cayman exempted limited partnerships for private equity funds and exempted companies for hedge funds.
An excellent practical example of the use of the Cayman LLC structure was the high profile launch of the Vanhau Fund and Vanhau Master Fund by Vanhau Asset Management Limited. The launch – on which Ogier's Hong Kong investment funds team advised – by Vanhau, a Hong Kong based investment manager. The firm was founded by Vishweshwar Anantharam and William Hau previously worked at Goldman Sachs in Hong Kong where they had long and distinguished careers, and the launch was one of the first of its kind in the Asian market.
This was a one-legged master-feeder fund structure with the feeder fund and master fund entities both being Cayman Islands limited liability companies. Both Vanhau Fund and Vanhau Master Fund, were established as section 4(3) CIMA regulated mutual funds.
Amidst the torrent of regulatory amendments and reforms for offshore practitioners, the introduction of the Cayman LLC structure stands out as a positive development that supports innovation and underlines the case for Cayman as a jurisdiction that is responsive to industry needs. It is not (and was not intended to be) a replacement for replace the exempted company or the exempted limited partnership, but stands as a useful alternative.
The introduction of the law demonstrates the continued ability of the Cayman Islands to be flexible and responsive to market needs and should reinforce the Cayman Islands’ position as a domicile of choice for offshore investment funds and structuring vehicles.
This article first appeared in HFM Special Report Cayman Islands 2017.