Access to justice is a fundamental right in developed legal systems. But, as with many rights, a balance has to be struck. The right of one citizen to seek redress from the courts must be weighed against the right of another not to be put to the expense of defending bad claims.
Historically, the Cayman Islands has addressed this through the allocation of liability for the costs of legal proceedings. In this regard, it is like many common law jurisdictions, with the notable exception (for most purposes) of the United States. But when it comes to the right of creditors of insolvent Cayman companies to challenge decisions by the appointed liquidators, a recent amendment to the Companies Winding Up Rules changes all that. The amendment appears to be a gift to those claiming to be creditors, but may actually leave genuine creditors worse off than before. In this article, the authors call for this change to be reconsidered, rather than leaving true creditors of an insolvent estate vulnerable to the unmeritorious claims of false creditors.
Costs follow the event
The Cayman Islands follows the England and Wales approach that the loser in litigation pays – or “costs follow the event.” Subject to the principles governing the nature and extent of costs that may be claimed, this means that the party that has (by definition, wrongly) forced the other side to court, pays the other side’s costs of the action in addition to its own.
Those costs recoveries are important. In jurisdictions where plaintiffs are able to bring claims with impunity, this can be combined with “no-win no-fee” arrangements to make speculative claims more common and result in settlements that are leveraged as a result of nuisance value rather than merit. For a plaintiff, the risk of having to bear the other side’s costs of being unsuccessful is a powerful deterrent to bringing claims that do not have real merit. In a system where the costs of pursuing legitimate rights are recovered, access to justice is preserved.
Security for costs
Even with these costs rules, there are some circumstances where an order from the Cayman court requiring a payment of costs may be worthless. If the plaintiff is a shell company stripped of any material assets, or is incorporated in a jurisdiction that does not recognize a Cayman costs order, the successful defendant is likely to remain out of pocket. And, of course, it is quite possible for claimants deliberately to engineer that situation.
To prevent this abuse, the Cayman court (like the English court) allows the defendant in civil litigation to take anticipatory steps to protect against that risk by applying to the court for an order that the plaintiff provide “security for costs” – a bank guarantee or deposit into court of a sum that may be used to satisfy any costs award in favour of the plaintiff. Therefore, the defendant is assured that if the court finds in its favor, its victory is not a hollow one.
As this potentially infringes on access to justice, the circumstances where such an order may be made are limited. The Grand Court Rules allow the court to order security to be given primarily where the plaintiff is a nominee plaintiff (and the real person for whom the action is brought is therefore not subject to the costs order) or resident outside of Cayman and therefore less likely to be responsive to a Cayman costs order. In addition, where the plaintiff is a company, the Companies Law provides for security to be ordered where the plaintiff company has insufficient assets to satisfy any costs award, unless that lack of assets was caused by the defendant.
The case law on security for costs is very well established and seeks to prevent it being abused inappropriately as a sword or shield. An order for security will not be allowed to stifle a meritorious claim, but the court has to balance the risk, if it does not require security, of the plaintiff being able to pursue a cause of little merit, at no financial risk to itself. This requires the Court to assess the merits of the case at an early stage, rather than determining the liability for costs after the full hearing. However, no payment is actually made to the defendant, and if the plaintiff is successful it will have the security back in full. The plaintiff must either establish that its case is bona fide, with a reasonable prospect of success, or that it can pay the costs of an action that the Court considers may be of questionable merit.
Application in the winding up of companies
The procedural rules relating to the winding up of companies are separate to the Grand Court Rules – the Companies Winding Up Rules (CWR). The CWR are made by the Insolvency Rules Committee, under powers delegated by the Companies Law. The committee is empowered to make rules and prescribe forms for the purpose of giving effect to, amongst other things, the parts of the Companies Law dealing with the winding up of companies. The CWR borrow lightly from the Grand Court Rules, adapting or creating new rules to fit the principles of insolvency law.
One of the key principles of insolvency is that it is a collective remedy: individual actions are subject to a moratorium and proofs of debt are submitted to the liquidator who has a quasi-judicial role in adjudicating these proofs of debt to determine whether the plaintiff may participate in a share of the assets of the company. In the Cayman Islands, only official liquidators have the capacity for adjudicating proofs of debt: voluntary liquidators, who may only remain in post if the company is solvent, must pay the claims of creditors in full. Official liquidators are court appointed officials who must possess certain qualifications, independence and experience and who then hold office as officers of the court with a duty to report to it.
However, if an official liquidator rejects a proof of debt, the putative creditor has a right of appeal to the Grand Court. The court hears the application as a de novo adjudication of the claim but the liquidator is required to provide evidence supporting or opposing the appeal and will usually need to have counsel attend the appeal. All this costs money, which comes out of the assets of the company as an expense of the liquidation. If the court rejects the appeal, then costs normally follow the event and the “creditor,” who may by this stage have been found not to be a creditor at all, or may have had his claim reduced, may be ordered to pay the official liquidators’ costs.
