By Ingrid Pierce (pictured) and Colette Wilkins - Following the global financial crisis, investors unhappy with an informal wind-down process are increasingly seeking to bring that process to an end and have the board replaced by a court-appointed liquidator.
With solvent funds also being targeted, managers need to be aware of the circumstances in which an informal wind-down can, and should, be replaced with a formal liquidation and, conversely, the options available to counter such action or enhance constitutional documents to mitigate risk.
There is no doubt that an insolvent fund can be wound up by the Grand Court of the Cayman Islands. For a solvent fund, the court has jurisdiction to wind up on a shareholder’s petition where it is ‘just and equitable’ to do so – that is, in certain limited circumstances such as fraud, mismanagement or minority oppression.
A recent trend has been for disaffected investors to argue that the purpose for which the fund was established – active investment – can no longer be achieved upon a lengthy suspension of redemptions or a ‘soft’ wind-down; put another way, the fund’s ‘substratum’ has been lost.
A number of recent Cayman cases have held that the mere fact that it has become impractical for a fund to continue its investment business (as set out in its offering document) is sufficient for the court to make a winding-up order.
We prefer the alternative view, supported by other first-instance decisions in the Cayman Islands and the BVI, that the purpose or substratum of a fund is wider than pursuing a certain investment strategy, and includes realising investments and returning proceeds to investors prior to a formal liquidation and dissolution.
In any event, simply because the court has jurisdiction to make a winding-up order does not necessarily mean that it will. The manager or directors may well still be considered the best placed to extract the greatest value from the fund’s portfolio, and we have already seen the court adopt a commercial approach and provide alternative relief available under the Companies Law, rather than the draconian and final step of liquidation.
Upon learning of a winding-up petition, managers should immediately consult their offshore and onshore counsel and seek urgent advice regarding whether it is appropriate for the fund to resist the petition.
As a petition can effectively paralyse a fund’s ability to operate, action should generally be taken swiftly. If it is to be resisted, consideration should be given to a strike out, an application to ‘validate’ the fund’s ability to make ordinary course payments, and possibly injunctive relief.
Conversely, management should be wary of expending the fund’s resources in unnecessarily defending a legitimate petition, although of course the views of other investors will be crucial. Adverse costs consequences may also arise. Regular investor communication will be key.
In addition to the options set out above, if possible, an accelerated return of capital may resolve the issues. Flexibility within the investment management agreement regarding fees payable during a soft wind-down, the utilisation of independent directors not affiliated with the manager, fund documents that expressly contemplate a wind-down by incumbent management and appropriate non-petition language are certainly worth considering.
Ingrid Pierce and Colette Wilkins are partners at Walkers in the Cayman Islands
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