In this edition of Law Talk we consider a recent decision of the Cayman Islands’ Court of Appeal in Michael Pearson (as Additional Liquidator of Herald Fund SPC (In Official Liquidation) v Primeo Fund (In Official Liquidation) that has provided further clarity regarding the rights of redeeming investors of Cayman Islands’ funds in liquidation. We also consider an important new law, the Cayman Islands’ Confidential Information Disclosure Law, 2016 which repeals the Confidential Relationships (Preservation) Law (Revised) and effectively de-criminalizes and facilitates the disclosure of confidential information in certain defined circumstances.
IN THE COURTS
Michael Pearson (Herald Fund) v Primeo Fund (In Official Liquidation)
(Court of Appeal, Unreported 19 July 2016)
Primeo is the latest in a line of decisions in the Cayman Islands courts since the 2008 global financial crisis, considering the issue of the status of redeemed investors in the liquidation of a Cayman Islands fund. In Primeo the Cayman Islands’ Court of Appeal has shed some light on the difficult questions of law arising in relation to section 37(7)(a) of the Cayman Islands Companies Law (Revised). In particular, it seeks to clarify the ranking of redeemed investors vis-à-vis other creditors and unredeemed investors in the waterfall of payments in a winding up.
Herald Fund SPC (“Herald”) was established as an exempted segregated portfolio company in the Cayman Islands in 2004 and registered as a mutual fund. Investors in the fund, including Primeo Fund (“Primeo”), also a Cayman Islands investment fund, received non-voting, redeemable, participating shares in exchange for their investments. Herald was a Madoff feeder fund and invested in Bernard L Madoff Investment Securities LLC (“BLMIS”) which was a limited liability company incorporated in New York.
In late 2008, Herald received redemption requests from a number of shareholders, including Primeo (the “December Redeemers”), for a Dec. 1, 2008 redemption date and, in accordance with the terms of Herald’s Articles of Association, the names of those redeeming shareholders were removed from Herald’s register of members on that date.
On Dec. 11, 2008, Mr. Madoff confessed that BLMIS was a fraudulent ‘ponzi’ or pyramid scheme. Subsequently, the directors of Herald suspended all redemptions and the calculation of Net Asset Value on Dec. 12, 2008 (the “Suspension”) and as a result, the redemption payments to be made to the December Redeemers, including Primeo, were not paid.
On Jan. 23, 2009, Primeo was voluntarily wound up and on April 8, 2009, Primeo was put into official liquidation under the supervision of the Court (the joint official liquidators were later changed on May 11, 2012). Herald was also put into receivership under the supervision of the Court on July 16, 2013.
The December Redeemers claimed they were entitled to receive their redemption payments as creditors, that they should be treated pari passu with all other unsecured creditors of Herald and that they should rank ahead of those shareholders who had not submitted redemption requests prior to the Suspension.
Conversely, the liquidators of Herald argued that the December Redeemers were caught by section 37(7)(a) of the Companies Law (Revised), that they therefore remained shareholders and had no entitlement to present claims as creditors in relation to the redemption proceeds.
The Companies Law
Section 37(7)(a) of the Companies Law (Revised) states:
(a) Where a company is being wound up and, at the commencement of the winding up, any of its shares which are or are liable to be redeemed have not been redeemed or which the company has agreed to purchase have not been purchased, the terms of redemption or purchase may be enforced against the company, and when shares are redeemed or purchased under this subsection they shall be treated as cancelled:
Provided that this paragraph shall not apply if-
(i) the terms of redemption or purchase provided for the redemption or purchase to take place at a date later than the date of commencement of the winding up; or
(ii) during the period beginning with the date on which the redemption or purchase was to have taken place and ending with the commencement of the winding up the company could not, at any time, have lawfully made a distribution equal in value to the price at which the shares were to have been redeemed or purchased.
The correct interpretation of the underlined phrase was the subject of this appeal.
Grand Court Decision
At first instance, Jones J ruled that section 37(7)(a) did not apply to the December Redeemers (and that they fell outside the scope of that section) on the basis of the reasoning of the Privy Council in Culross Global SPC Limited v Strategic Turnaround Partnership Limited [2010 (2) CILR 364]. Jones J differentiated between the scenario in the instant case and what he considered to be the intended effect of section 37(7)(a). The primary distinction Jones J made was that he considered that section 37(7)(a) would apply in situations where an investor had submitted a redemption request but had not completed some other requisite procedure or formality in order to validly redeem their shares. In the instant case, the December Redeemers had validly redeemed their shares but had simply not received payment prior to the Suspension. The redemption date had passed prior to the commencement of the winding up and following the reasoning in Culross the debt had crystallized and the December Redeemers had become creditors, fully redeemed even though they were awaiting payment. Jones J’s judgment left open the question as to whether the December Redeemers, including Primeo, would rank pari passu with other unsecured creditors.