To the extent that the costs order is not then satisfied by the losing appellant, the estate will therefore be left to bear the costs, meaning a reduction in return to all of the legitimate creditors of the company. This is where the concept of security for costs becomes important. Crucially, until recently the CWR said nothing about security for costs.
That lacuna was filled by jurisprudence of the Cayman Islands’ courts which held that the court had an inherent jurisdiction to grant security for costs in insolvency proceedings, to be exercised in accordance with the principles relating to a non-resident limited liability company when there is reason to believe that its assets will be insufficient to pay the costs of the defendant. Essentially, a creditor in winding up proceedings was not allowed a risk-free roll of the dice, and was treated in the same way as an ordinary plaintiff in court proceedings. If liquidators rejected a proof and the creditor appealed then, if the liquidators considered it appropriate to do so, they could apply for an order that the appellant provide security for costs in the absence of credible evidence that it could (and would) pay the liquidators costs thus reducing the risk to the estate that an unsuccessful appellant would not pay the costs. The true creditors of the estate were therefore protected against the actions of those deemed not to be creditors, unless and until the appeal was successful.
The recent amendment
As part of an amendment brought into effect on Aug. 1, 2016, the Insolvency Rules Committee decided that “On an appeal to the Grand Court an appellant shall not be required to provide security for costs in any appeal to which this Rule applies.” There is no ambiguity in this: the court no longer has discretion to order security for the estate’s costs in the event of an appeal.
The Insolvency Rules Committee is not required to explain its decisions. The Cayman Islands is known as a creditor-friendly jurisdiction. This amendment could be considered as a gift to creditors, to improve their access to justice.
However, on its true application, it is wholly detrimental to the true creditors of the estate, achieves no better prospect of justice and removes the gates of judicial discretion that protect insolvent estates.
The downside for true creditors
In short, the change in the CWR takes away the discretion of the court to consider whether it is appropriate for security for costs to be ordered. Previously, the court would only have ordered this in cases where the appeal was of questionable merit and there were concerns about the enforceability of a costs award. There was therefore a threshold test before additional costs of the estate were incurred.
The prejudice to the creditor in providing security was limited: a creditor’s appeal has a short timeline compared to standard litigation in which security is regularly ordered, and the creditor will have the security returned (potentially even a costs award in its favour) if its appeal is successful.
Now, any creditor may force the estate to incur the costs of responding to an appeal, regardless of the merits of the creditor’s position. It should be remembered that the liquidator, a court-appointed officer, will already have adjudicated on the claim and determined that the appellant is not a creditor, or at least not to the extent claimed. In cases where a plaintiff appeals a judgment of first instance, the court is less reluctant to order security for costs of the appeal as the plaintiff has already had substantial access to justice.
The Committee’s change appears to send a signal that they have little faith in liquidators’ initial decisions and that any appeal, regardless of merit, should go before the court. The only threshold to an appeal is whether the creditor can lodge a standard form with the Cayman court. Even in cases where the court could otherwise have exercised its discretion to protect the insolvent estate, the liquidators are required to incur the costs of responding to the appeal.
Cayman-registered companies that unsuccessfully appeal (rightly) cannot avoid enforcement of a costs order. In contrast, a liquidator may not feel that the costs and risks of enforcing a costs order against a foreign company of questionable solvency, which may include the need for recognition of the order or their appointment and the engagement of local attorneys, are justified. A foreign company therefore stands less risk of needing to satisfy any costs award than a Cayman-resident company, so the rule in practice creates a bias against local companies.
The liquidators’ costs are paid from the estate anyway, so the true creditors of the company are penalized to ensure the access to justice of a party that is twice affirmed not to be a creditor.
It is not clear why a claimed creditor, who already has access to an initial adjudication of its claim at minimal cost (there is no fee for submitting a proof of debt and having it adjudicated), should enjoy a greater right of access to justice than an ordinary plaintiff in civil litigation who needs recourse to the court to establish its rights – or should be allowed to make itself immune from the consequences of bringing bad claims in a way that ordinary court litigants are not. True creditors of Cayman Islands companies stand to suffer at the hands of this apparent gift.
The argument that security for costs would prevent the bringing of appeals with merit by those genuinely unable to provide security is adequately addressed by the discretionary nature of the remedy. In such cases it was always (until the court’s discretion was removed by the amendment) open to the court to refuse to order security.
In the authors’ opinion, the recent changes are detrimental to creditors of Cayman companies, and expose liquidation estates to unmeritorious claims at the true creditors’ expense, and should be reconsidered.
Andrew Bolton is a partner and Practice Group Head of Appleby’s Litigation & Insolvency department. Based in the Cayman Islands, he specialises in contentious insolvency matters and commercial litigation, including fraud, asset recovery and professional negligence.
Jeremy Snead is a Cayman Islands-based senior associate within Appleby’s Dispute Resolution practice group.