Redemptions and the Statutory Waterfall

Where do they fall now?

Originally published in the September 2013 issue

Five years have now passed since the liquidity crisis of 2008. In the immediate aftermath of the crisis, investment funds hurried to put measures in place which were designed to retain liquidity and prevent an escalation of the crisis: the imposition of gates and the suspension of redemptions were the tools most commonly used.

Members in turn sought to protect their own position: there was a scramble to make redemption requests, and for those disappointed by the prospect of redemptions being suspended for open-ended periods, attempts to wind up investment funds inevitably followed.

The result has been that it has fallen to the offshore courts to consider a myriad of questions, each under a particular legislative regime within the jurisdiction concerned, in relation to issues such as the validity of decisions taken to suspend redemptions, the status of the redeeming but unpaid members, and in the British Virgin Islands the standing of an unpaid member to bring winding up proceedings.

For those investment funds that went into liquidation, it was obvious that the day would at some time come when liquidations came to an end and liquidators were in a position to make distributions. It was therefore predictable, in the British Virgin Islands at least, that the courts would then have to grapple with the question of where a redeeming member ranks in the statutory waterfall. Does it rank ahead of those not quite so fast to submit redemption requests? Does it rank with, or behind, so-called external creditors?

In the British Virgin Islands, these questions were decided by the recent decision of the Court of Appeal in Somers Dublin Ltd & Ors v Monarch Pointe Fund Limited (HCVAP 2011/040). It is helpful, however, to briefly revisit some of the earlier decisions which fixed the battle lines in that case.

Western Union International Limited v Reserve International Liquidity Fund Ltd (BVIHCV 2009/322) and Westford Special Situations Fund Ltd v Barfield Nominees Limited (HCVAP 2010/014) were two cases in which investors had submitted redemption requests, were entitled to be paid their redemption proceeds, but had not been paid. The investors in question applied to appoint a liquidator over the respective funds, in order to recover (a proportion of) their entitlement.

The difficulty the investors faced was the apparent conflict between two statutory provisions which deal with redemption proceeds and claims in liquidations. These provisions provide as follows (emphasis added in both cases):

• Section 62 of the BVI Business Companies Act 2004:

If a share is redeemable at the option of the shareholder and the shareholder gives the company proper notice of his intention to redeem the share:

(a) The company shall redeem the share on the date specified in the notice, or… on receipt of the notice;
(b) Unless the share is held as a treasury share under section 64, the share is deemed to be cancelled;
(c) From the date of redemption, the former shareholder ranks as an unsecured creditor of the company for the sum payable on redemption.

• Section 197 of the Insolvency Act 2003:

A member, and a past member, of a company may not claim in the liquidation of the company for a sum due to him in his character as a member, whether by way of dividend, profits, redemption proceeds or otherwise, but such sum is to be taken into account for the purposes of the final adjustment of the rights of members and, if appropriate, past members between themselves.

Two questions arise. The first is whether a redeemed but unpaid member who seeks to claim redemption proceeds in a liquidation does so “in his character as a member”. If so, such a claim would be barred by section 197. But if that claim is barred, in what sense does that member “rank as an unsecured creditor”?

Western Union and Westford represent the courts’ attempts to reconcile these apparently conflicting provisions. Western Union was a decision of Bannister J in the BVI Commercial Court. He held that since redemption represented the surrender of the tokens of membership (i.e., the shares), a former member’s claim for redemption proceeds could not be one made “in his character as a member”. A redeeming member was therefore entitled to present a winding up petition. He did not deal specifically with the express inclusion of “redemption proceeds” as an example of claims made in the character of member in section 197, which certainly represents a difficulty with his reasoning.

