A series of high-profile Cayman Islands court judgements on redemptions and creditors have helped to clarify the language and documentation used by hedge funds.

Cayman’s legal profession has been busy dealing with the fallout caused by Gates and suspension of redemptions by hedge funds caught in difficult positions due to the financial crisis. Investors, increasingly frustrated with a lack of movement (and return of funds), have turned in some cases to the Cayman court for redress. This had led to a series of high-profile judgements that have sometimes, but not always, clarified the situation for investors and fund managers for the future.

One of the decisions most eagerly awaited was the Privy Council ruling that overturned the decision of the Cayman Islands Court of Appeal in the case of Culross Global SPC v Strategic Turnaround Master Partnership.

The decision of the Court of Appeal raised some interesting propositions for hedge funds and their service providers in relation to redemptions and suspensions and the timing of various steps in the redemption process. The Privy Council made clear its different view of certain key elements of the Court of Appeal’s decision and at the same time settled some of its more ­controversial aspects.

For Guy Manning, a partner at Campbells, case law being developed in Cayman is another reasons for the strength of the jurisdiction. He and his colleagues in the law practice believe some of the decisions being made will have an effect on documentation drafting in future as well as lead to a review of certain aspects of existing fund documents. “Strategic Turnaround was fairly big news. The other major development has been the rulings made on substratum,” says Manning.

There has been a considerable amount of interest as to the circumstances in which it may be ‘just and equitable’ for the court to order that a fund be wound up and placed into official liquidation at the request of a dissatisfied investor.

What is also interesting is the different approach between the recent Cayman Islands cases and decisions from the Eastern Caribbean Supreme Court (the court of superior jurisdiction of the British Virgin Islands (BVI), one of the other major offshore jurisdictions).

For example, the Cayman Islands the Court of Appeal’s March 2010 decision in Camulos Partners Offshore made it clear there were limited circumstances in which it was appropriate for a dissatisfied investor to present a winding-up petition against a solvent fund. Exactly what ‘just and equitable’ means is a matter of some debate. It is not defined in the Cayman Companies Law (2010 revision).

Historically, however, the criteria tend to fall within certain well-defined categories including lack of probity on the part of the directors, the need for an independent investigation of the fund’s affairs, deadlock or the oppression of minority shareholders and loss of substratum.

The recent Cayman cases have all involved an allegation that the investment fund in question was no longer viable. It was argued that the purpose for which it was formed has ceased and what is known as its ‘substratum’ had been lost.

Manning believes the substratum issue is important. He says both views have support but no one likes the uncertainty two differing judgements bring to the industry. Manning says as there are still quite a number of funds that are still in suspension, more cases are likely to come to court. How the differences between interpretations in BVI and Cayman will play out, however, is an open question.

Ian Dillon, another partner at Campbells, says he thinks it is still necessary to explain to investors what the various options are and that relying on past court decisions may not always be the best. He thinks investment managers need to discuss with investors what they are doing and why they are doing it as well as listen to their shareholders in order to find solutions that do not necessarily require an intervention by the court.

Manning says side-pocket issues are another area that he expects will eventually come before the courts. “It is a matter of time before we see someone challenging these in court, particularly the synthetic side-pockets. I think investors will challenge redemptions based on assets put into special purpose vehicle side-pockets with these shares distributed to investors,” he cautions. Again, he believes more communication between fund manager and investors is needed to avoid problems.

“The Camulos case probably represents the high point of the strategy that had been developed by a number of investors and lawyers representing the investors over the last few years. This was to seek to bring winding up petitions against funds which had failed to pay redemptions or had failed in some respects to comply with offering documentation, management was not transparent,” says Jeremy Walton, a partner at Appleby.

“The Court of Appeal in the Camulos case sent out a very firm message to the investor community and their lawyers that this was not the appropriate way to proceed with that kind of complaint. There are other legal remedies that are used and are used widely already and those procedures should be followed rather than bringing the threat of a winding-up petition, the nuclear option,” says Walton. 

Walton expects to see a continuation of cases coming before the Cayman courts but believes the subject of the complaints may be different. “There will be less of the kind of litigation we’ve seen in the last couple of years which have focused on the construction of documents, on the interpretation of investment contracts,” he predicts.

“I think lessons from that period of litigation have been learnt largely. The litigation now is moving more towards compensatory types of litigation in particular against service providers to those funds that have become insolvent or have lost significant sums. That is more conventional litigation against large service providers, auditors, administrators, prime brokers and so on. We’ll see a lot more of that kind of litigation,” he concludes.