While one could speak generally of Cayman companies that do business in Cayman, we are finding the greatest impact of this in the liquidation of Cayman hedge funds, particularly in those instances where the investment management, administration and/or assets are in the United States.
We are seeing the impact that the recession in the United States is having on the economy in the Cayman Islands. The number of liquidation appointments has increased substantially over the past year and there are rumours that we are only seeing the tip of the iceberg.
Given the current economic conditions, not only is the likelihood of companies having financial troubles increasing, the way that insolvency practitioners are appointed and how it is expected they conduct their duties and obligations is also changing. Much of this change is driven by the way bankruptcies have been and are dealt with in the United States and the power and authority that US investors, creditors and other stakeholders have in directing how a bankruptcy is administered.
While one could speak generally of Cayman companies that do business in Cayman, we are finding the greatest impact of this in the liquidation of Cayman hedge funds, particularly in those instances where the investment management, administration and/or assets are in the United States. As such this article will focus on Cayman funds since this is the industry that appears most affected by recent events.
Should a Cayman fund, that has assets in the United States or a substantial place of business there (because its investment management, administration or directors are located in the United States) become unable to pay its liabilities as they fall due and/or become otherwise insolvent (it should be noted the tests for insolvency are different in the United States as compared to Cayman), there are various options available. In the United States, the two primary alternatives are to file Chapter 7 or Chapter 11 bankruptcy proceedings. In dealing with the latter one first, since it is the one most often pursued, Chapter 11 is used when there is a possibility that the company can be restructured or the assets sold in an orderly fashion. The current management remains in the company for this purpose.
It is debtor-driven, meaning that the company is given the opportunity to provide a plan to pay creditors and bring the company back to profitability. Chapter 7 is different in that an independent bankruptcy trustee is appointed to wind up the company. Chapter 7 is most often used when the company cannot be restructured or management cannot be trusted to run the company.
An additional option exists for regulated companies, such as hedge funds, where the Securities Exchange Commission, or some other regulatory body, appoints a receiver.
While not technically appointed to liquidate entities, we are finding that receivers are practically performing similar functions as bankruptcy trustees do, including the distribution of assets to creditors and investors.
In Cayman, the primary option is to appoint a provisional or official liquidator. Where there are assets in the United States or a risk that a claim may be filed in court there, it may be appropriate to seek recognition in the United States under Chapter 15 of the US Bankruptcy Code. Quite clearly, the appointment of an insolvency practitioner in Cayman requires persuasion of the stakeholders of the benefits of an appointment in Cayman when the assets are in the United States or a substantial amount of the fund’s business took place there.
Sometimes it is not always easy to show these benefits, particularly with the lack of recent success of seeking Chapter 15 recognition. Should that continue, we may find more insolvency cases where Cayman funds with assets or a substantial place of business in the United States being handled by US bankruptcy trustees than by Cayman insolvency practitioners.
We have seen recently in Cayman a hybrid to this dilemma. Local Cayman insolvency practitioners and US bankruptcy specialised firms are being retained jointly on a contingency fee or combined fixed fee/contingency fee basis. Through this arrangement, the bankruptcy is handled substantially in the United States, while there is a Cayman representative to report to the Court and deal with matters pertaining to Cayman law. The recent changes to the Cayman Islands Companies Law allow for insolvency practitioners to consider taking appointments on a contingency fee or combined fee basis and it may be that for particular engagements involving the United States, this will become the more favoured approach to Cayman appointments. We will have to see.
Creditors and Liquidation Committees
The purpose of a creditor or liquidation committee is to represent the interests of all creditors or investors as a whole, not just those on the committee. The principal foundations of the committee are to sanction the exercise of certain of the liquidator’s powers and to approve his remuneration. In addition to these statutory functions the committee may also serve the liquidators generally and act as a sounding board for him to obtain their views on matters pertaining to the liquidation.
Unsurprisingly, Cayman hedge funds that have connections to the United States have US domiciled creditors and investors. These stakeholders are familiar with the US bankruptcy process. Members of the committee commonly include litigation attorneys or bankruptcy professionals who specialize in such matters.
We are finding more often than not that these same persons are sitting on creditors and liquidation committees of Cayman estates and that they expect the same role and authority as they would have in US bankruptcy proceedings. The power that a committee can have was highlighted by the Bear Stearns case and the removal of the liquidators in one of the Cayman funds. To remove a liquidator a creditor or investor must show due cause. While there were a number of other factors considered in the Bear Stearns decision, it has raised the question whether a disagreement in strategy or direction between the creditors and investors, and the liquidator, would be sufficient due cause to have him replaced. What that means for liquidators is that although the committee’s role is intended to be consultative, in practice the committee is able, when demonstrating unanimous agreement among themselves, to bear significant pressure on the liquidator and the estate. The impact is that, to the extent there are US creditors or investors on the committee, the committee may be more involved in the liquidation agenda.
Most of us are aware that the United States is particularly litigation driven. For numerous years attorneys in the US have had the ability to pursue claims on a contingency fee basis. Investors and creditors can file class action suits, even in cases where a bankruptcy trustee has been appointed. And unlike the Cayman Islands and most other jurisdictions in the world, it is juries (comprised of ordinary citizens) rather than judges who decide many cases and set the amount of damages. Because juries have such freedom and discretion and the only limit on the awards of punitive damages is a review by appellate courts, we have seen in the press some cases where significant amounts have been awarded.
That appetite for litigation creeps into the litigation strategies of insolvent companies in the Cayman Islands, and in particular hedge funds. It is difficult to argue against a strategy to pursue litigation in the United States where the estate only pays fees if there is a recovery and where the downside of not pursuing those claims is a suggestion that the liquidator has not done everything in his or her power to recover damages on behalf of the estate.
As such we should expect to see more lawsuits for insolvent Cayman companies pursued in the United States. It is not clear whether the United States will always apply Cayman Islands law depending on the facts of the case, even if there are choice of law provisions in the service agreement. That means that directors and other service providers involved in funds and more generally entities doing business in the United States, need not only know what is required of them to comply with the laws in the Cayman Islands, but also what are their duties and obligations in the United States, as it is possible that the laws there may also apply.
By sleeping with an elephant we are seeing that the world of the Cayman insolvency practitioner is evolving so that more and more of the management of Cayman liquidations are driven by how things are done in the United States. The impact that this is likely to have on liquidators and the litigation strategies pursued on behalf of insolvent Cayman funds is still unfolding. It will be interesting to see how events in the United States, particularly under a new president-elect, will affect us, but it is clear that practices and norms are changing for all of us.