The Privy Council issued its decision in the Fairfield Sentry case providing greater certainty as to the finality of the subscription price, redemption price and calculation of net asset value for hedge funds.
The Contracts (Rights of Third Parties) Law, 2014, and The Directors Registration and Licensing Law, 2014 have come into force. The Exempted Limited Partnership Bill, 2014 is expected to be adopted shortly, once corresponding regulations are drafted.
Finally, new legislation to address FATCA has also been introduced in Cayman.
CASE LAW OF NOTE
Privy Council provides certainty to hedge funds
On April 16, 2014, the Privy Council issued a welcome decision in the Fairfield Sentry Limited case (Quilvest Finance Limited and others (Appellants) v Fairfield Sentry Limited (Respondent)  UKPC 9), providing greater certainty as to the finality of the subscription price, redemption price and calculation of net asset value for hedge funds. This decision was an appeal from a judgment of the British Virgin Islands Court of Appeal but will equally be binding on courts in the Cayman Islands.
Fairfield Sentry, a BVI business company, was the largest feeder fund into Bernard L. Madoff Investments Securities LLC (BLMIS). On Dec. 18, 2008, the directors of Fairfield Sentry suspended the determination of its net asset value, thereby suspending the redemption of shares. On July 21, 2009, the BVI High Court placed Fairfield Sentry into liquidation.
The liquidators of Fairfield Sentry brought an action to recover the proceeds of redemption from some of the largest shareholders, who had redeemed their shares prior to the suspension of net asset value. Fairfield Sentry argued that the redeemers were paid out based on a mistake that the assets of the company were as stated by BLMIS, when there were in fact no such assets. The liquidators of Fairfield Sentry wished to treat the redeemed shareholders pari passu with the shareholders remaining in Fairfield Sentry.
The Privy Council, in a sensible and forthright decision, determined that the monthly emails, the contract notes and the monthly statements of account issued by the administrator of Fairfield Sentry, Citco Fund Services (Europe) BV, were sufficient to constitute certificates as to net asset value and, as a result, were conclusive as to the net asset value of Fairfield Sentry.
In carrying out a detailed review of the memorandum and articles of association of Fairfield Sentry, the Privy Council determined that the mechanics of the memorandum and articles of association depended upon the price being ascertained by the relevant dealing day and known to the parties shortly thereafter.
The court determined that it would be unworkable on any other basis. While the memorandum and articles of association provided that a certificate as to net asset value or subscription price or redemption price given in good faith by or on behalf of the directors shall be binding on all the parties, the BVI trial court and Court of Appeal had determined somewhat formalistically that this required a formal certificate to be issued by the directors. In contrast, the Privy Council determined that the monthly emails, contract notes and monthly statements of account issued by the administrator of Fairfield Sentry were sufficient to constitute certificates for the purposes of the company’s articles.
The Privy Council took a commercial approach, determining that the operation of hedge funds requires certainty regarding subscription and redemption prices, and that the informal documents issued by the administrator were sufficient to constitute a certificate.
As there was a certificate as to net asset value which was determinative, Fairfield Sentry was bound to pay the proceeds of redemption. The Privy Council determined that to the extent a payment made under a mistake discharges a contractual debt of the payee, it cannot be recovered unless (which was not suggested) the mistake is such as to avoid the contract.
The result of the judgment is that the redeemed shareholders are not required to contribute to the recovery of assets and will not participate pro-rata with unredeemed shareholders. In short, the Privy Council determined that the loss in the Ponzi scheme fell entirely on those investors whose funds were still invested when the money ran out and the scheme failed. However, the case conforms to investor expectations that once redeemed, an investor no longer has any exposure to a fund.
The Contracts (Rights of Third Parties) Law, 2014
The Contracts (Rights of Third Parties) Law, 2014 was published in the Cayman Islands Gazette on May 21, 2014, and comes into force with immediate effect. Subject to certain exceptions, the CRTP Law allows for the enforcement of contractual rights by a third party. Accordingly, the CRTP Law permits a variation of the pre-existing position under Cayman Islands law based upon the common law doctrine of privity of contract. The CRTP Law is similar to the United Kingdom’s Contracts (Rights of Third Parties) Act and to legislation enacted in several other common law jurisdictions. The CRTP Law is a welcome statute, providing flexibility for contracting parties to confer contractual benefits on third parties.
Rights of a third party
The doctrine of privity of contract provides that a person (a third party) may not acquire and enforce rights or have obligations imposed upon it by a contract to which it is not a party (even where it is the parties’ clear intention that a contractual right should benefit a third party, including, for example, indemnification and exculpation provisions).
Pursuant to the CRTP Law, a third party may in its own right enforce a term of a contract if:
- the third party is expressly identified in the contract by name, as a member of a class or as answering a particular description (and a third party may include a person not in existence when the contract is entered into); and
- the contract expressly provides in writing that the relevant third party may enforce the relevant term.
