BERMUDA BRITISH VIRGIN ISLANDS CAYMAN ISLANDS CYPRUS DUBAI HONG KONG LONDON MAURITIUS MOSCOW SÃO PAULO SINGAPORE conyersdill.com May 2010 A Plethora of Case Law The offshore hedge fund industry has typically suffered from a lack of relevant offshore case law. This has changed. While many offshore hedge funds have collapsed in the recent financial crisis, the positive result has been a plethora of offshore hedge fund cases in each of the British Virgin Islands, the Cayman Islands and Bermuda. Each case turns on the specific facts, constitutional documents and statutory framework of the fund in question. However, this article examines some of the general principles that can be derived from these cases as they relate to British Virgin Islands law. Almost all of the cases had a common fact pattern. Typically an investor had submitted a redemption request while the fund was in crisis, usually experiencing liquidity issues or perhaps the fund was a victim of fraud, such as the Madoff or Petters fraud. Usually shares were redeemed on a relevant dealing day, but the proceeds of redemption were never paid. On occasion the fund would suspend redemptions, but this would be after the relevant dealing day and before the payment day. In each case, the investors were taking action in an attempt to force payment of their proceeds of redemption. A common remedy under British Virgin Islands law for an investor who is not being paid his proceeds of redemption is to issue a statutory demand. Specifically, a creditor of a British Virgin Islands company who is owed a debt which is due and payable and which is for an amount of not less than $2,000 may issue a statutory demand under Section 155 of the Insolvency Act, 2003 (British Virgin Islands). The debtor, being the British Virgin Islands hedge fund, is required to pay the debt within 21 days failing which the creditor may apply to the Court in the British Virgin Islands for the appointment of a liquidator. The statutory demand route has been a simple and effective process for an investor in a hedge fund who has properly redeemed his shares to enforce payment of the proceeds of redemption. However, the investor cannot issue the statutory demand if he is not a creditor, and the Court may set aside the statutory demand if there is a substantial dispute as to whether the
debt is owing or due, or if the Court is satisfied that substantial injustice would be caused. The foregoing position in the British Virgin Islands contrasts with the position in Bermuda and the Cayman Islands where an investor who is not being paid his proceeds of redemption typically brings a winding up petition on just and equitable grounds arguing that the substratum of the company is gone. As stated by Vos JA in the Matter of Strategic Turnaround Master Partnership, Limited (Cayman Islands Court of Appeal, December 12, 2008), a winding up petition on just and equitable grounds has more work to do in these jurisdictions. It is perceived that a petition to wind up the fund is a more effective tool to ensure payment than the bringing of a writ and claiming for damages. A winding up petition on just and equitable grounds can also be used in the British Virgin Islands, but is generally saved for when the remedy of a statutory demand is not available. Creditor versus Shareholder In order for an investor in a hedge fund to issue a statutory demand for the payment of his proceeds of redemption, it is necessary for the investor to be a creditor. The question arises as to when the investor becomes a creditor. Fortunately, the case law is consistent in that an investor becomes a creditor on the relevant dealing date provided he submitted a valid and timely redemption request (SV Special Situations Fund Limited v. Headstart Class F Holdings Limited (British Virgin Islands High Court of Justice, November 25, 2008); the Matter of Stewardship Credit Arbitrage Fund, Ltd. (Bermuda Supreme Court, November 27, 2008); Strategic Turnaround Master Partnership, Limited, Citco Global Custody NV v. Y2K Finance Inc. (British Virgin Islands High Court of Justice, November 25, 2009)). As such, provided the relevant dealing day has passed and the fund did not suspended redemptions prior to that dealing day, an investor in a British Virgin Islands fund is a creditor and may prima facie issue a statutory demand if he is not being paid his proceeds of redemption on a timely basis. It is worth noting that somewhat confusingly Vos JA in Strategic Turnaround Master Partnership, Limited stated that notwithstanding the fact the investor becomes a creditor on the relevant dealing day, the investor also remains a shareholder of the fund until such time as the investor is paid and his name is removed from the share register of the fund. While it is correct that a person is a shareholder until his name is removed from the share register, it would appear that Vos JA was endeavoring to ensure that the investor continued to be bound after the dealing date by the memorandum and articles of association of the fund and its confidential explanatory Page 2 of 5
