Prior to investing in a Cayman Islands-based investment fund, it is customary for a proposed investor to ask the Cayman fund’s directors or investment manager to confirm the liquidity terms of the Cayman fund. By “liquidity,” the investor is referring to the possibility and frequency that the Cayman fund’s shares may be redeemed.
Follow-up requests from the incoming investor include confirmations of when redemption proceeds may be paid to the investor; whether the investor becomes a creditor in respect of the redemption proceeds as of the redemption date; and whether the payment of redemption proceeds may be suspended by the board of directors of the relevant Cayman fund.
In order to answer some of these queries, it is useful to observe some of the provisions of the Companies Law of the Cayman Islands and the judgment passed down by the Judicial Committee of the Privy Council of England in the Cayman case of Culross Global SPC Limited v Strategic Turnaround Master Partnership Limited.
Redemptions under the Companies Law
Section 37(1) of the Companies Law states that:
“Subject to this section, a company limited by shares or limited by guarantee and having a share capital may, if authorised to do so by its articles of association, issue shares which are to be redeemed or are liable to be redeemed at the option of the company or the shareholder and, for the avoidance of doubt, it shall be lawful for the rights attaching to any shares to be varied, subject to the provisions of the company’s articles of association, so as to provide that such shares are to be or are liable to be so redeemed.”
Section 37(2) goes on to say:
“Subject to this section, a company limited by shares or limited by guarantee and having a share capital may, if authorised to do so by its articles of association, purchase its own shares, including any redeemable shares.”
Lastly, section 37(3) states:
“(a) No share may be redeemed or purchased unless it is fully paid.
(b) A company may not redeem or purchase any of its shares if, as a result of the redemption or purchase, there would no longer be any issued shares of the company other than shares held as treasury shares.
(c) Redemption or purchase of shares may be effected in such manner and upon such terms as may be authorised by or pursuant to the company’s articles of association.
(d) If the articles of association do not authorise the manner and terms of the purchase, a company shall not purchase any of its own shares unless the manner and terms of purchase have first been authorised by a resolution of the company.”
Having looked at what is required under the Companies Law to permit a redemption of shares, it is now useful to examine what was determined under Strategic Turnaround regarding the effective date of a redemption and when redeeming investors become creditors of a Cayman fund.
Strategic Turnaround: When a redeeming investor is deemed to exit a Cayman fund
In delivering the opinion of the Privy Council in Strategic Turnaround, Lord Mance stated that it is a basic principle of company law that capital subscribed to a company may not be returned to shareholders otherwise than as prescribed by statute.
In this regard, reference was made by Lord Mance to above-mentioned sections 37(1) and 37(3)(c) of the Cayman Companies Law. In a nutshell:
If authorized to do so by its articles of association, a Cayman fund may issue shares which are to be redeemed or are liable to be redeemed at the option of the company or the shareholder.
The manner in which any redemption may be effected must be authorized by or pursuant to the articles of association.
Accordingly, if (i) a Cayman fund is authorized by its articles of association to issue redeemable shares, (ii) the Cayman fund issues redeemable shares pursuant to the authority in the articles of association, (iii) redeemable shares are redeemable at the option of the company or the shareholder, and (iv) the articles of association describe the authorized manner and the terms upon which any redemption may be effected, then the board of directors of the Cayman fund must ensure that the redemption is effected in the manner authorized by the articles of association.
Once a redemption is effected in the manner authorized by the articles of association, the redeemed investor will become a creditor of the Cayman fund.
Strategic Turnaround: Suspending payment of redemption proceeds after the redemption date
In practice, an investor in a Cayman fund may find himself in a position where his shares were validly redeemed in the manner authorized by the articles of association, the redemption proceeds remain unpaid for a period and the board of directors of the relevant Cayman fund indicate its intention to suspend the payment of redemption proceeds during the said period. This ability to suspend redemption proceeds was discussed by the Privy Council in Strategic Turnaround.
The Privy Council took the view that:
- the issue depends upon the construction of the articles of association, read with other documents as may be incorporated or referred to therein, and
- any power to withhold payment of redemption proceeds must be authorized by or pursuant to the articles of association.
It is consistent with the Privy Council’s view that, if the offering document of a Cayman fund contains a statement that the Cayman fund’s board of directors may suspend the payment of redemption proceeds and such description embraces powers which go beyond those set out in the Cayman fund’s articles of association – for example, where the articles of association contain no such power to suspend the payment of redemption proceeds – the description in the offering document of a Cayman fund will be of no legal effect as against investors.
The opinion delivered by the Privy Council in the Strategic Turnaround case highlights the importance for lawyers to properly draft a Cayman fund’s articles of association. Bearing this in mind, clients should be wary of any offer to them to utilize any “template” articles of association, which may not provide the Cayman fund’s board of directors with the appropriate powers or flexibility.