- If such conditions are satisfied, the third party, in exercising its right to enforce the relevant term of the contract, will have available to it any remedy that would have been available in an action for breach of contract.
While the CRTP Law is largely based upon the U.K. act, a significant difference is that, under the CRTP Law, a third party can enforce a contract term only when the contract expressly so provides.
Limitations on the third party
For the purposes of exercising its right to enforce a term of the contract, a third party will have available to it any remedy that would have been available to it in an action for breach of contract if it had been a party to the contract. Thus, if the contract legitimately excludes or limits the right of the contract parties to make claims, then the third party will also be subject to the same exclusions and limitations.
Variation and rescission of a contract
The CRTP Law restricts the contract parties’ ability to rescind or vary the third party’s right to enforce a term of a contract without its consent in circumstances where the third party has:
(a) communicated its assent (by word or conduct) to the term to the party against whom the term is enforceable (the promisor);
(b) relied on the contract, and the promisor is aware of such reliance; or
(c) relied on the contract, and the promisor can reasonably be expected to have foreseen that the third party would rely on the same.
In these cases, the consent of the third party is required to any variation or rescission of the relevant contract term, unless the contract itself expressly provides that the contract may be rescinded or varied without the consent of the relevant third party or that the consent of such third party is otherwise required in circumstances other than those set out above.
Exceptions to the rights of a third party
The CRTP Law does not confer rights on a third party in the case of a contract on a bill of exchange, promissory note or other negotiable instrument; rights under memorandum and articles of association; a contract of employment; a contract for the carriage of goods by sea, contract for the carriage of goods by road or for the carriage of cargo by air; or letters of credit. It also does not apply to contracts entered into before the commencement of the CRTP Law.
Defenses and protection against double liability
The CRTP Law provides that, with respect to any proceedings brought against it by a third party in connection with a term of the relevant contract by virtue of the CRTP Law, the “promisor” of the contractual term shall have available to it by way of defense or set-off any matter that, in essence, would have been available to it if the proceedings had been brought by a “promisee” party to the contract.
The CRTP Law provides protection to the “promisor” of a contractual term from double liability, such that, in essence, that promisor cannot be liable for the same obligation to the same extent both to a “promisee” party to the contract and to the relevant third party.
If the parties to a contract intend for a third party to be able to enforce a term of that contract, then the CRTP Law provides a convenient mechanism for the third party to be able to do so without itself either having to become a party to the relevant contract or the requirement for the parties to enter into additional documentation. As mentioned, we would envisage that this mechanism will be particularly helpful in the context of indemnification and exculpation provisions.
If, on the other hand, the parties do not wish the CRTP Law to apply, then they need simply do nothing – as described, the CRTP Law will not apply to a contract unless the contract expressly provides for its application.
The Directors Registration and Licensing Law, 2014
The Cayman Islands government has now enacted The Directors Registration and Licensing Law, 2014, which seeks to regulate directors of certain “covered” entities established in the Cayman Islands, including registered funds and “excluded persons” under the Securities Investment Business Law.
Despite numerous submissions and comments made by industry stakeholders on the corresponding Directors Registration and Licensing Bill, 2014 which was released in March 2014, the Director Law closely follows the terms of the bill. Persons involved in the hedge funds industry anxiously await the release of the regulations and fee schedules to see what registration under the Director Law will entail from a practical perspective and what it will cost. Since many of the individuals who will need to register will be resident outside of the jurisdiction it is hoped that the regime will be simple and user-friendly. Following on from the somewhat controversial introduction in 2012 of registration requirements for master funds (and attendant fees), the fees proposed to be charged for director registration will also be of keen interest to the funds industry.
There are three classes of directors which will be regulated: (1) “registered directors” who comprise natural persons appointed as directors to fewer than 20 covered entities; (2) professional directors, who comprise natural persons appointed as directors for 20 or more covered entities; and (3) corporate directors, comprising bodies corporate appointed as directors for any covered entity. The Director Law applies to each category whether or not the director is resident in the Cayman Islands.
Persons currently acting as directors of covered entities will have three months from the date of the commencement of the Director Law to register. An application for registration may be refused where the applicant has been convicted of a criminal offense involving fraud or dishonesty, or the subject of an adverse finding, financial penalty, sanction or disciplinary action by a regulator, self-regulatory organization or a professional disciplinary body. Registered directors will be subject to annual filing and fee requirements but are not required to maintain insurance.
There is a carve out which applies to a director of a covered entity who is a natural person and is a director, employee, member officer, partner or shareholder of a holder of a company’s management license or a mutual fund administrator’s license and to fund managers of regulated mutual funds where the fund manager is registered or licensed by an overseas regulatory authority listed in the schedule.