Although Western Union was appealed, an appellate judgment was never given, the parties having agreed to reverse the decision following argument. Westford gave the Court of Appeal the opportunity to consider the question anew, and to reach the opposite conclusion to Bannister J: claims for redemption proceeds were claims under the “statutory contract” represented by the fund’s memorandum and articles, and therefore represented claims made in the character of a member. Any application to wind up the fund was therefore barred by section 197.
The Court of Appeal emphasised, in its decision in Kenneth Krys & Anor v Stichting Shell Pensioenfonds (HCVAP 2011/036), that nothing in Westford should be taken as deciding that a redeeming member was not a creditor (which, given the terms of section 62, is reassuring). However, a redeeming member was not a creditor with standing to apply to put a fund into liquidation.

Against this background, redeeming members in the Monarch Pointe case sought to claim their redemption proceeds during the currency of a liquidation properly commenced by external petitioning creditors. Following Westford, it was clear that the claims – if admissible at all – would rank behind those of external unsecured creditors. The liquidator sought directions from the BVI Commercial Court following the payment of all external claims. If he paid redeeming members in priority to continuing members, the redeemers would receive around 20 cents in the dollar, leaving the continuing members empty-handed. If they ranked equally, existing and redeeming members would receive around five cents in the dollar.

In the BVI Commercial Court the continuing members relied on a statutory ranking (under section 207 of the Insolvency Act), which passes from “all admitted claims” (and interest), to “surplus assets”. By section 197 (above), redemption claims are not “admitted claims” until external creditors have been paid up. Since the redemption proceeds did not represent surplus assets – so the argument went – the redemption proceeds fell into a legal black hole, leaving the redeeming members without a claim at all.

Bannister J rejected that argument, but also rejected the redeeming members’ contrary submission that they ought to rank ahead of continuing members in the final distribution. He directed a distribution on the basis of an equal ranking, considering this approach to be consistent with the decision of the Court of Appeal in Westford. The judge noted that this approach had the additional benefit of preventing an “unseemly scramble in the dying days of a company.”

The case proceeded to the Court of Appeal, which noted that the section 207 ranking was subject to the other provisions of the Act. By section 197, redemption proceeds are to be taken into account in the “adjustment” of the rights of members past and present. Accordingly, the combined effect of sections 197 and 207 was held to be as follows: whilst redeemed but unpaid members were creditors of the company in the wider sense, they did not have standing to apply for the appointment of liquidators, or to compete with “outside” creditors in the early stages of the distribution (decided in the Westford and Shell Pensioenfund cases). However, once those external creditors had been paid up, redemption claims would be taken into account in carrying out the “adjustment” contemplated by section 197.

Whilst noting the force in the redeemed members’ contention that they ought to rank ahead of remaining members as a matter of principle, drawing an interesting analogy with the old English building society cases, the Court of Appeal determined the “adjustment” question on the wording of the Memorandum and Articles of the fund in question. Given that “surplus” was therein defined as the aggregate of total assets over total liabilities, and given that the unpaid redemption proceeds were liabilities, these could form no part of the surplus distributable under section 207: “The redeemed members must be paid before any surplus is ascertained out of which the continuing members may be paid.”

The present state of the law is therefore as follows:

Assuming his contractual entitlement to redemption is established, an unpaid redeeming member:

  1. Is an unsecured creditor of the fund, and may bring an action in debt and obtain a judgment against the fund;
  2. May not, on the basis of the entitlement to redemption proceeds alone, apply to appoint a liquidator over the fund;
  3. May, once a liquidation is underway, claim the redemption proceeds, and such claim will rank between those of “external” unsecured creditors, and the claims by continuing members to a share of surplus assets (if any).

A question that has not yet been settled is where a redeeming member with the benefit of a judgment against a fund ranks in a liquidation: by becoming a judgment creditor, is that creditors’ claim any less made in character as a member? It is possible that the Court would draw a distinction between the position of a judgment creditor and an unpaid redeeming member. Given the twists in the road so far, such a person – and the fund in question – would be well advised to seek professional guidance.

Johnny Ward is a barrister and an associate in the litigation and insolvency department at Appleby in the British Virgin Islands. Ward was called to the English Bar by Lincoln’s Inn in 2007 (he is not currently practising in England) and joined Appleby in 2013, having developed a successful practice at Kings Chambers.