In the current economic climate many offshore funds are continuing to receive large numbers of redemption requests. The funds, their directors and managers alike, are facing an ongoing struggle with liquidity in attempting to satisfy these requests and in that context many funds are taking the decision to suspend redemptions, the calculation of net asset values, and/or the payment of redemption proceeds.
The Cayman Islands is the leading offshore jurisdiction for fund establishment, and the recent decision of the Cayman Islands Court of Appeal in the matter of Strategic Turnaround Master Partnership, Limited (the "Fund") is a truly significant legal marker for all fund advisors, directors and managers in its treatment of the relationship between a redeeming shareholder and the Fund.
The Court in its judgement made a clear determination of the following issues:
- When does a redeeming shareholder become a creditor of the fund?
- Does the redeeming shareholder remain bound by the fund's Memorandum and Articles post-redemption date?
- Can the fund suspend payment of the redemption proceeds post-redemption date?
In its analysis of these issues the Court closely examined the provisions of the Memorandum and Articles of Association of the Fund together with its Confidential Explanatory Memorandum and Subscription Agreement. Under the collective provisions of those documents the Court determined that although a shareholder which has properly filed a request for redemption in accordance with the prescribed procedures is to be regarded as a creditor of the Fund following the relevant redemption date, that shareholder remains bound by the provisions of the Fund's Articles of Association and any provisions of the offering materials that have been incorporated by reference.
The Court held that the redemption of a shareholder from the Fund and payment of the proceeds was together to be properly regarded as a process which was not completed, and the shareholder could not be regarded as redeemed, until the shareholder had received the relevant monies and the Fund had removed the redeeming shareholder’s name from its register of members. Any steps that remained unfulfilled could, for so long as they were unfulfilled, be subject to suspension provided that the fund had the power to suspend redemptions. As a result, the Court ruled that the redeeming shareholder's right to receive the proceeds of redemption was itself subject to suspension by the directors even after the redemption date.
In that context the shareholder was held to have no right to petition the Court for an order requiring the Fund to be wound up on the basis that it was unable to pay its debts. The redemption proceeds were held by the Court to be a future or prospective debt and the investor an unliquidated creditor. The valid suspension by the Fund of payment of the proceeds thus prevented the shareholder from being able to establish that the redemption proceeds were 'absolutely due' in the sense that the shareholder could demand immediate payment.
In its treatment of the redeeming shareholder’s right to petition for a winding-up the Court was clear to affirm that balance sheet insolvency, as it applies under the English Insolvency Act, does not apply in the Cayman Islands. At present under Cayman law only a 'cash flow test' is applied for the purposes of determining the solvency of a fund. On the basis of the Court's decision, the valid suspension of redemption payments by a fund will allow the directors to successfully challenge redeeming shareholders attempts to proceed to a winding up on the basis that the fund is unable to pay its debts.
The judgement of the Court was heavily focused on the language of the Fund's Articles and the terms of the offering document incorporated by reference. As a consequence the case has already generated much discussion between funds and their legal advisors in the Cayman Islands as to the content of their suite of documents and whether the Court findings can be extended to funds with similarly drafted documentation. The general structure and content of those provisions will be familiar to all Cayman attorneys whose practice involves the establishment of investment funds, but now more than ever, advisors will be carefully analysing the width of the discretion afforded to the directors in the context of suspension of redemptions.
Importantly, the Court left open for determination by the Grand Court the question of whether the exercise of the power to suspend payment of redemption proceeds was improperly exercised by the Fund. It observed that if the redeeming shareholder was able to establish to the Court's satisfaction that the suspension was invalid, the redemption proceeds would be regarded as properly due and payable and thus the shareholder would have standing to petition for winding up on the basis that the Fund was unable to pay its debts.
The Cayman Islands Court of Appeal decision in this case is an important affirmation of the legal principles to be applied in the context of the suspension of redemptions, made even more significant by the fact that the Cayman Islands is the leading offshore jurisdiction for the establishment of investment funds. Particularly given the current economic climate fund managers, directors and their advisors should closely review the judgement and its implications for the operation of their own fund(s).
This article was first published by Financier Worldwide