Strategic Turnaround
The decision of the Privy Council makes it clear that powers of suspensions and redemptions and the status of a redeeming but unpaid investor are matters of interpretation of the fund’s articles of association and, to the extent they are incorporated into the articles of association, its offering documents.
The facts
An investor had submitted a redemption request to the fund for a 31st March 2008 redemption date and the NAV was duly struck. However, in April 2008, and before the investor had received the redemption proceeds, the fund purported to suspend the calculation of the NAV, redemptions and the payment of redemption proceeds. On this basis the fund withheld the redemption proceeds due to the investor. The investor issued a winding up petition against the fund on the basis of cash-flow insolvency (i.e. it was unable to pay the debt due under its redemption notice) and on other grounds. The fund applied to strike out the petition summarily on the basis that the investor lacked legal standing to bring the petition. The Privy Council refused to strike it out on the insolvency ground[2] and perhaps more importantly, clarified a number of concerns that arose from the Court of Appeal decision.
The Court of Appeal decision
The Court of Appeal found that on the proper construction of the fund’s constitutional documents, the fund had a power to suspend the payment of redemption proceeds after the relevant redemption date had passed but before the payment of those proceeds. As we will see below, the Privy Council agreed that it was a question of construction of the fund’s constitutional documents but disagreed with the Court of Appeal’s interpretation of them.
Before we look at the Privy Council judgment in more detail it is useful to understand why the investor appealed the decision. This is important to dispel some misunderstandings that have arisen from the Court of Appeal judgment which, in fact, helpfully confirmed some well-established principles:
• It emphasised that the effect and timing of redemptions and suspensions must be carefully assessed by reference to a fund’s constitutional documents; and
• It confirmed that a redeeming investor will become a creditor on the redemption date even if payment of his debt is subsequently suspended in accordance with the fund’s constitutional documents.
The Court of Appeal did not disturb the finding at first instance that redeeming but unpaid investors will rank ahead of other investors but behind “ordinary” unsecured creditors. However, despite this, the Court of Appeal concluded that until the redeeming investor’s name was removed from the register of shareholders, and perhaps until paid, the redemption process is incomplete and the redeeming investor will remain a shareholder of the fund. As such, he would be both a creditor and a shareholder and entitled to use the constitutional machinery of the fund to convene meetings and propose resolutions, even after the redemption date. The Privy Council rejected this unorthodox concept.
Findings in Strategic Turnaround
The key point from the Privy Council’s decision is that it is the fund’s articles of association (including the terms of the offering memorandum to the extent those terms have been incorporated) that determine the rights of the fund and its investors. The terms of the offering memorandum may be incorporated by way of express reference to them in the articles of association (as was unsuccessfully attempted in Strategic Turnaround) or by way of an express power in the articles of association given to the board of directors to issue shares carrying such rights as the board considers appropriate and the board exercising that power in a way that clearly incorporates the terms contained in the offering memorandum. More specifically, the Privy Council confirmed:
• The rights of the fund in respect of redemption of investors are determined by the fund’s articles of association and the relevant statutory framework. Terms contained in the fund’s offering documents would only be relevant to the extent that they are clearly incorporated into the articles of association. In the absence of such a clear wording, the court will give effect to the plain meaning of the articles of association even if that is inconsistent with what the offering documents state is in the articles of association. It is important to bear in mind that, in this case, the Privy Council was not prepared to allow the fund to rely on discrepancies between the articles of association and the offering memorandum to the fund’s own advantage. The Privy Council specifically noted that it was not an appropriate occasion to address situations where an investor had an arguable case that it was entitled to rely on representations set out in the offering documents;
• The terms of the fund’s articles of association determine at what point in the redemption process a redeeming investor is entitled to be paid its redemption proceeds. At that point in time the redeeming investor becomes a creditor. They will also determine whether the redemption proceeds are currently payable (in which case the investor is an actual creditor) or are payable at some future date (in which case the investor is, until that date, a prospective creditor);
• The terms of the fund’s articles of association determine whether there is a power to suspend the payment of redemption proceeds after a redemption date has passed. The existence of such a power does not depend on whether or not the investor must or should remain a shareholder of the fund until payment of the redemption proceeds;
• A power in the articles of association to suspend payment of redemption proceeds to an investor pursuant to a valid redemption notice after the redemption date has passed and with retrospective effect must be in clear and unambiguous terms;
• Once a redeeming investor has become a creditor pursuant to the articles of association it remains a creditor until it is paid the redemption proceeds owed to it; and
• The decision also reaffirms the well-understood and long-standing position that redeeming but unpaid investors rank ahead of other investors who have not redeemed but behind ordinary unsecured creditors.
