The concept of cell companies was first introduced to Jersey in February 2006. In addition to the widely recognised principle of the protected cell company ("PCC"), a new concept of incorporated cell company ("ICC"), the first of its kind, was also implemented.

The key issue which differentiates both types of cell company from traditional (non-cellular) companies is that they provide a flexible corporate vehicle within which assets and liabilities can be ring-fenced, or segregated, so as only to be available to the creditors and shareholders of each particular cell.

PCCs and ICCs

A protected cell structure involves a single legal entity (the "protected cell company" or "PCC") within which there may be established numerous protected cells. Each protected cell, despite having a separate memorandum and articles of association, shareholders and directors, as well as being treated for the purposes of the Companies (Jersey) Law 1991, as amended (the "Companies Law") as if it were a company, does not have a separate legal identity from the PCC itself. Where a cell wishes to contract with another party, it does so through the PCC acting on its behalf.

In contrast, an incorporated cell company (or "ICC") is a completely separate legal entity, with the ability to enter into arrangements or contracts and to hold assets and liabilities in its own name. The ICC is intended to act as a robust alternative to the PCC and, due to its familiarity with normal corporate concepts, is often considered attractive in those jurisdictions which are not familiar with the concept of protected cells.

Segregation of assets and liabilities

The assets of a PCC are divided between those which are cellular and those which are non-cellular. Cellular assets are attributable to particular cells, non-cellular assets belong to, or are owned by, a PCC in its own right. The directors of a PCC are required to exercise their powers, and to discharge their duties, in order to ensure that: (i) the cellular assets of the cells are kept separate and are separately identifiable from the non-cellular assets of the PCC; and (ii) the cellular assets attributable to each cell are kept separate and separately identifiable from the assets attributable to the other cells of the PCC. In order to ensure that creditors and third parties are aware of this position, a director of a PCC is under a duty to notify counterparties to a transaction that the PCC is acting in respect of a particular cell. A director who fails to make this notification, or to accurately reflect this in the minutes of the PCC or protected cell, is guilty of an offence.

The crucial protection which the Companies Law affords to shareholders of a protected cell or PCC against creditors is that losses in a cell of a PCC, or the PCC itself, do not affect profits in another cell. If a protected cell or the PCC is unable to satisfy the liabilities it owes to a creditor out of its own assets that creditor is not entitled to have recourse to the assets of other cells or the PCC.

The Companies Law contains detailed provisions to ensure that, although protected cells are not themselves distinct legal entities, similar protection is offered and creditor recourse is limited to relevant assets only. Thus, the recourse available to a creditor of a PCC or protected cell is limited:

  • to non-cellular assets if he has entered into a transaction with the PCC in its own right; and
  • to the cellular assets of the cell in respect of which he has transacted, if he has entered into a transaction attributable to a particular protected cell.

Specific provisions have been included within the Companies Law to ensure that creditors of Jersey cells treat cellular and non-cellular assets in the correct manner. In particular, if a creditor recoups any assets of a PCC which are not assets of the relevant cell, such creditor is prevented from using such assets to meet its claim. Instead, the creditor must hold the assets on trust for the PCC and must pay or return them on demand to the PCC. Similarly, a creditor who succeeds in obtaining cellular or non-cellular assets to which he or she is not entitled is liable to repay to the cell or PCC (as applicable) an amount equal to the benefit improperly obtained. If the creditor fails to pay or return such assets to the PCC on demand, he or she will be guilty of an offence.

The only way in which the PCC is required to meet the liabilities of a particular cell is if its articles of association provide for such and that it makes a statement of solvency at the time the assistance is given. In practical terms, this is often of little use as PCCs usually consist of paid up share capital only and are unlikely to hold any material assets, sufficient to satisfy any creditor claims.

In the majority of cases, it is ensured that the requirement to meet the liabilities of other cells is expressly precluded within the PCC and protected cell articles of association, as well as making sure any contracts entered into by the PCC on behalf of a protected cell provide for the exclusion of any third party rights against the PCC or any other cells within the PCC structure.

As each cell of an ICC is a company with separate legal identity, the treatment of segregation is straightforward, with assets and liabilities being held separately within each incorporated cell.

Jersey insolvency

Jersey law also applies these ring-fencing rules to any liquidator or receiver of a PCC or protected cell. Thus, as a result of the Companies Law (and in the absence of any special provisions in the articles of association subjecting the non-cellular assets to the liabilities of an insolvent cell), creditor claims are restricted to the relevant cellular assets and creditors are denied access to non-cellular assets. The insolvency of a protected cell should not therefore affect the business of the PCC entity, the performance of the other protected cells within the PCC structure or lead to the insolvency of the PCC or other protected cells.

