When Cayman Islands funds undergo liquidity stress on their balance sheet due to holding illiquid assets or irregular large redemption requests, directors of Cayman Islands funds generally consider mechanics to provide for an orderly restructure to meet redemption requests which arise. Common arrangements are to implement a “redemption gate” which limits redemptions to a certain percentage of shares in the fund or a stronger response such as a suspension of all redemptions. Specific legal advice should generally be taken to consider if any shareholders who have previously submitted redemption requests will be subject to, or exempt from, such liquidity restrictions. Shareholders which have a priority for full payment of their redemption price over other shareholders may receive a significantly higher price per share if insufficient cash is ultimately realised to pay other shareholders.
These issues are also relevant for consideration in the context of a Cayman Islands winding up and liquidation as to whether shareholders who have submitted redemption requests prior to these insolvency filings have priority in payment to remaining shareholders. The Cayman Islands Court of Appeal recently upheld a decision of the Grand Court in Michael Pearson (in his capacity as Additional Liquidator of Herald Fund SPC (in Official Liquidation)) v Primeo Fund (in Official Liquidation), unreported, 19 July 2016 which provided clarity in these matters. The redemption liquidity restrictions the subject of the Court of Appeal hearing arose principally due to investments in the Bernard Madoff fraud schemes.
The decision considered the application of certain provisions of the Cayman Islands Companies Law in the determination of claims by (a) shareholders who have had their redemptions processed by the fund, yet to receive payment as well as (b) other shareholders who have submitted their redemption applications, with the fund yet to process the redemption request such as for example if the net asset value of the fund is yet to be determined.
The Court of Appeal determined that shareholders in the circumstances in (a) above have a priority claim for their redemption proceeds ranking behind ordinary creditors, but in priority to other shareholders. These shareholders may claim in the liquidation as a creditor.
It was further held that in the circumstances in (b) above and specifically where the fund could legally have otherwise effected the redemption payment between the redemption date and the commencement of liquidation proceeding, the relevant shareholder has a priority claim for their redemption proceeds which ranks behind ordinary creditors, and then in priority to all other shareholders. Although not required to be considered in the matter, the Court found the shareholders in (a) and (b) would rank equally in payment priority.
The decision reinforces the necessity for fund directors and administrators to consider carefully and obtain legal advice if anticipated liquidity issues will likely hamper a fund’s ability to meet redemption requests. Proper planning can ensure payments are consistent with legal requirements and avoid mistakes.