The majority of hedge funds, nearly 10,000, are registered in the Cayman Islands. It is likely that some may become insolvent in the near future and it is, therefore, important to have an understanding of the insolvency regime in the Cayman Islands, particularly in light of some recent developments, both internal and external.
Historically, the Cayman Islands have marketed themselves as having a very creditor-friendly insolvency regime. The Caymans have also highlighted the experience of their insolvency practitioners and judiciary. Neither of these attributes is in doubt, but the system has perhaps been a little inflexible, lacking some of the tools available to practitioners in other jurisdictions. For example, there is no equivalent procedure to an administration, or to Chapter 11 of the US Bankruptcy Code, available to creditors.
Provisional liquidation has often been used in a manner akin to administration, and companies (as well as creditors) are able to petition for their own winding-up. The court has acceded to these petitions when persuaded that there was a likely dissipation of assets or a loss or danger to the company. Petitioners then negotiate deals following which the petition is dismissed1. It is notable that no moratorium is available in provisional liquidations, but the court has made orders to that effect (and it is automatic in liquidation). In addition, schemes of arrangement2 have played an important role as a restructuring tool. Cayman schemes are very similar to schemes in England under the Companies Act3 and are often devised in conjunction with overseas schemes and/or plans of reorganisation under Chapter 11. There is no substantive test for court approval of a scheme but the interests of all creditors must be considered and no creditors may be prejudiced.
In a liquidation, the ranking for the distribution of assets is very similar to the UK, with secured creditors being paid first, followed by the expenses of the insolvency practitioner, preferential payments, and then the ordinary unsecured creditors.
One major problem has been the inability of the courts to wind up foreign entities with assets in the Cayman Islands. In those circumstances, practitioners have had to commence insolvency proceedings in the Cayman Islands to run in parallel with overseas proceedings and a liquidator has had to be appointed locally.
As for recognition of Cayman Islands procedures overseas, the US Bankruptcy Courts have, historically, looked favourably on Cayman Islands’ insolvency proceedings and have usually recognised liquidations, for example with Amerindo4 and Basis Yield Alfa5.
The first major change to the regime has been legislative, as the authorities have sought to bring the law up to date. Following consultation with the legal and insolvency practitioner communities, the Companies (Amendment) Law 2007 has been enacted and will be the first overhaul of the insolvency legislation since 1961. However, it is not yet in force and it is understood that the accompanying rules are sitting on the Chief Justice’s desk, suggesting that some time may yet elapse before this comes into force.
When it does, the principle changes it will introduce include:
1. Obligatory licensing of insolvency practitioners
2. Allowing for the liquidation of foreign companies conducting business in the Cayman Islands provided they are a general partner of a limited partner or registered, and allowing overseas practitioners to recover assets in the islands
3. Allowing for the automatic winding-up of a company on the expiry of a fixed term or on the occurrence of a predetermined event
4. Allowing contingent and/or prospective creditors to petition for the winding-up of a company (although their claims will still not be included for the purposes of the cash-flow insolvency test) and
5. A codification of the investigative powers available to liquidators. They will then have similar powers to those available to liquidators in England under sections 206-210 of the UK Insolvency Act 1986. Liquidators will continue to be able to pursue directors for misfeasance or breach of trust and to recover transactions at undervalue. In addition, they will be able to pursue directors for fraudulent trading (though not for wrongful trading) and to conduct criminal investigations into directors’ activities
There will still be no administration/Chapter 11 or similar procedures, nor any disqualification process for directors, but overall it is felt that the changes are positive and make the procedures attractive to practitioners and creditors.
The second important change was the decision of the US Bankruptcy Court in the Bear Stearns case6. For those unfamiliar with it, two Bear Stearns hedge funds were put into liquidation in the Cayman Islands following which the liquidators sought recognition in the Southern District of New York Bankruptcy Court under Chapter 15 of the US Bankruptcy Court (enacted to bring into force the UNCITRAL Model Law7). In this lower court, Judge Lifland controversially found that the Cayman Islands Liquidations should not be recognised even though recognition was not opposed. He found that both of the funds’ centre of main interest (“COMI”) was in the US, so that the Cayman proceedings could not be foreign main proceedings, nor could they be foreign non-main proceedings. He relied upon the funds being exempt funds under Cayman Islandsâ€™ company law (a peculiarity allowing companies to conduct business solely overseas while being registered in the islands). The presumption that main proceedings would be recognised in the jurisdiction of registration was rebutted, and the court found that they would not be unless the COMI or at least an establishment could also be identified.
This was in marked contrast to the position previously adopted by the US courts (under section 304 of the Bankruptcy Code) and in recent decisions such as in re: SPhinX Limited. In SPhinX the court had recognised the Cayman Islands liquidation, although it only did so on the grounds that no one objected to the Cayman liquidatorsâ€™ appointment, and they were ready to perform their task8.
The Bear Stearnsâ€™ liquidators appealed the lower court’s decision on the grounds that it had failed to accede to the principle of comity and co-operation and it had erroneously interpreted the requirements of COMI. They tried to rely on the fact that two directors of the funds had been resident in the Cayman Islands. However, District Judge Sweet of the appeals court found that recognition turns on a strict application of objective criteria and, in the absence of COMI or an establishment in the Cayman Islands, no recognition could be granted. The Appeal was refused.
A number of distinguished commentators have condemned the decision as being contrary to the aims of the UNCITRAL Model Law, one of the aims of which was to leave in place existing modes of recognition and assistance, even if they are broader than the Model Law.
In the Cayman Islands, practitioners have suggested that the “facts” relating to an insolvency might be “rearranged” prior to proceedings so that there is at least an establishment in place. There may also be an element of forum-shopping, either within the US (and any state could in theory be seized of bankruptcy proceedings) or internationally, with London a potential beneficiary. Alternatively, joint liquidators will have to be appointed in the US and the Cayman Islands.
It has been suggested that US Judges might be educated about Cayman Islandsâ€™ proceedings, a somewhat fanciful notion, and it remains unfortunate that the liquidators did not take this appeal further. It will take a brave practitioner to commit funds to take an appeal in similar circumstances to a higher authority.
It, therefore, seems that, following the introduction of new legislation, Cayman Island practitioners are well-placed to deal with insolvencies and the regime is probably the best of the offshore jurisdictions. However, in the absence of a change of approach in the US, for those funds managed in the US, some may not be able to avail themselves of the new insolvency procedures. THFJ
Louise Verrill is Partner, Bankruptcy & Corporate Restructuring, Brown Rudnick LLP and Patrick Elliot is Associate, Bankruptcy & Finance, Brown Rudnick LLP
“The first major change to the regime has been legislative, as the authorities have sought to bring the law up to date”