If directors are in any doubt as to whether a liability should be met by cellular or non-cellular assets of a PCC, or by a combination of both, Article 127YW of the Companies Law enables a PCC to apply to the court for determination. In the appropriate circumstances this may be a solution enabling directors to ensure that they have complied with the relevant law and their responsibilities.

In addition to the above, since the cell of a PCC is not a separate company in its own right, the provisions regarding winding up of companies contained within the Companies Law do not apply. This means that protected cells in isolation cannot be wound up. The only manner in which a PCC structure can be wound up is if the PCC itself, and all protected cells, are insolvent (or are (i) transferred to another PCC, (ii) wound up, (iii) continued as a separate body corporate or cell under the law of another jurisdiction, (iv) incorporated independently of the PCC, or (v) merged with another company). In each other circumstance, recovery by a creditor is limited to those cellular or non-cellular assets of the cell or PCC only.

Due to their corporate nature and separate legal personality, Jersey ICCs and incorporated cells are treated for all purposes as separate companies. This means that the normal provisions regarding insolvency apply to each, as they would to an insolvent traditional limited company (i.e. that no creditor of an incorporated cell would have recourse as a matter of law against the ICC or another cell within the structure).

Insolvency in foreign jurisdictions

Although the interpretation of insolvency law in so far as it relates to protected cells in Jersey is straightforward, there is no guarantee that foreign jurisdictions will treat such companies in the same way. This may be particularly true where a foreign jurisdiction does not provide for similar structures in its own legislation. There is some legal opinion (most notably, based on the US bankruptcy court case involving a number of connected hedge funds known as the SPhinX funds1) that argues that PCCs should be treated as akin to a trust. However, this approach appears to have been rejected by the majority of commentators on the grounds that the PCC concept struggles to fit within conventional trust law notions and, in particular, the fact that a trust is unable to segregate its assets in an effort to protect them from creditors in the event of an insolvency.

Although not providing clear guidance on the nature of PCCs, the SPhinX case did provide some useful guidance on some of the potential pitfalls and practical safeguards which could be followed when managing PCC structures.

While the segregation principle seems relatively simple to comply with, a key problem in the SPhinX case was the intermingling of monies in non-segregated accounts. This problem was compounded by a poor system of internal controls, lack of accounting measures and records, and an inability to unwind inter-company transactions. The directors of the cells had effectively treated the companies as a single entity. There were common directors, board meetings and, critically, decision making. All of the measures resulted in an inability to "look through" the transactions and clearly identify the assets and liabilities of particular cells.

In addition to the above, it was also apparent that little consideration had been given to funding expenses not applicable to the cells, as the PCC itself did not maintain, or, seek to raise, any share capital of its own. This resulted in the PCC being unable to meet its liabilities arising in respect of general creditors, which could not be legitimately met with funds held in the portfolio cells.

These failures suggested that the protected cells were not ring-fenced companies at all, but were one entity making joint decisions for a series of connected companies. Although not conclusive, avoidance of the pitfalls identified in the SPhinX case should support the recognition of the segregation of PCCs or cells in overseas jurisdictions.

The majority of commentators appear to believe that most jurisdictions will, in due course, accept the principle of ring-fencing on the grounds that segregation is not contrary to public policy or so offensive to the general principles of contract law to deem it unlawful. In the interim, to ensure that cell companies are treated appropriately, and to mitigate against the possibility of foreign jurisdictions not recognising their existence, it is vital that clarity is achieved in all contracts entered into by a PCC: clearly stating that the contract is entered into in respect of a particular protected cell only, confirming (if relevant) that assets are to be treated as segregated (one of the fundamental failures of the SPhinX case) and, finally, where possible, submitting to the law of Jersey. Such provisions, being a clear indication of the contracting parties' intentions, should, in our view, be persuasive in most jurisdictions, regardless of whether a form of segregated cell company exists in its legislation or not.

Furthermore, we note that the English courts have shown a willingness to co-operate with a foreign insolvency jurisdiction where such foreign jurisdiction is considered more appropriate than England for the purpose of dealing with outstanding questions in a winding up. In the case of McGrath v. Riddell2, the House of Lords upheld the principle that, where a principal liquidator has been appointed in the home jurisdiction of the company or cell, UK courts should ensure that assets are remitted to such liquidator in order to be distributed under a single system. Such approach should support the assumption that assets of cells held in the UK will nevertheless be remitted to a Jersey appointed liquidator to be dealt with in accordance with the Companies Law.

It is clear that, presently, not all jurisdictions will necessarily recognise and enforce provisions in relation to protected cell structures. However, the robust statutory position in Jersey is designed to bolster the concept of protected cells and should provide comfort for those using PCCs. In addition, with the number of jurisdictions adopting legislation providing for cellular companies increasing, any risks arising from the non-recognition of the segregation of assets and liabilities appear likely to recede.