In a decision that should be warmly welcomed by the funds industry and the legal profession, the Privy Council has reversed the Cayman Islands’ Court of Appeal decision In Re Strategic Turnaround Master Partnership Limited, 2008 CILR 447. The Court of Appeal’s decision was unpopular because (subject to the constitutional documents of the fund in question) it potentially imposed a 5-stage redemption process on redeeming investors, thereby permitting funds to suspend payment of redemption proceeds after the redemption day had passed. In the wake of the outcome of the appeal to the Privy Councili, the industry can breathe a collective sigh of relief as certainty has been returned to the redemption process for open-ended investment funds.
The Privy Council decided (having regard to the constitutional documents of the fund in that case and contrary to the earlier decision of the Court of Appeal) that it was not open to the board of directors to suspend redemptions after the redemption day had passed but before redemptions had fallen due for payment. Perhaps most significantly for the industry, the Privy Council stated that:
- The legal contact between the investor and the fund is to be found in the memorandum and articles of association alone (albeit that the articles can incorporate terms of the offering documents by express words);
- The offering documents merely provide a description of the fund’s investments, the mechanics of placing the investment with the fund and a summary of the terms upon which the investment is made;
- Insofar as the description in the offering documents embraces powers going beyond those in the articles, the description is of no legal effect as against the investor; and
- Despite extensive disclaimers contained within offering documents, an investor who has relied on a mis-description of the articles might have an arguable case against the fund for misrepresentation.
The relevant facts of Strategic Turnaround were as follows. On 31 October 2007 the investor gave a redemption notice which fixed a redemption date for the end of Q1 2008. In accordance with the articles, the redemption notice was received by the fund some 60 days before the redemption date. The redemption request was accepted by the fund’s administrator, which confirmed that payment would be arranged within 30 days. However, shortly after that confirmation, the directors of the company resolved to suspend calculations of net asset value (NAV) and further resolved that no shares in the company could be redeemed until such time as the directors had lifted the suspension. The suspension was imposed on the basis that the fund’s portfolio values were temporarily depressed, impacted by low market volumes and that the then current period was one of extreme volatility or illiquidity.
The investor petitioned to wind up Strategic Turnaround as both a creditor and shareholder. The fund applied to strike out the petition. At first instance, the Chief Justice dismissed the strike out application. The fund appealed to the Court of Appeal.
The Court of Appeal held that, reading the articles and the offering documents together, the fund could suspend redemptions notwithstanding that the redemption date had passed and the actual day for payment of the redemption proceeds was scheduled for only 1 week after the suspension resolutions were passed. In the context of the particular articles of that fund, the Court of Appeal held that “redemption” must refer to the entire process of redemption including:
- the notice to redeem;
- the debt that arises on the redemption date;
- the valuation of the NAV at the redemption date and, as a consequence, the redemption sum;
- the payment of the redemption sum; and
- the removal of the member from the register.
Although there was nothing in the articles which expressly permitted suspension after a redemption date had passed, the Court of Appeal looked to the offering documents which said, amongst other things, that the board of directors may suspend “the payment of redemption proceeds”. The Court of Appeal said of this particular provision that “… this extra detail is not inconsistent with the articles; it merely explains in detail how the powers in the articles may be used in practice”ii.
The Court of Appeal held that the company had power to suspend both (a) the effective redemption of 31 March 2008 and (b) the payment of redemption proceeds to the investor.
On appeal to the Privy Council, the Court of Appeal’s decision was reversed, and it was decided that (notwithstanding the provisions of the offering documents) the fund had no relevant power to suspend the payment of redemption proceeds to the investor, once the redemption date had passed.
Analysis of the Privy Council’s Decision
The Privy Council held that the natural inference to be drawn from the relevant provisions of the articles was that it was not contemplated or intended that suspension could or should affect the position of an investor once its redemption notice had expired and the redemption date had passediii. In order to suspend payment of redemption proceeds after the redemption date had already passed, the Privy Council held that the articles of a fund would require clear words to this effect.