Judgment of the Court of Appeal
The Court of Appeal upheld the prior decision of the Grand Court and stated that Jones J was correct in holding that section 37(7)(a) did not apply to the December Redeemers. The Court of Appeal found that section 37(7)(a) does not apply in scenarios where, at the commencement of the winding up, the redeemable shares in question have been redeemed in accordance with the Articles of Association, notwithstanding that the redemption proceeds are yet to be received. Field JA stated that section 37(7)(a) applies in situations where at the commencement of the company’s winding up, a shareholder with redeemable shares has a right of redemption under the relevant Articles of Association but there has been no redemption because the steps required by the Articles for this to occur have not been completed.
Notably, the Court of Appeal clarified that redeemed but unpaid investors would not rank pari passu with other unsecured creditors. The basis of this reasoning was that the redemption proceeds claimed by the investors were founded in the statutory contract between the investors and Herald and therefore would be classified as claims due “in his character of a member” under section 49(g) of the Companies Law (and were therefore subordinated to claims of ordinary third party creditors). Accordingly, the December Redeemers had provable contingent claims in Herald’s liquidation, although those claims would rank behind Herald’s other unsecured creditors but ahead of other Herald shareholders.
The Court of Appeal’s decision provides helpful clarification as to the status and ranking of claims for unpaid redemption proceeds. It remains to be seen whether the decision will be appealed to the Privy Council by Herald (with respect to the application of section 37(7)(a)) or by Primeo (with respect to the ranking of its claim).
New confidential information disclosure law, 2016
A new confidentiality regime was introduced in the Cayman Islands on July 22, 2016, in the form of the Confidential Information Disclosure Law, 2016 (the “CIDL”), replacing the (now repealed) Confidential Relationships (Preservation) Law (Revised) (the “CRPL”) which was often unfairly described as a “secrecy” law. The CIDL has been enacted to reflect the continuing commitment of the Cayman Islands’ government to global tax information exchange and cooperation between law enforcement authorities.
The CRPL was first enacted back in 1976, when the development of the Cayman Islands as a global financial center was in its early stages, and made it a criminal offense for any person in the Cayman Islands to disclose confidential information obtained during the course of business without consent, subject to a number of limited exceptions .
The CIDL removes the criminal sanctions that attached to disclosure of confidential information under the CRPL and sets out clear pathways through which confidential information can now be disclosed, without the prior consent of the person to whom it relates.
When a duty of confidentiality arises during the course of business, the CIDL makes it clear that the disclosure of information in the following circumstances, among others, will not constitute a breach of the duty and shall not be actionable:
1. In the normal course of business (as defined in the CIDL) or with the express or implied consent of the principal;
2. Pursuant to or in accordance with any right or duty created by other laws and regulations in the Cayman Islands;
3. In response to requests by Cayman tax, law enforcement and financial regulatory authorities, including the police, the Cayman Islands Monetary Authority and the Financial Reporting Authority; and
4. Upon direction of the Grand Court pursuant to an application under the CIDL.
A breach of the common law duty of confidentiality will still give rise to a right of remedy (including damages or injunction), so that the question of liability for breach of confidence will now be dealt with under the auspices of the common law and the rules of equity.
Section 3(2) of the CIDL also provides a “whistle-blowing” defense to an action for beach of a duty of confidence to a person who discloses confidential information on wrongdoing, or in relation to a serious threat to the life, health, safety of a person or to the environment. The defense will apply as long as the person acted in good faith and in the reasonable belief that the information was substantially true and disclosed evidence of the wrongdoing or serious threat.
Importantly, as the CRPL did before it, section 4 of the CIDL provides an avenue by which a person may be permitted by the Cayman Islands’ Courts to give confidential information in evidence before any court, tribunal or other authority, whether in the Cayman Islands or elsewhere. Giving of evidence includes making a statement, producing a document by way of discovery, answering interrogatories or testifying during or for the purposes of any proceeding. A person who intends to or is required to give evidence and the evidence consists of or contains confidential information is required to apply to the Cayman Court for directions unless the principal to whom the duty is owed has consented expressly.
The provisions of the CIDL are a further demonstration that the Cayman Islands does not support “secrecy” laws and that this jurisdiction is committed to working with international tax and law enforcement authorities and governments globally to improve corporate and tax transparency, while maintaining necessary respect for the privacy of individuals and corporate entities.