Hedge Fund Liquidators’ Considerations

When dealing with the United States

Originally published in the January 2018 issue

One of the structures often encountered by insolvency practitioners who reside and practice in jurisdictions outside of the United States, and those who act for them, are hedge funds. Given the proximity of the Caribbean to the United States (and specifically those jurisdictions that are recognized international financial centers such as the Cayman Islands, the British Virgin Islands and Bermuda; anecdotally referred to as ‘offshore’), and the specialization in those jurisdictions in the provision of certain financial services and products to the US market (for example hedge funds registered offshore), it is no surprise that when things go wrong, legal advisors and other professionals are often called upon to look back as to what may be available in the US. This especially applies when assessing what assets or information may exist in the US and what options are available to investigators to retrieve or collect them. This is certainly the case with offshore hedge funds, where the connection to the US may be as simple as an account with a bank or an US institution, or as elaborate as the hedge fund having been managed, administered and, for all intents and purposes, operated out of the US despite being registered offshore.

When offshore hedge funds find themselves in financial difficulty or insolvent, or the subject of fraud or mismanagement, it is customary for creditors or members to want to ascertain promptly what is happening and take decisive action to place someone independent and competent to conduct such an investigation. One of the more frequently used options is for the creditor or member to apply for the hedge funds to be ‘wound up’, in which case a liquidator is appointed, or where insolvency is unclear, seek the appointment of an insolvency practitioner to assume control of the company and gather in its assets and investigate the alleged problem (referred to as a ‘provisional liquidation’). Those proceedings will usually be pursued in the jurisdiction of incorporation and the court there will appoint an insolvency practitioner to assume control of the fund. In those jurisdictions that are based on English common law and precedent, such as the jurisdictions mentioned earlier, the liquidator, when appointed, will typically assume the role of the directors of the fund and have duties to investigate the affairs of the hedge fund and, where a winding up order is made, to maximize the assets for the benefit of and eventual distribution to creditors and members. Where such documentation, information, or assets are sited in the US, it is therefore important if not crucial for the insolvency practitioner to assess what steps he or she needs to take to comply with her duties to the court and investigate and or gain access to that information or those assets.

With the enactment of Chapter 15 of the US Bankruptcy Code in 2005, insolvency practitioners had a mechanism that they could seek to employ (if they could meet certain criteria) which provides effective mechanisms for dealing with insolvency cases involving debtors, assets, claimants, and other parties of interest involving the US. Chapter 15 was particularly alluring for offshore insolvency practitioners as the ability of a liquidator to obtain recognition in the US enables the liquidator not only to employ the powers and remedies provided by the local Caribbean courts and obtain enforcement of these in the US but also to benefit from powers and other remedies available under the US Bankruptcy Code (such as the flexible and broad US discovery powers) which provides the liquidator with additional valuable and powerful tools to investigate, discover and collect assets. Simply put, Chapter 15 places offshore insolvency practitioners in a position to investigate and collect in assets and information without the hurdles and wasted resources that previously applied to cross-border cases.

It took some time for offshore liquidators to gain traction in the US and receive favourable decisions on seeking recognition. However, we eventually were able to find the road map for doing so. The decision in Morning Mist Holdings Ltd. v. Krys (In re Fairfield Sentry Ltd.), 714 F.3d 127 (2d Cir. 2013) , has become the leading Chapter 15 case in this regard. But as liquidators and insolvency practitioners utilize Chapter 15 more and more, we are also learning it employs certain duties and obligations on liquidators which may not be evident on a cursory review of the legislation. A liquidator may should want to be aware of and consider these factors before proceeding with Chapter 15 as they may create unwanted responsibilities or use of limited resources which one may not have otherwise incurred. There are of course other remedies available to offshore liquidators to seek discovery or gain control over an asset in the US outside Chapter 15. Some of those are less expensive than an application under Chapter 15 and many may meet the same objectives as Chapter but via alternate routes.

