The Port Fund: Privy Council clarifies test for derivative action by a limited partner

Summary

In the recent judgment of Kuwait Ports Authority and Ors (Respondents) v Mark Eric Williams & Ors (Appellants),[1] delivered on 28 October 2024, the Judicial Committee of the Privy Council (“JCPC”) clarified the test for determining whether a limited partner in a Cayman Islands exempted limited partnership (“ELP“) is entitled to bring a derivative action on behalf of the ELP. This test is governed by section 33(3) of the Exempted Limited Partnership Act (2021 Revision) (“ELP Act”), which provides that such an action may be brought by a limited partner only if the general partner has “without cause, failed or refused to institute proceedings”. This is the first case in which this test has been considered by the JCPC.

The Board ultimately dismissed the appeal, finding that the limited partner Respondents had the right to bring the derivative action because the general partner had failed to bring proceedings without cause as its decision making was subject to a relevant inhibition in the form of a conflict of interest. In doing so, the Board overruled certain material aspects of the lower Court decisions, and endorsed eleven principles which will serve as a useful guide for approaching and determining future applications made under section 33(3).

The Board also dismissed the Respondents’ cross-appeal, which concerned the point at which the section 33(3) test is to be assessed, upholding the Court of Appeal’s finding that the relevant point in time is the date of the strike out hearing, rather than, as the Judge had held, the time the derivative action was commenced.

Background

The Port Fund L.P. (the “Fund”), a private equity fund structured as an ELP, is the subject of ongoing litigation in the Cayman Islands[2], and is the first Cayman Islands ELP in which limited partners have brought derivative claims under section 33(3) of the ELP Act. The relevant limited partners are two Kuwaiti state entities, the Kuwait Ports Authority and the Public Institution for Social Security (“KPA” and “PIFSS” respectively, together the “Respondents”).

The Respondents have issued proceedings against (amongst others) Port Link GP Ltd (the general partner of the Fund – the “General Partner”), Mark Williams (the ultimate beneficial owner of the General Partner), Wellspring Capital Group Inc (“Wellspring”), and KGL Investment Company Asia Ltd (“KGLI Asia”) (together, the “Appellants”). The Respondents’ claims are in unlawful means conspiracy, and allege dishonest breaches of trust and fiduciary duty, knowing receipt and/or dishonest assistance. The claims are brought both as direct claims for the alleged loss each Respondent claims to have suffered as a limited partner of the Fund, and as derivative claims on behalf of the Fund.

In the Grand Court of the Cayman Islands, the Appellants and the General Partner sought to strike out the Respondents’ derivative claims on the basis that the Respondents did not have a right to bring such actions by operation of section 33 of the ELP Act, subsection 1 of which provides that a claim belonging to an ELP must be brought by the general partner acting on behalf of the ELP. Exceptionally, pursuant to section 33(3) of the ELP Act, a limited partner may bring a derivative claim for and on behalf of an ELP if the general partner has “without cause, failed or refused” to bring the claim.

The Appellants and the General Partner argued that the Respondents did not have a right to bring the derivative actions because the professional directors of the General Partner, who took office after the alleged wrongdoing, had conducted an extensive investigation into the subject matter of the derivative claims and concluded that there was not cause to bring the derivative claims advanced by the Respondents. Having taken these steps, it was submitted that the General Partner had not, without cause, failed or refused to institute proceedings, and therefore the Respondents did not have a right to bring a derivative claim on behalf of the Fund.

The Respondents argued that section 33(3) does not require the Court to embark on a detailed enquiry of the merits of the underlying claims. Their case was that the derivative claims are maintainable as pleaded and that the General Partner had a reasonable opportunity to bring those claims but did not do so. It therefore failed to do so “without cause”, within the meaning of section 33(3) of the ELPA.

On 25 November 2021, the Grand Court found[3] that there was a good arguable case that the General Partner had failed or refused to bring the claims, and that it still has a ‘relevant inhibition’ to do so because it is conflicted (it being the target of or alleged to be implicated in certain of the claims). The Grand Court therefore dismissed the strike-out applications.[4]

The Appellants and the General Partner appealed to the Court of Appeal of the Cayman Islands (the “CICA“). On 20 January 2023, the CICA struck out[5] the derivative claim against the General Partner on the basis that direct claims are being pursued against it. However, it upheld the Grand Court’s decision not to strike out the derivative claims brought against the Appellants owing to the inhibition of the General Partner.[6]

Privy Council decision

The Appellants appealed to the JCPC, which heard the appeal in June 2024.

JCPC’s findings

The JCPC ultimately dismissed the appeal and the cross-appeal.

