The Grand Court of the Cayman Islands has provided important guidance to hedge funds and liquidators about the ability to claw back redemption payments made to investors.
Legislative changes are also afoot in the form of the Grand Court (Amendment) Law, and consultation continues on a controversial new Data Protection Bill for the Cayman Islands.
There have been a number of interesting decisions in the Cayman courts over the past quarter, including RMF Market Neutral Strategies (Master) Limited v DD Growth Premium 2X Fund (In Official Liquidation), which requires special mention. This recent decision of the Grand Court provides clear guidance on clawback claims to the Cayman Islands’ funds and insolvency industries.
Misconceived clawback claims by liquidators
There has been a notion floating around the offices of Cayman Islands liquidators that a redeeming investor from a fund is liable to have its redemptions clawed back in favor of the estate in circumstances where it is subsequently shown that the fund was insolvent at the time the payments were made. In a 100-page decision of the Chief Justice in RMF Market Neutral Strategies (Master) Limited v DD Growth Premium 2X Fund (In Official Liquidation) on Nov. 17, 2014, that notion has been demonstrated to have been wholly misconceived.
The judgment represents a victory for common sense and for the Cayman Islands’ funds industry which is based upon investors’ confidence. Investors need to be able to rely upon the net asset value (NAV) struck and the receipt of payments based on that NAV as being the end of their involvement with the fund. This is especially so where, as in this case, the investor was itself a fund of funds.
As the chief justice said, citing the Privy Council decision in Fairfield Sentry Limited (in liquidation) v Migani & others, “Having had their redemption paid on the basis of NAVs which are also published in keeping with the constitutional documents of the fund, those who have redeemed, would not expect that there could be recourse against them by those who were still members of the fund when it collapsed.”
The liquidators’ argument was based upon Section 37(6)(a) of the Companies Law which provides: “A payment out of capital by a company for the redemption or purchase of its own shares is not lawful unless immediately following the date on which the payment out of capital is proposed to be made the company shall be able to pay its debts as they fall due in the ordinary course of business.”
In the case before the court, a NAV had been struck on the basis of a valuation of certain assets which turned out to be worthless so that the NAV had been so overstated that when the assets were realized, there was a shortfall such that the redemptions could not be paid in full. Full payments were made to some redeeming investors, partial payments to others, including RMF, and no payments at all to others. The fund was subsequently wound up and liquidators appointed by the court.
The liquidators sought to recover the payments made to the redeeming investors on the basis that they were unlawful payments out of capital because, when they were made, the fund could not pay its debts as they fell due.
In a detailed judgment, the chief justice examined the capital maintenance doctrine as reflected in Section 37(6)(a) and then considered whether the payments made were payments out of capital. He held unequivocally that they were not.
The mainstay of the chief justice’s reasoning is that save for a de minimis amount of US$1/1000 per share, the purchase price of the fund’s shares represented share premium, and the redemption price of the shares represented share premium plus (or minus) the profit (or loss) on the investment of that share premium (in this case into a similarly named master fund).
Section 34(2) of the Companies Law provides what share premium can be used for and specifically authorizes the use of share premium to be used for “providing for the premium payable on redemption or purchase of any shares of the company” (Section 34(2)(f)).
Accordingly, share premium was not to be regarded as having become part of the paid up share capital of the company for the purposes of the capital maintenance rule as embodied in Section 37(6)(a).
The liquidators had sought to argue that under the 2007 Revision of the Companies Law (applicable at the relevant time) Section 37(5)(a), no reference was made to “share premium,” unlike the 2011 Amendment Law which added such a reference.
Therefore, the argument went, share premium was by Section 37(5)(b) deemed to be capital for the purposes of Section 37(6)(a). The chief justice described this as a “strained and tortuous construction.”
The chief justice expressly rejected an argument that because changes to the wording of Section 37(5)(a) were made in 2011 to include the words “share premium” in that provision, that a change in the law had been made so that prior to 2011 share premium was to be treated as capital, and after 2011 that was no longer to be so. As the chief justice observed, there was no policy change that would justify such a conclusion. The 2011 amendment served to clarify the existing law and not to alter it.
He held that Section 34(2)(f) was to be read without being limited by Section 37 and that there were in effect two separate regimes: that provided in Section 34 and that provided in Section 37. This conclusion was reinforced by the fact that Section 34(2)(c) provided for share premium to be used “in the manner provided in Section 37,” in addition to providing by Section 34(2)(f) that it could be used for providing the premium on redemption. Thus there was no prohibition on using share premium for the purposes of redeeming shares, even if a fund is cash flow insolvent at the time it makes those redemptions.
In the alternative, the liquidators had argued that the payments were a fraudulent preference contrary to Section 168(1) of the Companies Law which requires the payments to be have been made “with a view to giving such creditor a preference over the other creditors.” It has been held previously in the Cayman Islands that this requires the liquidators to prove that the “dominant intention of the debtor was to prefer the creditor.”