As an aside, I do not propose to spend time in this article discussing Chapter 15. It is itself a relatively specialized area and well familiar to offshore attorneys and insolvency practitioners, and those in the US who are often retained to assist them on such matters. I have assumed for the purposes of this paper that the reader has a working knowledge of Chapter 15 and is aware of the differences between seeking foreign main and foreign non-main recognition under its provisions. I have also avoided any discussion of the concept of the center of main interest (COMI) which is essential to obtaining foreign main proceeding recognition and some of the recent developments in the law on recognition issues. Clearly, anyone considering Chapter 15 should get legal advice in that regard.

The objective of this article is to identify some of the factors and options that insolvency practitioners and their advisors will want to consider, whether within the context of Chapter 15 or outside of it, when investigating hedge funds and collecting assets, specifically where there is a US element or connection.

Obtaining and collecting information and documents are critical to the success of a liquidator investigating the affairs of hedge funds offshore. The reason for this is that there is little public information offshore. In addition, offshore hedge funds often have no staff or premises in the jurisdiction where they are incorporated. Given their nature and structure, the relevant information, documents, and those who have knowledge of such pertinent information, be it financial or strategic, will reside on-shore. As such, finding the easiest and most cost-effective means of getting access to that information and to those persons is of upmost importance to the liquidator. In many instances, that information will be in the US.

When considering the US, there are principally two means of seeking discovery in the US for liquidators of offshore hedge funds: (i) 28 USC Section 1782, which is a federal statute that allows a litigant contemplating or pursuing a legal proceeding outside the United States to apply to an American court to obtain evidence for use in non-US proceedings; and (ii) Rule 2004, which the basic discovery and examination tool for bankruptcies in the US (and has uniformly been held to be available to liquidators under Chapter 15, whether as incorporated into Section 1521(a)(4) or otherwise). When considering whether to use one versus the other, there a number of considerations that may be relevant:

  1. Is the proceeding going to be pursued in or out the US? One of the first considerations you will want to consider is whether the civil action you are contemplating or going to pursue will be filed in the US or not. If it is, then Section 1782 may not be available. While there have been instances, after Section 1782 discovery was obtained, where plaintiffs have obtained approval to use the information received in Section 1782 discovery in a claim filed in the US, this is the exception rather than the rule.
  2. Is the proceeding contemplated or already filed? There is a slightly different nuance between Section 1782 and Rule 2004 discovery. Section 1782 needs one to contemplate or have a civil action already filed. Therefore it cannot be used simply to explore the possibility of a claim and cannot be used to pursue general collection of the estate’s books and records. Rule 2004 is exactly the opposite. It is primarily utilized to assist with investigating the acts, conduct or property or the liabilities and financial condition of the estate, or to any matter which may affect the administration of the asset. Once an adversary proceeding has been commenced, then discovery directed to those claims made in the lawsuit needs to be made pursuant to Federal Rule of Bankruptcy Procedure 7026 rather than Rule 2004.
  3. What is your budget? In my experience an application for Chapter 15 recognition is expensive. An analysis of the factors related to COMI needs to be developed, along with consideration of the aspects of the liquidation that needs to be disclosed to the US Bankruptcy Court. Section 1782 is usually much cheaper and easier than a Chapter 15. The support for the discovery application is shorter and focuses on the contemplated or current litigation outside the US. It does require a separate application to be filed for each respondent and in each jurisdiction where the party of interest resides, unlike a Chapter 15 application which applies nationally across the US. But usually that is not a major factor in considering the costs.

Another consideration is whether you want or need time to investigate the affairs of the estate before issuing proceedings. If the proceedings are being contemplated in the US, a successful application for Chapter 15 foreign main proceeding recognition will give the foreign representative access to Section 108 of the US Bankruptcy Law, which provide an automatic two (2) year toll to commence or continue a civil action in the US. This is useful when a liquidator is facing the potential expiry of deadlines on the statute of limitations and still needs time to explore whether a claim is viable. For instance, this was particularly of assistance when we were investigating whether to file claims in Fairfield Sentry against the redeemers of shares for return of the redemption proceeds. As redemptions were made on a monthly basis, each month that passed the ability to pursue certain claims passed as well.

