By Jeremy Walton, Partner and Jayson Wood, Counsel, Appleby Global – After being a hot topic in the Cayman Islands for a number of years, the Grand Court has handed down two decisions in quick succession relating to side letters entered into by Cayman Islands corporate hedge funds.
The first was Medley Opportunity Fund Ltd. v. Fintan Master Fund Ltd & Nautical Nominees Ltd (21 June 2012), where Justice Quin decided the point that a side letter must be signed by the investor of record, and not some other party such as the beneficial owner of the shares, in order to be enforceable.
More recently, the Court took its analysis of the enforceability of side letters significantly further in Lansdowne Limited & Silex Trust Company Limited v. Matador Investments Limited (In Liquidation) & Ors (23 August 2012).
In the Matador case, A incorporated a Cayman Islands hedge fund in which both Lansdowne and Silex invested. B was a shareholder in Lansdowne and also a beneficial owner of Silex. It was alleged that, prior to the establishment of Matador, A had verbally agreed with B that the fund’s gating and suspension powers in the articles of association would not apply to B’s investment. B claimed this amounted to an “oral side letter”.
Matador subsequently went into liquidation and the question before the Court was whether, assuming the alleged facts to be true, the oral side letter was capable of binding Matador and therefore its liquidator.
In his judgment, Justice Quin held that neither Matador nor the liquidator was bound by the agreement for the following primary reasons:
• No agreement was made between Matador and either Lansdowne or Silex. It was made between A and B. Applying the principles in the Medley case, it could not be contended that the agreement was binding on Matador or the liquidator.
• The articles of association of a company comprise an agreement that creates collective rights and obligations, as between the company and all of its shareholders, and between its shareholders inter se. In addition, third parties are entitled to rely on the accuracy of the Articles when purchasing shares.
• In order to protect non-redeeming shareholders, the terms and manner of the redemption of shares must be sufficiently set out in the articles (applying the Privy Council decision in Culross Global SPC Ltd v. Strategic Turnaround Master Partnership Ltd and s.37(3)(c) of the Companies Law).
• Therefore, even if the oral side letter had been between Matador, Lansdowne and Silex, it was inconsistent with the Articles and could not change the prescribed redemption and suspension process.
The Matador decision clarifies the status of side letters and identifies issues which a fund and its promoters need to consider when deciding the nature and extent of different terms to be given to investors via side letters.
For existing funds, care needs to be taken to ensure that the directors do in fact have the power (discretionary or otherwise) under the articles of association to grant terms contained in side letters to investors (either with or without creating a new share class); and also that the side letter is directed to the registered shareholder and not some other party merely associated with the shareholder. If this is not possible, funds and fund promoters will need to consult their lawyers as to alternative methods of achieving their aims.
For new funds, this case serves as a further reminder to both lawyers and fund promoters that clear drafting of both the articles of association and offering documents is a must, if a fund wants to have flexibility to offer preferential terms to certain investors. The articles of association must contain appropriate discretionary powers for the directors, especially in relation to liquidity; and any offering documents must contain disclosure that the fund may enter into side letters with investors which will contain different terms from those set out in the main offering document.