These individuals will not be required to be licensed as professional directors but will still be required to register. There are penalties for acting as professional director without licensing and annual filing and fee requirements. Professional directors must also maintain insurance with an authorized insurer. Applicants must be fit and proper persons. The fit and proper person test is the same as set out in the Mutual Funds Law, focusing on (a) honesty, integrity, reputation; (b) competence and capability; and (c) financial soundness.
The licensing requirement for corporate directors applies from the first directorship. A carve out applies to the holder of the company management’s license or a mutual fund administrator where the holder of the license is providing directors to or acting as director for a covered entity. The transitional provision for corporate directors is six months or until a license is refused.
A corporate director must be registered as an ordinary resident, an ordinary non-resident company, an exempted company or foreign company in accordance with the Companies Law, must appoint to its board two natural persons who are registered under the Director Law and have any new or additional director appointed to its board approved by the Cayman Islands Monetary Authority prior to that appointment. Corporate directors (and members of their board) must themselves be fit and proper persons and comply with annual filing and fee requirements. Corporate directors must also maintain insurance.
Power and duties of the Monetary Authority
The authority is to maintain a register of directors to include the name and address, location of the registered office and date of registration or license issuance and shall maintain a general review for the requirements for the qualification of directors, examine the capacity of registered directors, professional directors and corporate directors to carry out their duties and to give directions where necessary and, inter alia, wherever it considers it necessary to examine by scrutiny the prescribed regulatory terms or onsite inspections or in such other manner as it may determine the affairs of business of any registered, professional or corporate director. The balance of the authority’s powers broadly mirror those contained in the Mutual Funds Law.
The Exempted Limited Partnership Bill, 2014
As noted in my previous quarterly legal update, The Exempted Limited Partnership Bill, 2014 was gazetted on Feb. 21, 2014. The Cayman legislature is currently drafting the necessary regulations to accompany the new law and it is expected that the ELP Bill will come into force within a few weeks.
As previously noted, the ELP Bill is a major reworking of the Exempted Limited Partnership Law (2013 Revision) following an extensive public and private sector consultation. The ELP Bill gives partners greater contractual flexibility to determine their affairs and will enhance the overall attractiveness of the Cayman Islands as a domicile for partnership formation.
New FATCA-related legislation
The Cayman Islands has issued draft guidance notes and the Tax Information Authority (Amendment) (No. 2) Bill, 2014 in connection with the United States Foreign Account Tax Compliance Act (FATCA) and the related Intergovernmental Agreements (IGAs) between the Cayman Islands and each of the United States and the United Kingdom.
Cayman Islands Tax Information Authority Guidance Notes
The Cayman Islands Tax Information Authority issued draft Guidance Notes in May 2014 relating to the international tax compliance requirements of the IGAs. The deadline for feedback from the Internal Revenue Service of the United States, HM Revenue & Customs and the Cayman Islands financial services industry was June 6; the Guidance Notes will be finalized shortly thereafter.
The Guidance Notes provide consolidated, practical guidance to assist industry in interpreting and applying the IGAs and the U.S. and U.K. FATCA agreements.
The Tax Information Authority (Amendment)
(No. 2) Bill, 2014
The Tax Information Authority (Amendment) (No. 2) Bill, 2014 was published in the Cayman Islands Gazette on April 30, 2012. The TIA Amendment Bill will facilitate the automatic exchange of information under the Tax Information Authority Law (2013 Revision) (the Principal Law).
The scope of the Principal Law is amended to expressly include the automatic exchange of information.
The TIA Amendment Bill seeks to amend the scope of the Principal Law to facilitate the automatic exchange of information. The Principal Law shall apply for the purpose of giving effect to the terms of a scheduled Agreement for the provision of information for tax purposes including the automatic exchange of information. For this purpose “automatic exchange of information” means the systematic and periodic exchange of information for tax purposes between parties to a scheduled Agreement in the manner and to the specifications agreed between the parties or their competent authorities” and “tax purposes” means “any tax purpose for which information may be provided under a scheduled Agreement or matters incidental thereto.”
Protection of persons disclosing confidential information
The TIA Amendment Bill extends those protections afforded to persons disclosing confidential information under the Principal Law. Persons providing information to the Tax Information Authority to facilitate the automatic exchange of information or otherwise providing information to the Authority for tax purposes shall, by reason only of such disclosure, not commit any offense under the Confidential Relationships (Preservations) Law of the Cayman Islands or under any other laws in force in the Cayman Islands.
The changes to the Principal Law will only apply from the effective date of the TIA Amendment Bill. The changes are necessary to allow parties to fulfill their obligations under the IGAs and to implement requirements under FATCA and other similar agreements.
The current year continues to be a busy one for law changes in the Cayman Islands. In our next review, we will consider the regulations released for the Director Law and the ELP Bill. We will also explore a major issue presently facing Cayman as to whether or not a public register for beneficial owners should be introduced here, following on from a decision by the U.K. to establish one in their jurisdiction.