In a recent judgment,[1] the Cayman Islands Court of Appeal (the “Court”) has upheld the decision of the Grand Court which found that investors who have redeemed their shares but remain unpaid at the commencement of a company’s liquidation are entitled to prove in the liquidation for their redemption proceeds as a creditor. This is the case irrespective of whether or not the company could lawfully have distributed the redemption proceeds to them prior to the commencement of the liquidation. The Court also resolved uncertainty as to the priority of such redemption creditors, by finding that they rank behind the company’s general creditors but ahead of its shareholders.
Background
The first instance case, which was heard by the Honourable Mr Justice Jones QC, arose as a result of redemption requests submitted by Primeo Fund (“Primeo”), one of several investors in Herald Fund SPC (“Herald”), for a redemption date of 1 December 2008. Shortly thereafter, in light of the Madoff fraud, Herald’s directors suspended (among other things) its obligation to pay redemption proceeds. Primeo therefore never received its redemption proceeds and, in July 2013, Herald was wound up by order of the Grand Court.
The Judgment of the Grand Court
As discussed in our briefing note dated 29 July 2015, the case concerns a dispute about the applicability of section 37(7) of the Companies Law (2013 Revision) (the “Law”), which provides, in summary, that an investor whose shares are or are liable to be redeemed but have not been redeemed before the commencement of a liquidation may enforce its redemption claim in the liquidation, provided that the company would lawfully have been able to distribute the redemption proceeds up until the commencement of the liquidation.
At first instance, Jones J held that section 37(7) had no application at all where shares have already been redeemed as at the commencement of a company’s liquidation, and that if an investor had been redeemed by that stage, but had not yet been paid the proceeds of its redemption, it would be an unsecured creditor for those proceeds. Herald appealed this decision.[2]
The Court’s Decision
In summary, the result of the Court’s decision is that:
- section 37(7)(a) of the Law does not apply to an investor (such as Primeo) whose shares were redeemed in accordance with the company’s articles of association before the commencement of its liquidation;
- such investors’ claims are enforceable in the company’s liquidation and rank behind ordinary creditors but ahead of unredeemed shareholders pursuant to section 49(g) of the Law;
- section 37(7)(a) of the Law applies where a holder of redeemable shares has an accrued right to redemption under the articles of association at the commencement of a company’s liquidation, but redemption has not taken place because some further step which was required to be taken by the company to complete the redemption was not taken;
- such investors’ claims will also be enforceable in the liquidation, provided that the company could lawfully have made a distribution equal in value to the redemption proceeds between the due date of redemption and the commencement of the liquidation; and
- if such claims are enforceable then they will rank behind ordinary creditors but ahead of unredeemed shareholders pursuant to section 37(7)(b) of the Law and, it appears (although the Court’s remarks in this regard were strictly obiter), equally with the unpaid investors to whom section 37(7)(a) of the Law does not apply.
Analysis
The Court followed the now well established principle that, as a matter of common law, an investor ceases to be a member of the company and becomes a creditor upon redemption of its shares occurring pursuant to the company’s articles of association.[3] Having found that Primeo’s shares had been redeemed before the commencement of Herald’s liquation, it was then necessary for the Court to determine whether Primeo’s claim was enforceable in Herald’s liquidation pursuant to section 37(7)(a) of the Law or otherwise. There were two reasons why the basis of enforceability of Primeo’s claim mattered.
First, if Primeo’s claim had fallen within section 37(7)(a) then it would have been subject to the proviso in section 37(7)(a)(ii), which prohibits the enforcement of a redemption claim in a liquidation unless the company could lawfully have made a distribution of that amount to the investor between the date of redemption and the commencement of the winding up. As a matter of construction of section 37(7)(a), the Court found that it did not apply where shares had already been redeemed before the liquidation, and that such investors had claims which were capable of being proved pursuant to section 139(1) of the Law.
