The Court of Appeal of the Eastern Caribbean Supreme Court on 11 March handed down an important ruling on the question of where investors stand in the “waterfall” of distributions in the liquidation of investment funds under British Virgin Islands law.
According to law firm Harneys, it affirms the widely held industry view that debts owed to past members for redemption proceeds provide them with deferred creditor status and thus they rank behind external creditors of the company, but their claims have priority over the interests of existing members in the liquidation of a BVI company.
The decision brings certainty to the position and will be welcomed by investors, particularly those with secondary market positions, as well as by insolvency practitioners who may now proceed to make distributions with clarity.
Whilst the conventional practice in insolvency law is that creditors always come before members, and that as between themselves members rank pari passu according to their shareholdings, the generality of these two maxims had been called into question following the first instance decision of the BVI Commercial Court in November 2012. At first instance it was held that an investor who had redeemed his shares in the fund and was owed redemption payments would rank alongside investors who had not redeemed their positions and who were still members.
Section 197 of the Insolvency Act 2003 provided only for an “adjustment” to be made between past members and members, but without particularising how this adjustment should be made. At first instance, the Commercial Court considered that this provision did not specifically provide that continuing members should be subordinated to past members, and was reluctant to create an intermediary class of claims not expressly contemplated by the legislation, even where, as is customary, the memorandum and articles of association of the fund clearly described redeemed members as creditors and that their debts were liabilities owed to them by the company. Instead, it was held that former members ranked pari passu with continuing members. Their respective rights to share in the surplus were valued by reference to the NAV at the time of redemption (in the case of redeemed members) or their initial subscription price (in the case of continuing members).
The Court of Appeal however found that the “adjustment” provisions of section 197 did provide for “inside” creditors such as former members of the fund to be given priority of distribution against the members, after the payment of external creditors but before distribution of the residual surplus. In addition, it was held that the application of the subscription price as a means for determining the rights of continuing members to share in any residual surplus was flawed as a matter of British Virgin Islands law. Instead, the relevant provisions of the memorandum and articles of association or, in the absence of specific provisions, the default position in section 34 of the BVI Business Companies Act, should be applied in determining rights of members and past members to participate in the distribution of surplus assets of the fund.
A number of liquidators are believed to have been waiting for this judgment before making any distributions to ensure that there was a clearly defined route forward. This judgment therefore provides welcome clarity for investors in BVI funds and liquidators of BVI funds by laying down a clear priority of distributions for vehicles in liquidation. It also realigns British Virgin Islands insolvency law with the orthodox position found in most other fund domiciles.
Harneys acted for the successful appellants, a consortium of investment funds.