While information is critical, success (or the lack of it) in a hedge fund liquidation is measured by what the insolvency practitioner collects for the benefit of and ultimate distribution to creditors and members. Assets come in various forms. They can be something simple like a bank account, or they can be more complicated, such as a claim in a liquidation in the US, an investment in a privately held company, or the commencement of legal actions against those who were involved in a fraud. Each of these are different and therefore may have different rules and processes that need to be applied in a liquidation context.

There are a number of considerations that apply when an offshore liquidator has an asset located in the US. Issues arise for liquidators of hedge funds because it is not always the case that the financial institution will recognize the court order appointing a liquidator and give the liquidator authority over the asset, say for instance where there are securities accounts. Before deciding what is necessary, one important question that a liquidator may need to determine is what is an US asset. In making this assessment, Section 1502(8) is relevant. The phrase ‘within the territorial jurisdiction of the United States’ is defined therein as ‘… intangible property deemed under non-bankruptcy law to be located within [the territory of the United States], including any property subject to attachment or garnishment that may properly be seized or garnished by an action in a Federal or State Court in the United States.’ In simple terms, if there is a mechanism where the property at issue can be attached or garnished in the US through US legal processes, it is a US asset.

The first issue that a liquidator will want to consider is whether the asset is at risk of attachment from creditors and/or whether the party holding the asset will recognize the liquidator without the need for formal recognition in the US. If the asset is at risk of attachment or the need for recognition arises to gain control of the asset, then a liquidator will want to contemplate seeking recognition under Chapter 15. If the need is limited, it may not be necessary for the liquidator to obtain foreign main recognition. Foreign non-main recognition may be sufficient and easier to obtain, particularly if there are issues around COMI but an establishment can determined.

Recognition pursuant to Chapter 15 however brings with it additional responsibilities for the liquidator. As determined in Krys v. Farnum Place, 768 F.3d 239 (2d Cir. 2014), however, when considering whether to sell or monetize the asset, it may be necessary to seek US Bankruptcy Court approval pursuant to Section 363. Under Section 1520(a)(2) of the US Bankruptcy Code, Section 363 applies to a sale of assets in a Chapter 15 ancillary proceeding to the same extent as it would in a Chapter 11 proceeding if the sale is a ‘transfer of an interest of the debtor in property that is within the territorial jurisdiction of the United States…’. In Chapter 11 proceedings, Section 363 review of a sale is only required when such sale is outside the ordinary course of business.

A further issue may arise under Section 1521(b) of the Bankruptcy Code. Section 1521(b) provides that upon Chapter 15 recognition, a court may ‘entrust the distribution of all or part of the debtor’s assets located in the United States to the foreign representative . . . , provided that the court is satisfied that the interests of creditors in the United States are sufficiently protected.’ Therefore it may be necessary to also seek approval of the US Bankruptcy Court to repatriate the assets to the offshore for use in the liquidation or to distribute to creditors or members.

Liquidators of hedge funds offshore can easily find themselves getting entrenched in complicated litigation and incurring substantial costs where cross-border issues may arise. What information the liquidator is able to access and what assets he collects and gathers, and how quickly he gathers such information and assets into the estate are critical to a successful liquidation. Obtaining discovery as to and/or collecting and monetizing an asset located in the US can be important considerations when dealing with an offshore liquidation. There are various alternatives to consider and if a certain route is pursued, it can have consequences on exploring other options and on the duties and obligations of a liquidator when wanting to deal with the proceeds of that asset and ultimately his ability to distribute it to creditors and members. Offshore liquidators and their advisors will want to be cognizant of the implications on their administration when considering the best way forward while complying with their duties to the court and to stakeholders.


1. The author is one of the joint official liquidators of Fairfield Sentry Ltd (in liquidation).
2. Section 1521(a)(4) provides: “(a)Upon recognition of a foreign proceeding, whether main or nonmain, where necessary to effectuate the purpose of this chapter and to protect the assets of the debtor or the interests of the creditors, the court may, at the request of the foreign representative, grant any appropriate relief, including—
(4) providing for the examination of witnesses, the taking of evidence or the delivery of information concerning the debtor’s assets, affairs, rights, obligations or liabilities….”
3. “establishment” means any place of operations where the debtor carries out a nontransitory economic activity
4. See footnote 1, in which Fairfield Sentry Ltd (in liquidation) was the appellant in the proceedings.