The JCPC agreed with the reasoning and conclusion of the CICA that a failure to bring proceedings may be “without cause” for the purposes of section 33(3) where the decision making is subject to a relevant inhibition, and that an actual conflict of interest would amount to a relevant inhibition.[7] In this case, the JCPC found that the General Partner had an actual conflict of interest by reason of it (amongst other things) having been the subject of the derivative claim that it refused to bring.[8]

The Board also agreed with the CICA and Grand Court that the fact that a commercial decision was taken by the General Partner’s professional directors not involved in the alleged wrongdoing did not avoid that conflict of interest for three reasons:[9]

• if the General Partner was subject to a disqualifying conflict of interest in making the decision whether or not to bring proceedings then that is not affected by the identity or independence of its directors;
• the directors were also subject to a disqualifying conflict of interest as they owed a duty to act in the best interests of the General Partner and where there is a conflict between the interests of the General Partner and the Fund then that duty puts the directors in a conflicted position; and
• the directors were unable to assess the claims properly in an independent and objective way because they had been guided in their investigations by information provided by those who were under investigation themselves, and by their legal advisers, who were also conflicted.

Finally, the JCPC disagreed that any perceived potential conflict of interest would inevitably render any decision not to bring such claims as one “without cause”. The JCPC held that the CICA’s findings are only likely to apply in the case of a claim against persons closely associated with the general partner, or a claim in which the general partner is implicated, and which is seriously arguable.[10]

More generally, the JCPC found that the CICA erred in adopting a two stage approach whereby the court considers first if the section 33(3) “without cause” test is satisfied, and secondly whether as a matter of discretion the derivative claim should be permitted. The JCPC ruled that there is only a single evaluative decision to be made as to whether the statutory requirements are met, but that decision allows for account to be taken of discretionary considerations. For the same reason, it is not strictly correct to refer to the court permitting or allowing derivative proceedings to be brought. There is no permission or leave requirement.[11]

With respect to the cross-appeal, the JCPC agreed with the CICA’s conclusion that the court should reach its decision by reference to the facts as they appear at the date of the hearing of the strike out or preliminary issue. This approach allowed, amongst other things, the court to have regard to circumstances that may have changed since the initiation of the proceedings including, for example, the removal of the inhibition or conflict that was the basis for contending that the refusal or failure to institute proceedings was without cause.[12]

JCPC’s guidance for future applications

In light of the JCPC having found that the CICA erred in certain respects, the JCPC took the opportunity to clarify the guidance given by the CICA as to how applications under section 33(3) should be approached and determined. Specifically, the JCPC set out eleven principles which will serve as a helpful guide in future applications made under section 33. Those principles are as follows:[13]

1. There is no requirement for leave to bring derivative proceedings under section 33(3) of the ELP Act. A limited partner may simply institute such proceeds.
2. A limited partner must however plead the facts and matters relied upon as showing that it can bring itself within the requirements of the subsection.
3. If a defendant wishes to raise an issue as to whether the requirements of the subsection are met, it should do so by means of a strike out application or seek the trial of a preliminary issue.
4. Whichever of these routes is chosen does not affect the test which has to be applied in deciding whether section 33(3) is complied with.
5. The decision of the court on such an application or preliminary issue is determinative (subject to appeal). If the court holds that the derivative claim may be continued, the limited partner may pursue the claim. It is not an issue which is deferred until or revisited at trial (save possibly in the context of costs at the end of the trial).
6. The court should not conduct a mini trial as to whether the requirements of section 33(3) are satisfied. The Court has to reach its decision on the basis of the material before it, which will be more limited than it will be following discovery and trial.
7. At the hearing, the onus in on the limited partner to satisfy the court that the requirements of section 33(3) are met.
8. The essential task for the court at such a hearing is to determine whether the limited partner has brought itself within the terms of section 33(3), namely that the general partner has failed or refused to bring the relevant proceedings without cause.
9. In determining this issue, the court is likely to be assisted by consideration of whether “special circumstances” (as developed in cases concerning trusts, limited partnerships and other entities) exist, but the court’s task remains one of applying the statutory test set out in section 33(3).
10. The court should consider, inter alia, the strength of the evidence that the general partner has failed or refused to institute proceedings without cause, the strength of the underlying claim which is sought to be brought and the likelihood and nature of any injustice if the derivative claim does not proceed. This will allow for account to be taken of discretionary considerations, such as whether the plaintiff has an alternative remedy.
11. The court should reach its decision by reference to the facts as they appear at the date of the hearing of the strike out or preliminary issue.

Comment

This decision will be of interest to private equity and other stakeholders familiar with the widely-used Cayman ELP structure. The JCPC’s judgment provides welcome guidance regarding the approach to be taken to limited partner derivative claims under section 33. On one view, the JCPC’s judgment sets the bar for such derivative claims relatively low, enabling limited partners to pursue claims derivatively that the general partner may have legitimate reasons not to pursue by implicating the general partner in the derivative claim. This may therefore lead to an increase in the number of derivative claims that are threatened or brought by limited partners against general partners and others. Conversely, limited partners may take comfort from their ability to pursue claims derivatively should the need arise.

Andrew Pullinger

Partner

+1 345 914 5865

apullinger@campbellslegal.com

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Matheo Vinciullo

Associate

+1 345 914 6931

mvinciullo@campbellslegal.com

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