On the evidence, the chief justice held that the liquidators had failed to prove such a dominant intention; indeed, on the contrary, he held that the payments were made due to the increasing pressure being exerted by RMF, including unannounced visits to offices and threats of reporting to authorities, and a desire to cover up or postpone the discovery of the catastrophic losses suffered by the fund.
The Grand Court (Amendment) Law 2014
The Grand Court (Amendment) Law 2014 has now come into force, introducing much anticipated clarification of the law providing for interim relief in the absence of substantive proceedings in the Cayman Islands. As a result, the Grant Court will now clearly have the power to grant a free standing Mareva injunction to freeze Cayman Islands’ assets in aid of foreign proceedings.
Consequential changes to the Grand Court Rules will also be required to provide for service of such applications out of the jurisdiction of the Cayman Islands, as well as to specify the requisite originating procedure which will be applicable to commencing a claim under the new provisions.
The availability of interim relief, including free standing Mareva injunctions, in aid of foreign proceedings, will prove a helpful remedy for litigants in foreign jurisdictions wishing to secure assets located in the Cayman Islands, which are at risk of being dissipated, pending the outcome of the foreign proceedings.
Consultation on data protection
The last few months have seen a resurgence of consultation papers for former Bills that never made law. In particular, in September 2014, the government of the Cayman Islands launched a further and final consultation on data protection. An earlier Data Protection Bill was issued in 2012 but never made it to the legislative floor, being sent back after the consultation phase for further drafting. The 2014 Data Protection Bill seeks to protect the rights of individuals relating to the collection, use and sharing of their personal information. Proponents of the bill suggest instituting this legislation in Cayman is necessary to comply with European directives and international standards in order to make Cayman’s financial services industry more attractive. We consider some of the key sections of the draft bill below.
Data protection principles
The bill sets out eight key principles relating to data protection:
- Personal data must be processed fairly and in compliance with the data protection law.
- Personal data must be obtained for one or more specified, explicit and legitimate purposes and cannot be processed in any manner incompatible with that purpose or those purposes.
- Personal data must be adequate, relevant and not excessive in relation to the purpose(s) for which they are collected or processed.
- Personal data must be accurate and, where necessary, kept up to date.
- Personal data processed for any purpose shall not be kept for longer than necessary for that purpose.
- Personal data shall be processed in accordance with the rights of data subjects under the data protection law.
- Appropriate technical and organizational measures shall be taken against unauthorized or unlawful processing of personal data and against accidental loss or destruction of, or damage to, personal data.
- Personal data shall not be transferred to a country or territory unless that country or territory ensures an adequate level of protection for the rights and freedoms of data subjects in relation to the processing of personal data.
The bill also provides guidelines to aid in the interpretation of the data protection principles.
The bill requires “data controllers,” defined as “any person who, alone or jointly with others, determines the purposes and means of the processing of personal data,” to adopt “appropriate technical and organizational measures” to prevent “unauthorized or unlawful processing of, accidental loss or destruction of, or damage to” personal information.
The appropriateness of the measures will be determined based on the harm that might result from unauthorized or unlawful processing of, or accidental loss, destruction or damage to, the personal data and the nature of the personal data to be protected. The bill also makes data controllers accountable for the “reliability” of those employees that have access to personal information.
Breach of security
Breaches of security must be reported to the Information Commissioner’s Office and to the individual concerned. A personal data breach is defined as “a breach of security leading to the accidental or unlawful destruction, loss, alteration, unauthorized disclosure of, or access to, personal data transmitted, stored or otherwise processed by, or on behalf of, a data controller.” Data controllers are required to have in place a strategy for dealing with a breach, including a recovery plan that addresses damage limitation; assessment of the risks associated with the breach; informing the appropriate people and organizations that the breach has occurred and updating information security.
There are a number of exemptions to certain general rules relating to data protection. The exemptions are based on the classification of the data as well as other criteria. Significant exemptions relate to crime and taxation, journalism, literature and art, law and legal proceedings, corporate finance and legal professional privilege.
Complaints regarding the application or interpretation of the data protection legislation can be made to the information commissioner. The information commissioner has the power to gather information to determine whether the legislation has been violated and hear complaints made pursuant to the legislation.
The commissioner may intervene and order the rectification, blocking, erasure or destruction of data. The commissioner can make recommendations for reform and engage in proceedings where a violation of the data protection legislation has occurred. The commissioner will maintain a public register of data controllers and their processing operations. No person is permitted to process personal data unless registered or taken to be included in the register.
The period for consultation with stakeholders on the new Data Protection Bill has now closed. Those opposed to the form of the latest draft bill cite such issues as: it is overly complex, it will be burdensome to business and it will be extremely difficult to enforce. We will watch the progress of the bill with interest and will provide further updates in the coming months.