An additional important point (where it overruled the Court of Appeal) is that it is the terms of the articles that determine whether or not a redeeming investor retains any shareholder rights until payment of the redemption proceeds. In so doing, the Privy Council relied on long-standing authority that whether or not a shareholder’s name should remain on the register depends on the terms of the articles of association[3]. The mere fact that the fund has left a redeeming investor’s name on the shareholder register is not of itself conclusive of the existence of it still having shareholder rights. It held that various nineteenth century cases relied upon by the fund concerning redemptions by members/depositors of building societies were not applicable in these circumstances. It held that each case turns on its own factual framework (i.e. the relevant constitutional document, the subscription/redemption rules and the relevant statutory framework) and that the factual and statutory framework in these cases[4] was not applicable to the articles of association of this particular investment fund or the Cayman Islands statutory framework for investment funds. In the same vein it held that a number of first instance decisions[5] from around the British Commonwealth relating to redemptions turned on the particular statutory and contractual provisions in question.
Can’t suspend payments
The fund sought to rely on Article 17: “Subject to these Articles, Shares shall be issued on the terms referred to in the [offering memorandum] …”. The offering memorandum described a power to suspend payments after a redemption has passed which was not contained in the articles of association. It argued that the articles of association should be read together with the offering memorandum, with the articles of association supplementing the terms of offering memorandum where they were not wholly inconsistent.
The Privy Council rejected this argument. It held that properly understood, the wording of Article 17 could only incorporate those provisions of the offering memorandum to the extent that they related to the terms concerning subscription, such as the timing, numbers, par value and price, and did not incorporate the terms concerning suspension of payments after the redemption date has passed. It noted that this construction of Article 17 was consistent with other provisions in the articles of association. It concluded, “… in so far as the description embraced powers going beyond those in the articles, the description was and is, in [our] view, of no legal effect as against investors such as [the fund].”
The Privy Council was keen to point out that it was not addressing a situation in which an investor is claiming the benefit of the effect of the description of the articles of association given in the offering memorandum. The Privy Council said: “[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 memorandum]. Despite the disclaimers in the [offering memorandum], 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. In the present case, it is the [Fund] itself that is seeking to draw advantage from what appears to [us] to be a discrepancy between its own description of the articles in the [offering memorandum] and the reality; and in this situation [we] see no basis for entitling the [Fund] to rely in its own favour upon its own mis-description of its own articles.” No doubt it will not be long before an investor seeks to persuade a court that a fund’s articles of association incorporate the terms of offering documents and he is thereby entitled to rely on a fund’s mis-description of its own articles of association in those offering documents.
Articles of association: provisions
In light of Strategic Turnaround, it is critically important that the articles of association of a Cayman Islands fund must clearly state:
• when a shareholder’s redemption notice crystallises into an obligation to pay the redemption proceeds;
• The extent of the power of the fund to suspend NAV calculations;
• The extent of the power of the fund to suspend requests for redemptions;
• The extent of the power of the fund to suspend pending redemption requests and substitute new redemption dates;
• The power to suspend payment obligations pursuant to a redemption notice that has crystallized, and whether or not that suspension of a payment obligation has retrospective effect;
• To the extent that specific terms in offering memoranda, or in any other documents, are to be incorporated then either the articles of association must clearly incorporate those terms by way of express reference or the articles of association must contain a sufficiently wide power for the board to enable them to issue shares on those terms and the board’s resolution exercising that power must clearly incorporate the relevant terms contained in the offering memorandum;
• Whether or not the name of a redeeming shareholder should appear on the register of shareholders in respect of his redeemed shares and, if so, what rights he should have to attend and vote at meetings, receive dividends etc; and
• The rights of investors upon partial redemption of their shares both as creditors for any redemption proceeds due and as shareholders of their remaining shares, and the valuation issues that may thereby arise.