memorandum. As a result, it is now generally recommended that the memorandum and articles of association of a fund state the investor becomes a creditor on the relevant dealing day, and ceases to be a shareholder on such date (to the extent permitted by law notwithstanding his name remains on the share register for a short period time). In any event, this somewhat confusing position would not appear to be an issue under British Virgin Islands law where Bannister J in obiter in Y2K Finance Inc. found that an investor becomes a creditor on the dealing day rather than remaining a shareholder (see also Western Union International Limited v. Reserve International Liquidity Fund Ltd. (British Virgin Islands High Court of Justice, January 26, 2010)). Substantial Dispute Pursuant to section 157(1)(a) of the Insolvency Act, 2003, the British Virgin Islands court is required to set aside a statutory demand if it is satisfied that there is substantial dispute as to whether the debt is owing or due. Summarising the case of Sparkasse Bregenz Bank AG (British Virgin Islands High Court of Justice, June 18, 2003), Joseph Olivetti J. in SV Special Situations Fund Limited found that substantial dispute means having substance and not being frivolous, and that the dispute must be genuine in both a subjective and objective sense in that the reason for not paying the debt must be honestly believed to exist and must be based on substantial and reasonable grounds. The onus is on the debtor, being the hedge fund, to bring forward a prima facie case to satisfy the Court that there is a substantial dispute which ought to be tried before the Court. In Professional Offshore Opportunity Fund Limited v. Daiwa Securities Trust and Banking (Europe) PLC (British Virgin Islands High Court of Justice, June 4, 2009), Bannister J found that the ability to suspend the payment of a debt to a creditor pursuant to the suspension powers in the memorandum and article of association does not cease to make a debt owing or due (although perhaps not payable). As such, the statutory demand remedy appears to still be available to an investor whose shares have been redeemed but who has not received payment, notwithstanding the suspension of the payment of redemptions. Substantial Injustice The British Virgin Islands court may set aside a statutory demand if it is satisfied that substantial injustice would be caused by the winding up of the debtor. The case law has confirmed that a substantial injustice does not exist merely because the amount claimed pursuant to the statutory demand is small compared to the assets of Page 3 of 5
the fund as a whole, but otherwise greater than the amount prescribed by the Insolvency Act, 2003 (SV Special Situations Fund). Substratum In the event an investor is not a creditor or otherwise the statutory demand route is not available to an investor, the investor may still petition to wind up the fund on the basis it is just and equitable to do so. Typically the argument is made that it is just and equitable to wind up the fund because its substratum, or raison d etre, is gone. There are numerous English law cases on loss of substratum. However, what is interesting in the offshore fund cases is the presumption that a fund which is in crisis, has lost the ability to buy and sell assets in the ordinary course, has suspended redemptions and is merely waiting to realise assets to redeem all of its participating shareholders has lost its substratum (Stewardship Credit Arbitrage Fund, Ltd.; Matter of Belmont Asset Based Lending Ltd. (Cayman Islands Grand Court, January 19, 2009); Western Union International Limited). This is probably right. However, Bannister J in Y2K Finance Inc. found that notwithstanding the fact that there was no dispute that the commercial life of the company had come to an end, the redemption of shares and the distribution of assets as part of that redemption is not necessarily a justification for an order for a just and equitable winding up, notwithstanding that at the end of the process there would be few if any participating shareholders remaining. A virtually complete redemption of shares and distribution of assets is part of the commercial functions of a fund and can be carried out by the directors. He found that the formal liquidation (presumably with only management shares remaining) is wholly different from a sale of assets to meet redemption requests, even if this sale and redemption will eventually lead to a formal winding up of the fund. This decision is welcome comfort to funds and their managers that are redeeming shares and distributing assets as part of a closing down of the fund, but before the formal liquidation of the fund. Conclusion While the economic crisis has had a negative impact on the offshore hedge fund industry generally, a silver lining is the offshore case law, which going forward will only strengthen the offshore hedge fund product. It is also reassuring to see the simplicity and effectiveness of the statutory demand mechanism in action under the Insolvency Act, 2003 (British Virgin Islands). The statutory demand mechanism is able to provide redeeming investors with a simple remedy to enforce their redemption requests. However, it also balances the needs of funds and their Page 4 of 5
managers, and the rights provided to them under British Virgin Islands law and their memorandum and articles of association, including, in particular, the ability to set aside the statutory demand in the event of a substantial dispute or substantial injustice. Robert Briant Partner +1 (284) 852 1100 robert.briant@conyersdill.com This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information. About Conyers Dill & Pearman Conyers Dill & Pearman advises on the laws of Bermuda, British Virgin Islands, Cayman Islands, Cyprus and Mauritius. Conyers lawyers specialise in company and commercial law, commercial litigation and private client matters. Conyers structure, culture and expertise enable responsive, timely and thorough service. Conyers provides clients with the highest quality legal advice from strategic global locations including offices in the world s leading financial centres in Europe, Asia, the Middle East and South America. Founded in 1928, Conyers comprises 600 staff including more than 150 lawyers. Affiliated companies (Codan) provide a range of trust, corporate secretarial, accounting and management services. For more information please contact: Naomi Little +1 (441) 298 7828 naomi.little@conyersdill.com www.conyersdill.com Page 5 of 5