In referring to the requirement of an investor to give 60 days’ notice of redemption of its investment prior to the nominated redemption date, the Privy Council observed that this period allowed the fund time to consider the investor’s redemption notice in the context of all redemption notices received, thus giving the fund a measure of security as to its overall management of the underlying investments, and thereby its own liquidity. On the other hand, investors were entitled to certainty that once they had given a redemption notice, and the redemption date had passed, they would receive the net asset value of their shares at the agreed time.iv
In the Privy Council’s view, the Court of Appeal had been wrong to proceed on the basis that the offering documents and the articles of the fund ought to be read together to determine the terms of the contractual relationship between the investors and the fund. The fund’s offering documents contained an express reference to power to suspend payment of redemption proceeds whereas the articles did not. The Privy Council held that, contrary to the Court of Appeal’s view, the power to suspend purportedly contained in the offering documents was “of no legal effect as against investors such as the Appellant.”v
The Privy Council explained that the offering documents of the fund served various distinct purposes including:
- identifying the commercial terms upon which shares were available for issue;
- conveying general information about the fund, investment advisor, investment objective, approach and strategy;
- identifying the reporting process, risk factors, fees and expenses and tax issues;
- describing generally the effect of the fund’s memorandum and articles and other legal documents; and
- identifying terms of subscription regarding timing, numbers, par value and price.
They do not, however, (in the absence of clear wording to that effect) create any of the respective legal rights and obligations of the parties to the investment. These rights and obligations are set out in the company’s articles.
Lessons to be Learned – Consistency is Key
It is important to remember that the terms of the contract between the investor and the investment fund are contained primarily within the articles. It is also important that investment funds’ offering documents contain an accurate description of the articles. Where it is intended to grant the power to suspend the right to receive redemption payments, as well as the power to suspend redemptions generally, draftsmen will need to use clear and express language to ensure that these aims are met. If draftsmen wish to incorporate terms of the offering documents into the articles then they must use clear and express language to that effect.
A Cause for Concern – Potential Investor Claims
It is a matter of conjecture just how it came about in Strategic Turnaround that the offering documents contained terms so very different to those in the articles. Whilst the industry might be breathing a collective sigh of relief that the Privy Council has reimposed a degree of certainty on the redemption process, there might still be cause for some concern for funds and their service providers.
In referring to the discrepancies between the offering documents and the articles of the fund the Privy Council stated “[We are] not concerned with a situation in which an investor is claiming the benefit of the effect of the description of the articles given in the [offering documents]. Despite the disclaimers in the [offering documents], it may be that an investor who had relied upon the description in the articles might have an arguable case for being entitled in one way or another to do so.”vi
It appears that here, the Privy Council is referring to the possibility of potential claims against the fund by investors who have subscribed on the basis of offering documents which turn out to be inconsistent with the articles. Such claims might be founded upon allegations that investors have been misled as to the terms of their investment.
Potential Causes of Inconsistency in Practice
Discrepancies between offering documents and articles might arise because of time pressures in practice, where typically the investment managers are pressing to have their fund ready to launch so as to take advantage of a new financial product and so that they can obtain favourable terms for their investors in the underlying investment. As can sometimes occur, investment managers might instruct their onshore counsel to prepare the offering documents so as to get them to their investor client base at the earliest opportunity with a view to obtaining subscriptions in short order. Indeed, in Strategic Turnaround the investor subscribed to the fund having acknowledged receipt of the offering documents alone. It will then fall to the offshore lawyers to prepare the articles in accordance with the offering documents within an extremely limited period of time.
Notwithstanding the time pressures that exist in the preparation and launch of a fund, it is incumbent upon the fund and its service providers, in light of the Privy Council’s decision, to ensure that the articles accurately mirror the terms of the investment as explained in the offering documents. If they fail to do so, they might be exposing themselves to the risk of litigation by disgruntled investors at a later stage. Funds might, in turn, look to their service providers entrusted with drafting the relevant documents, for relief.
The process of redemption in an investment fund will always turn upon its own facts, according to its own constitutional documents. Nevertheless, the Privy Council’s decision has laid to rest the proposition that redemption of investments in funds can be generally described as a 5–stage process. This provides welcome certainty as to the mechanics of the redemption process and is a positive development for investors and the industry at large.