Introduction
A recent judgment of the Cayman Islands Court of Appeal ('CICA') has provided a welcome degree of certainty for investors and insolvency practitioners alike with respect to the priority to be afforded to investors' claims for unpaid redemption proceeds in the winding up of Cayman Islands investment funds. The judgment has, however, given rise to a suggestion that the relevant part of the legislation may operate such as to allow investors, in certain circumstances, to convert themselves from shareholders to creditors after the commencement of a winding up.
The CICA decision is one of the most recent in the ongoing liquidation proceedings of Herald Fund SPC ('Herald'). Herald was, in terms of its constituent documents at least, a fairly typical Cayman Islands domiciled open-ended mutual fund, often referred to as a 'hedge fund' (the Cayman Islands remaining the most popular hedge fund jurisdiction in terms of both number of registered entities and total assets under management). However, as explained below, Herald's sole investment turned out to be a substantial investment in the Madoff Ponzi scheme and Herald ultimately ended up in official liquidation in the Cayman Islands.
As with most developed common law jurisdictions, the legal framework in the Cayman Islands for winding up insolvent companies has long been the domain of statute, codifying common law principles developed over two centuries of jurisprudence. Prior to the first instance decision which was appealed to the CICA, the Companies Law (2013 Revision) (as amended) (the 'Companies Law') and its subordinate rules, The Companies Winding Up Rules 2008 (as amended) (the 'CWR'), had been considered by many practitioners to provide a relatively clear mechanism for determining the enforceability and priority of creditor claims in a Cayman Islands liquidation, drawing a clear distinction for the purposes of priority in the liquidation between ordinary unsecured third party or 'outside' creditors (e.g. trade creditors and service providers) and those creditors whose claims arose in their capacity as members, for example, redeeming shareholders (i.e. those shareholders who sought to redeem all or part of their investment, but had not been paid prior to the commencement of the winding up - what has become known, perhaps colloquially, as a 'redemption creditor'). This distinction was temporarily displaced as a result of the first instance decision of the Grand Court of the Cayman Islands ('Grand Court'), with clarity being provided by the CICA – effectively confirming and restoring a common law principle that has existed for over 100 years.
This aspect of the proceedings involves an important point of statutory construction, namely how section 37(7) of the Companies Law operates in the factual context of Herald which involved claims to significant unpaid redemption proceeds which were sought to be enforced several years after the discovery of the Ponzi scheme and which with the benefit of hindsight were clearly based on a wholly fictitious NAV. The outcome of the proceedings is highly material to Herald's various categories of stakeholders (the redemption claims, if valid, being valued at almost USD 200m). The issue is one that has rarely confronted the Grand Court in any detail and certainly this was the first time it had been considered at appellate level.
The Additional Liquidator of Herald has subsequently issued a further appeal from the decision of the CICA to the ultimate appellate court of the Cayman Islands, the Judicial Committee of the Privy Council ('Privy Council').
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This article was originally published in International Corporate Rescue (Volume 14, issue 1).
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