Offshore centres are seeing the continual fallout on the funds industry from the market collapse but differing approaches have emerged from the BVI and Cayman Islands. Andrew Thorp and Thomas Williams report

We are now over two years on from the onset of the liquidity crisis, but many hedge funds remain suspended, with investors unable to access their investments through redemptions while fund managers seek to realise residual portfolio assets in difficult markets. Inevitably, some investors have lost patience with the process and have turned to the courts for redress.

In two of the world's major funds domiciles, the Cayman Islands and the British Virgin Islands (BVI), two very different views have emerged from the courts providing salient lessons on the way in which hedge funds continue to operate.

With over 15,000 open-ended investment funds in Cayman and the BVI, the financial world has kept a close eye on those hedge funds which, following the onset of the global financial crisis, exercised their contractual rights to suspend redemptions and closed the funds to new investors.

These suspensions were designed to avoid a run of redemptions on the fund that might otherwise have created a fire sale of its assets and ultimately led to its insolvency. It also gave fund managers breathing space in which to operate, without the investors making formal demands for outstanding payments.

The race to redeem

The second half of 2008 saw many investors race to pull out of funds, and the initial round of litigation in both Cayman and the BVI unsurprisingly focused on the timing of redemption requests and the status of those that had made them to access their returns.

In Cayman, the recent decision of the Privy Council in Culross Global SPC v Strategic Turnaround Master Partnership has brought to a halt the debate over whether the redeeming member in the case had, under the pre-2009 liquidation provisions in Cayman, standing to petition to wind up the fund. Specifically, the status of a redeeming investor between the redemption date and the payment date was unclear.

The Privy Council overturned the Cayman Court of Appeal and found that, on the proper construction of the articles of the fund, (a) redemption took place on the intended redemption date, rather than the date on which payment of redemption proceeds occurred, and therefore (b) the redeeming investor ceased to be a member and became a creditor on the intended redemption date and thus had standing to petition to wind up the fund.

In the BVI, the position appears quite different. While written reasons are awaited from the Court of Appeal, the likely interpretation of the BVI insolvency legislation in Westford Special Situations Fund Ltd v Barfield Nominees Limited and another civil appeal is that it effectively restricts an investor from seeking to wind up a fund based upon unpaid redemption payments.

To fulfil the statutory definition of 'creditor' and to have standing to seek the liquidation of a fund, an investor must have an admissible claim in the liquidation. S.197 of the Insolvency Act 2003, however, does not allow a member to claim in a liquidation for redemption proceeds or other payments due in his character as a member. Without an admissible claim, therefore, an investor will not gain the necessary standing to apply to the court for relief.

Fund euthanasia?

As time has drawn on, investors in suspended Cayman and BVI funds have looked to alternative means of having a liquidator appointed over the fund and to take control of and realise its portfolio of assets. In both jurisdictions, members may apply to the court for the appointment of a liquidator on just and equitable grounds.

In Cayman, this tactic has met considerable success. In five recent decisions, Re Belmont Asset Based Lending, Re Wyser-Pratte Eurovalue Fund, Re ICP Strategic Credit Income Fund, Re Steel Partners II (Offshore), and Re Heriot African Trade Finance Fund, the Cayman court has taken the view that, because a fund has suspended redemptions and has stopped taking new money and making fresh investments, it could be considered as having ceased to operate as an open-ended investment vehicle, its substratum lost, and it should therefore be wound up on the just and equitable ground.

In Belmont, Justice Jones held that: "‚ĶIt can be said that it is just and equitable to make a winding up order in respect of an open-ended corporate mutual fund if the circumstances are such that it has become impracticable, if not actually impossible, to carry on its investment business in accordance with the reasonable expectations of its participating shareholders, based upon representations contained in its offering document."

Justice Jones also stated: "Wherever it is proved that a company established as an open-ended mutual fund is no longer viable as such, for whatever reason, the court will ordinarily conclude that it is just and equitable to make a winding up order."

The BVI court, however, rejected the Cayman line of authority in the recent case of Aris Multi-Strategy Lending Fund v Quantek Opportunity Fund, preferring the well-established English common law test of impossibility when considering whether a fund is able to continue or had lost its substratum.

The fact that a fund had contractually suspended redemptions did not mean that it was impossible for it to carry on its business which, in this instance, was of an offshore feeder fund. Justice Bannister stated that: "No longer taking on or soliciting new investments did not mean that it had ceased to carry on business or that it is impossible for it to carry on business. If it were not so, many pension funds and insurance companies would be liable to find themselves being wound up."

Statutory help?

In response, some funds are relying on a provision of the Cayman companies law to help redress the balance. S. 95(2) of the companies law provides support for non-petition clauses in a fund's contractual documents, which effectively ousts the court's jurisdiction to wind up a fund where an investor has contracted out of its right to petition.

Whether this will redress the imbalance, and the effect it will have on funds' investors, is yet to be seen. While of diminished relevance following Westford, there is no equivalent provision in the BVI.

Going forward

While individual cases may differ, in general in the BVI suspended funds and their managers enjoy the room to wind down their asset holdings in an orderly and responsible manner without the immediate threat of a disgruntled investor seeking the appointment of a liquidator.

They gain further comfort through what is likely to be determined as a statutory bar on investors advancing liquidation proceedings based on unpaid redemption proceeds. In turn, investors that are content for the current management to utilise their skills and experience in realising assets, without an additional tier of costs being added by a liquidator, need not be dictated to by an agitating minority.

In Cayman, on the other hand, the case law so far has proved to be more supportive of investors, some of whom, unhappy at the continued drawing of fees by investment managers and the sluggish realisation of assets, have successfully appointed liquidators to oversee the process.

All of these cases turn on their facts, and with funds now considering the revision of their subscription documents and the Cayman line of authority widely considered ripe for appeal, the gap between the BVI and Cayman in the fallout of the financial crisis may well be closing.

Andrew Thorp is a litigation and insolvency partner in Harneys British Virgin Islands office and Thomas Williams is an associate in the firm's Cayman office.