Those of you who know me will recognise an old hobby horse. The importance of a fund’s constitutional documents.
There have been a few interesting cases reported from the Cayman and BVI courts that are worth bearing in mind – if for no other reason than to emphasise why any due diligence on a fund cannot be done properly without a thorough reading of the constitutional documents and in particular the articles of association.
I have often been chided for my interest in these documents. Investment teams are quick to point out that these documents are no more than standard templates churned out by lawyers. But they are relevant because they form the basis of the contract between shareholders and the fund. Their significance increases when a member needs to exercise rights to get back investments in the face of suspensions and other impediments that a fund board may put up when an investor is trying to recover their investment.
This importance has been emphasised by the ruling of the Privy Council in a Cayman case that was heard before it on appeal – Culross Global SPC Limited v Strategic Turnaround Master Partnership Limited. The ruling given in December 2010 is relevant because a subsequent ruling in March 2011 in the BVI is not consistent with the Cayman ruling and therefore underlines the importance of understanding what the articles of association say about a redeeming investor’s status in order to determine what rights may exist to recover money.
These cases have revolved around determining the status of a redeeming shareholder. The distinction between whether you are a member or a creditor of a fund determines what rights you may have to enforce the recovery of money owed to you.
Where a shareholder is trying to get out of a fund that is making losses – the member will have a clear interest in trying to minimise its losses by crystallising the amount owed to it and then enforcing its rights as a creditor of the fund in order to be paid a distribution in priority to other members. A creditor typically would be able to enforce its rights by applying to the court for a winding up order against the fund if money owing to the creditor is not paid when the amounts fall due.
In addition, the Privy Council judgement analyses in great detail how the articles of association have been constructed and then looks at a common mechanism used by offshore lawyers to incorporate the prospectus into the articles – which the judges rejected on the facts of this particular case because of the caveats and disclaimers used by the lawyers in the prospectus.
Establishing the status of a redeeming member was also clarified in a case in the BVI but takes a position contrary to the Privy Council decision in the Cayman case. In Westford Special Situations Fund Ltd v Barfield Nominees Limited & Ors the Court of Appeal took a different view from the court of first instance (which had taken an approach similar to the Cayman Privy Council decision) and determined that BVI insolvency law does not recognise a redeeming member as being a creditor with locus for the purposes of applying for the winding up the company even though they may be a creditor of the fund in a wider sense.
This of course can create a difficulty for a redeeming member if they are no longer a member of the company because the articles are often constructed so that upon redemption a member ceases to have any rights as a member but by virtue of this ruling is also not a creditor of the company able to enforce its rights by seeking a winding up of the fund.
Because of the differences in approach in these offshore jurisdictions, investors would do well to ensure that they seek clarification of the position or seek to have the articles amended to ensure that their position and rights of enforcement are expressly articulated as part of the due diligence that they complete.
Amending articles is an expensive business which investment managers will be reluctant to do but it may be even more expensive if the position is unclear and investors have to place themselves at the mercy of the offshore court lottery in order to recover investments.
©Jaitly LLP