Clear drafting of the fund’s articles of association and offering materials is essential. Although there are a number of old decisions in England and modern decisions in other offshore jurisdictions relating to the rights of investors with respect to redemption notices, considerable care should be taken in assessing whether the factual and statutory framework relevant to those decisions is applicable to the particular articles of association of a Cayman Islands investment fund.
What next?
The Privy Council decision underlines a number of very practical points for the many investors and fund managers in the Cayman Islands funds industry. The Strategic Turnaround decision also throws up a number of interesting (and unanswered) questions. There may be occasions where particular funds’ articles of association are not entirely clear as to the investors’ rights and/or where there is, or may be, inconsistency between the articles of association and the offering documents with respect to investors’ rights, powers of suspension, etc. The immediate consequence of the decision is that investors and funds alike will be closely scrutinising the inter-play between their funds’ articles of association and offering documents to establish whether: (i) the articles of association need to be amended to incorporate provisions in the offering documents; and if so (ii) what consents are required in order to effect any changes considered necessary? These are the practical questions that funds are faced with on a daily basis. There will rarely be a “one size fits all” solution to questions such as these. Each is fact specific and requires bespoke analysis relevant to the particular fund’s structure.
Recently, a significant number of investment funds have included express articles of association to provide that a redeeming shareholder rights upon the relevant redemption date are extinguished except for the right to receive redemption proceeds as a creditor, thereby, creating the same outcome as in Strategic Turnaround. The key point from the Privy Council’s decision is that it is the terms of a Cayman Islands fund’s articles of association that determine the rights of the fund and its investors. This is self-evidently practical and common sense. It provides Cayman Islands funds and investors a great measure of flexibility to agree terms for the operation of their funds that are tailored to the specific commercial requirements of the investors.
Colin McKie is a partner, and William Peake an associate with Maples and Calder in the Cayman Islands.
Footnotes
1. Culross Global SPC Ltd v. Strategic Turnaround Master Partnership Ltd [2010] UKPC 33
2. The Court of Appeal held that the investor had standing on the alternative ground. The fund did not appeal against this finding, so the Privy Council’s decision is limited to the insolvency ground.
3. Reese River Silver Mining Company Ltd v. Smith (1869) LR 4 HL 64, a principle confirmed as recently as Michaels v. Harley House (Marylebone) Ltd [1997] 2 BCLC 166.
4. Re Planet Benefit Building and Investment Soc. (1872) LR 14 Eq 441; Walker v. General Mutual BS (1887) 36 Ch D 777; Sibun v. Pearce (1890) 44 Ch D 354; Pepe v. Cit & Suburban PBS [1893] 2 Ch D 311 (notably, the Privy Council declined to express a view as to whether or not this last case was in fact correctly decided).
5. Australia – Basis Capital Funds Management Ltd v. BT Portfolio Services Ltd [2008] NSWSC 76; Bermuda – BNY AIS Nominees Ltd v. Stewardship Credit Arbitrage Fund, Ltd (unrep., 27th Nov 2008), Re New Stream Capital Fund Ltd (unrep., 18th Dec 2009); BVI – Western Union International Ltd v. Reserve International Liquidity Fund Ltd (unrep., 26th Jan 2010), SV Special Situations Fund Ltd v. Headstart Class F Holdings Ltd (unrep., 25th Nov 2008), Re Livingston International Fund Ltd (in liq.) (unrep. 2002).