Gavel and scales

Cayman Islands court decides on effectiveness of side letters

The Cayman Islands court has delivered judgment in a high-value dispute concerning the effectiveness of investor side letters and whether restructuring agreements limited an investor’s redemption rights under the fund’s articles.

Fintan Master Fund Limited, acting through its nominee, invested USD45m in the Medley Opportunity Fund in late 2007.

Shortly before investing, Fintan entered into a side letter with the fund, which granted Fintan favourable terms vis-à-vis other investors. This included a concession that when Fintan redeemed its investment, the fund would pay the redemption proceeds immediately in cash, so far as possible.

When the fund suffered a liquidity crisis in 2008, it offered two successive restructuring options to investors. These options, if accepted, would limit the investors’ redemption rights, by cancelling any existing redemption requests and providing for quarterly distributions of excess cash pro rata with all other investors accepting these options. The Fintan nominee agreed to the restructuring proposals and signed agreements to that effect in 2008 and 2009 on behalf of Fintan. However, in December 2011, the Fintan nominee submitted a redemption request, seeking a full and prompt cash redemption pursuant to the articles and side letter.

The resulting litigation concerned whether Fintan was still entitled to preferential treatment under the side letter or, whether the restructuring agreements meant that Fintan had waived its redemption rights under the articles and the side letter. The court found that Fintan was not entitled to an immediate cash redemption in full. In reaching this decision, the court relied on the following:

Fintan had signed the side letter, but it was not a shareholder in a fund; the shareholding was held by its nominee. The court was robust in holding that they were separate entities, and the side letter was therefore not effective in achieving its purpose.

In any event, the side letter was superseded by the nominee agreement with the registered shareholder which had since exercised its rights under the articles.

The articles were subsequently trumped by the restructuring agreements, since they constituted variations of the investors’ redemption rights.

One difficulty was that the restructuring agreements were silent about future redemption requests. There were two possible interpretations of the restructuring agreements but, applying the English Supreme Court decision of Rainy Sky SA v. Kookmin Bank, commercial common sense dictated that the investors could not agree to a restructuring plan - to exchange their existing redemption rights for periodic cash distributions – only to exercise those rights later. The judge held, effectively, that the restructuring agreements implemented a partial and periodic compulsory redemption of all participating investors’ shares by way of a quarterly cash distribution.

This decision represents a sensible interpretation of the restructuring agreements, in line with commercial realities. It also highlights two practical lessons. First, putative investors must ensure that any side letter is signed by the entity which is subsequently used to hold the shares. Otherwise, the side letter will not actually secure preferential treatment for either the nominee or the beneficial investor - there will be a gap. Second, restructuring agreements should state clearly whether they are varying or replacing redemption rights and, if so, in what way. These precautions will help to avoid uncertainty, disputes and litigation.

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