Second, the statutory basis on which the claim was enforceable would arguably have affected the order of priority which Primeo’s claim would have in the liquidation, and in particular whether it would rank equally with or behind the claims of ordinary creditors.
Section 37(7)(b) provides that claims falling under the section are payable (a) behind (i) all other liabilities of the company (other than any due to members in their character as such) and (ii) amounts due in respect of capital or income to the holders of shares which are preferred to the rights of the section 37(7) claimant as to capital; but (b) ahead of amounts due to members (whether as to capital or income).
The Court’s finding that section 37(7) did not apply to Primeo’s claim meant that the order of priority prescribed by section 37(7)(b) was not engaged. Primeo argued that the consequence of this was that its claim was not statutorily subordinated to, and therefore ranked equally with, the claims of ordinary creditors. The Court found, however, that Primeo’s claim ranked behind ordinary creditors but ahead of unredeemed shareholders pursuant to section 49(g) of the Law.[4]
Section 49(g) of the Law provides that the claims of a company’s ordinary creditors shall have priority over sums “due to any member of a company in his character of a member by way of dividends, profits or otherwise”, but that such sums “may be taken into account for the purpose of the final adjustment of the rights of the [members] amongst themselves”. Although a redeemed investor’s claim for share redemption proceeds arises pursuant to the “statutory contract” between the company and its members, it is somewhat difficult to reconcile the Court’s interpretation of section 49(g) (which applies to sums due to a “member” of the company) with its acknowledgment that redemption proceeds are due to a redeemed investor in its capacity as a creditor which has ceased to be a member.
Although the question did not arise on the facts, the Court went on to observe that claims for redemption proceeds falling outside section 37(7) (such as Primeo’s) and those falling within the section would rank equally with each other.
Conclusion
The Court’s decision brings helpful clarification to the status and ranking of claims for unpaid share redemption proceeds in the liquidation of Cayman Islands funds. It remains to be seen however whether there will be further appeals to the Privy Council either by Herald (in relation to the application of section 37(7)) and/or by Primeo (as regards the construction of section 49(g) and the ranking of its claim).
Aside from any potential appeals, the judgment does call into question the practical relevance of section 37(7). Herald had argued strenuously that the consequence of Primeo’s interpretation was that section 37(7) would have no application in practice, such that it cannot have been correct. In rejecting that argument the Court relied on Herald’s example of section 37(7) applying where an investor’s shares had been liable to be redeemed but were not redeemed because the NAV was not calculated prior to the liquidation. In practice, however, this example would appear to have limited relevance, because the redemption of shares in Cayman funds almost invariably occurs automatically on the redemption date. The timing of the redemption is rarely dependent and effective on the completion of the NAV calculation, which would typically not occur until some time after the applicable redemption date. Shares are generally redeemed on the redemption date for a price to be determined upon completion of the NAV calculation.
Further, in light of the Court’s view that redemption claims rank equally whether or not they fall under section 37(7), the only remaining consequence of the section’s application is its requirement, under section 37(7)(a)(ii), that for a redemption claim to be enforceable in the liquidation the company must have been able, between the redemption date and the start of the liquidation, to have lawfully made a distribution equal in value to the redemption price. But subject to the possibility of a successful appeal to the Privy Council of the Court of Appeal’s earlier decision in DD Growth Premium 2X Fund (in Official Liquidation) v RMF Market Neutral Strategies (Master) Limited[5], it is now difficult to envisage circumstances in which it would ever be unlawful, within the meaning of section 37(7), for a Cayman Islands fund to distribute redemption proceeds in accordance with its articles of association.
Lastly, the Court’s judgment also highlights the policy question of whether an investor which has redeemed its shares and become a creditor before the liquidation should rank behind the fund’s ordinary creditors (including those ordinary creditors whose claims arise after the investor has exited the fund) or equally with them. That is a question for the legislature, but section 37(7) and section 49(g) are both arguably ripe for statutory reform.
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