Decision: Cayman Funds May Suspend Redemptions After Redemption Date

Jan 13 2009 | 10:44am ET

By Lawrence Cohen -- In this weakened global economy, investors are flooding hedge funds with demands for withdrawal of their capital. A recent judgment delivered by the Cayman Islands Court of Appeal addressed certain critical questions relating to the suspension of redemptions of shares in a Cayman Islands investment fund.  The Court of Appeal held that, depending on the terms of its governing documents, a Cayman fund may suspend redemptions of investors who have submitted their redemption notices, even after the redemption date has passed.

Background

Strategic Turnaround Master Partnership Limited is an exempted limited company incorporated under the Cayman Islands Companies Law and registered with the Cayman Islands Monetary Authority. Culross Global Limited, a British fund-management company, subscribed for USD$1.84 million worth of Strategic shares in May 2007.  After almost half of Culross’ investment was lost, it submitted a request on October 31, 2007 to redeem all of its shares and identified the redemption date as March 31, 2008.  On March 24, 2008, a director of Strategic sent an e-mail to Culross confirming that payment of 90% of the cash would be paid by the end of April 2008, as per Strategic’s Confidential Explanatory Memorandum. 

On April 17, 2008, the directors of Strategic resolved to suspend all redemptions in the best interests of the shareholders.  Five days later, they suspended the fund’s NAV calculations.  On April 23, 2008, Strategic’s attorneys notified CIMA that all redemptions were suspended and Strategic notified its shareholders of the suspension on April 28th.

Culross petitioned the Grand Court of the Cayman Islands to force Strategic to wind up its business, arguing that Strategic was unable to pay its debts and failed to treat Culross in a “just and equitable” manner.  Strategic responded by applying for a ruling to summarily dismiss, or “strike out,” Culross’ petition.  When this application was dismissed, Strategic filed an appeal with the Court of Appeal.

Judgment Relating to Redemptions

The Court of Appeal focused on “issues of construction and law” and emphasized that “it cannot and will not resolve disputed issues of fact.”  It would decide only whether Strategic’s suspension of redemptions was appropriate or “whether it constitutes an abuse of the Court’s procedure.”

The first question that the Court of Appeal addressed was at what point did Culross become a creditor of Strategic?  Culross’ counsel argued that a debt could not exist until it was quantified.  The Court disagreed, pointing out that Strategic’s Articles of Association provided that the price to be paid for redeemed shares “shall be deemed a liability. . . from the close of business on the Redemption Day.”  Thus, Culross became a creditor of Strategic on March 31, 2008, the redemption date, in the amount of the redemption value “that was yet to be quantified.”

Having concluded that Culross was a creditor on the redemption date, the Court of Appeal next examined whether Culross ceased to be bound by the Articles on that date, notwithstanding that it was still listed on Strategic’s register of shareholders.  Reviewing the compulsory redemption provisions in the Articles, the Court of Appeal held that the specific language confirmed that Culross, even though it voluntarily redeemed its shares, continued to be bound by the Articles after the redemption date.  Culross would remain subject to the Articles until its name is removed from the shareholder register and it receives its redemption proceeds.

Next, the Court focused on whether the directors’ had the power to suspend redemption payments, even after the redemption date.  Apart from the facts and circumstances considered by the lower court and Culross’ argument that it had properly withdrawn from Strategic, the Court of Appeal stated that the CEM clearly expressed that Strategic’s power to suspend redemption payments applied throughout the entire process of redemption (i.e., (i) the redemption notice, (ii) the debt arising on the redemption date, (iii) the calculation of the NAV at the redemption date and the redemption sum, (iv) the payment of the redemption sum, and (v) the removal of the shareholder from Strategic’s shareholder register).  The power to suspend redemptions was not impeded by the language in the CEM providing that 90% of the redemption proceeds will be paid out upon the redemption of shares.  The Court of Appeal stated that this should not be interpreted as a promise to pay out the proceeds, and even if it were, the power to suspend redemptions qualified that promise. 

According to the Court of Appeal, Strategic was not limited to suspending the shareholder’s right to redeem.  It had the power, under its Articles and as expressed in its CEM, to suspend both the “effective redemption” on March 31, 2008 and the later payment of proceeds to Culross.  The March 31st redemption date meant nothing more than Culross became a creditor as of that date -- it did not signal the end of the redemption process and suspension of payments could still occur.

The Court of Appeal next considered Culross’ petition to wind-down the fund.  Since Strategic appropriately suspended the payment of Culross’ redemption proceeds, the debt owed to Culross (which became a creditor upon the filing of its redemption request) was also suspended.  The Court of Appeal reasoned that, since no debt was presently due and payable, Culross had no standing to petition for the liquidation of Strategic on the basis that Strategic was unable to pay its debts.

This decision is important because it confirmed that the redemption of shares is not a single event, but a process.  If appropriately set forth in a fund’s documents, investors that request redemptions retain all of their rights and obligations as shareholders (including the right to bring a petition for the winding up of the company on “just and equitable” grounds), but are also subject to suspension of the payment of proceeds until monies are actually paid out and the investors are removed from the register.

Lawrence Cohen is a director in the corporate department at law firm Gibbons P.C.  As a former legal officer and compliance director of mutual fund groups, he brings practical experience to the regulation and registration of public investment companies and the formation and operation of private investment companies.


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