Redemptions Post-Cayman Appellate Decision

Getting to the heart of the Court of Appeal’s ruling

PAUL GOVIER, HEAD OF THE INVESTMENT FUNDS GROUP, MAPLES & CALDER

On 12 December 2008 the Cayman Islands Court of Appeal delivered a judgment dealing with important aspects of the law in relation to redemptions and suspensions in a hedge funds context. An appellate decision in the world’s leading hedge fund jurisdiction it is not surprising that the decision has attracted significant attention. However, amid the flurry of client updates and briefings that have followed, it appears that half truths and misconceptions have flourished and that lawyers and clients alike are confused as to exactly what the decision means for them. The purpose of this article is to resolve that confusion.

Background
In re Strategic Turnaround Master Partnership Limited (the “Fund”) an investor had submitted a redemption request to a fund for a 31 March 2008 redemption date. After that redemption date, but before the investor had been removed from the register of members or been paid its redemption proceeds, the fund purported to suspend redemptions and refused to pay the investor’s redemption proceeds. The investor subsequently presented a petition for the fund to be wound up on the basis that it was unable to pay its debts. The Court of Appeal was asked to consider certain issues of construction and law.

What did the Court decide?
1. The timing of redemptions and suspensions is determined by the fund’s constituent documents Each set of facts must be considered against the terms of each set of documentation. There is no “one size fits all” answer.

2. A shareholder with a valid redemption request due for a particular redemption day (a “Redeemer”) becomes a creditor on that day and will be due the redemption price applicable on that day.

3. The redemption price becomes due for payment at the time stated in the fund’s governing documents. If the documentation permits the payment of redemption proceeds to be suspended and the fund validly invokes such a power, then the debt owed to the Redeemer is similarly suspended.

4. A Redeemer would not be able to petition the court for the winding up of the fund on the grounds of insolvency where the redemption payment has been validly suspended, because the Cayman Islands test for insolvency is a cash flow test. A Redeemer may have the right to petition for winding up on “just and equitable” grounds.

5. The redemption process is only complete once the redemption price has been paid and the register of members has been updated. Therefore, where the fund’s documents allow for the payment of redemption proceeds to be suspended, the fund may do so at any time until the Redeemer has been paid and removed from the register.

6. A Redeemer remains a member of the company until he has been paid and removed from the register of members. From the redemption day until that time he is both a creditor and a member.

7. As creditor, a Redeemer enjoys priority in respect of his debt over other shareholders but ranks behind other “ordinary” creditors and any secured creditors.

What did the Court not decide?
1. The Court did not decide that a fund can retrospectively suspend redemptions. The Court held that it was only the payment of redemption proceeds that had been suspended.

2. The Court did not decide that the power to suspend redemptions includes a power to suspend payment of redemption proceeds after a redemption day. The Court based its decision on the express power to suspend payment of redemption proceeds contained in the Fund’s offering memorandum and not the more general power to suspend redemptions conferred in the Articles of Association.

3. The Court did not decide that a Redeemer cannot petition for the winding up of a fund. The court expressly confirmed that a Redeemer has standing to apply for the winding up of a fund on just and equitable grounds. The Court’s reasoning also indicates that if the redemption price has become due for payment, for example because payment of redemption proceeds has not been suspended, then a Redeemer may also have standing to petition for the winding up of the fund on the basis of insolvency.

What does the decision mean to me?
There are a range of “frequently asked questions” emerging as news of the decision has spread. In each case, the answer will be determined by the application of the governing documentation to the particular circumstances. However, below are some examples of “typical” questions and answers.

1. “I am a manager of a fund with significant redemption requests due on the next redemption day. I have concerns as to the ability of the fund to meet these requests. I was planning to approach the board of directors to recommend a suspension of redemptions before the next redemption day. Does this decision mean that I can wait until after the redemption day to decide?”

No. After the redemption day the redeeming shareholder will become a creditor owed the redemption price as at that day. If the Directors want to prevent that occurring then they must make a decision before the redemption day.

2. “I am an investor in a fund whose offering document states that the Directors may suspend the calculation of net asset value and/or redemptions, but it does not refer to suspending payment of redemption proceeds. I was due to be redeemed and paid last month. The Directors have just informed me that the fund has decided to suspend redemptions going forward and that Cayman Islands law requires them to also defer payment of my redemption proceeds. Is that correct?”

No. It maybe arguable that a suspension of redemptions includes a suspension of the completion of any incomplete redemption process (including payment), but the Court did not decide that. This is an area that requires clarification.

3. “I am a hedge fund administrator whose practice is to update the register of members after the net asset value has been finalised, which is usually some time after the relevant dealing day. My clients are asking me to start updating the register on the relevant dealing day. Is that necessary?”

Yes. Registers should be updated promptly on the relevant dealing day. While that may be feasible for redemptions of an entire holding or for a fixed number of shares, it may be more difficult where redemptions for a value of shares are accepted. It may also be problematic for subscriptions. It may be necessary for administrators and funds to revisit their procedures in this regard.

4. “I am an investor who has been asked to vote on a restructuring proposal at a general meeting of shareholders. Will redeeming investors who have not yet been paid also be able to vote? If so, will they also be bound by the terms of any such restructure?”

If the register of members is updated promptly, this issue should not arise. However, if the investor remains on the register at the time of the meeting then it appears that they would be entitled to vote at it. Arguably, it follows that they should also be bound by such vote. This is an area which requires clarification.

5. “I am a hedge funds lawyer. Should I be reviewing and updating my precedent documentation to address these issues? Should my clients be doing so for existing funds?”

Yes. The Court made it clear that its decision turned on the drafting of the particular documentation. Lawyers and clients can address these issues through appropriate drafting.