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15 April 2010
The Commercial Court, which was established in May 2009, has handed down an important decision on the status of a redeemed shareholder and the application of Section 197 of the Insolvency Act 2003 to an investor's status. It held that a redeemed shareholder was to be viewed as an unsecured creditor and, as such, could petition for the liquidation of the company in which it was previously a shareholder and should rank alongside other third-party unsecured creditors.
Reserve International operated daily redemptions that ceased following the collapse of Lehman Brothers. Western Union, as one of Reserve's shareholders, had submitted redemption requests for its entire shareholding on September 15 2008. These requests were received and acknowledged on the same day and Reserve announced a net asset value of $1 per share for that day. Redemptions were subsequently suspended. The redemption proceeds were not paid and Western Union petitioned as a creditor to wind Reserve up on just and equitable grounds.
In its defence, Reserve:
Scope of redemption process
On the first issue raised by Reserve, the court held that the question of whether the redemption process had been completed fell to be determined by an analysis of the fund's articles, rather than as an independent question of fact. The court examined the provisions of the articles that dealt with the redemption of shares and concluded that the effect of the articles was that if a redemption request was received by the fund before 5:00pm Eastern Time on a dealing day, the shares referred to in that request were redeemed on the day of receipt.
The court also examined the provisions of the articles when reaching a conclusion as to whether the fund had a power to suspend the payment of redemption moneys. The court concluded that there was no such power, but noted that there was also no specific date by which the fund was obliged to remit the redemption proceeds, stating:
"The fact that the redemption proceeds have not been paid does not, in my judgment, mean that the shares have not been redeemed, nor does it mean… that the redemption process is incomplete, except in the sense that [Western Union] remains unpaid. The redemption was complete when the Company accepted the request on 15 September 2008. The fact that [Western Union] has yet to receive the redemption proceeds has no bearing on that fact."
Effect on status of redeeming shareholder
In relation to the second issue raised by Reserve, the court highlighted the difference it saw between: (i) a case involving a redemption that was still in progress, in which case the redeeming shareholder will continue to be and claim as a member, and therefore Section 197 of the Insolvency Act 2003 will prevent it from claiming in competition with third-party creditors; and (ii) a case involving a redemption that had been completed, save for payment of redemption proceeds, in which case the redeeming shareholder will no longer be a member and will claim as a creditor, and therefore Section 197 will not apply and it will be able to claim in competition with third-party creditors.
In this case, the court found that, on its interpretation of the articles, the redemption had been completed and Western Union was a creditor of Reserve.
There may be no factual difference between the positions of redeeming shareholder in either of the above-mentioned situations, other than how that company's articles define the process of redemption, including when that process ends.
Chapter 15 concerns
On the third issue raised by it, Reserve suggested (and the Financial Services Commission agreed) that the fund should not be wound up so that the parallel proceedings regarding the distribution of the fund's assets in the United States could continue. The foundation of this argument was that in light of the recent decision in re Bear Stearns High-Grade Structured Credit Strategies Master Fund Limited,(1) the prospects of liquidators appointed in the British Virgin Islands obtaining recognition and assistance from the US Bankruptcy Court were negligible or worse. The court rejected this argument, stating that:
"It seems to me of the highest importance that those who become creditors of, or who invest in, companies incorporated under the laws of the BVI, as well as those who finance them, should have complete confidence that if the company in question gets into difficulties, their rights will be determined in accordance with the law of this jurisdiction… this confidence will be weakened if the perception is allowed to be gained that the Courts here are prepared to decline or defer jurisdiction in insolvency matters in favour of foreign courts."
The statement by the BVI court that it will not stand idly by and allow foreign courts to determine insolvency proceedings involving BVI companies will be welcomed by those that manage and invest in BVI companies, as they would expect a BVI company to be liquidated in accordance with BVI law and under the supervision of the BVI courts. Any contrary indication would have risked undermining the certainty afforded to investors utilizing BVI companies.
The court's attention does not appear to have been drawn to the successful application before the Delaware court for Chapter 15 recognition of a Cayman liquidation in Saad Investments Finance Company (No.5) Ltd, in which judgment was handed down on December 4 2009.
The analysis regarding the effect of Section 197 of the Insolvency Act will have surprised many BVI practitioners, who had formerly regarded that section as subordinating the claims of redeeming shareholders to redemption proceeds in a company's liquidation below any claims of third-party creditors. Section 197 states as follows:
"A member, and a past member, of a company may not claim in the liquidation of the company for a sum due to him in his character as a member, whether by way of dividend, profits, redemption proceeds or otherwise, but such sum is to be taken into account for the purposes of the final adjustment of the rights of members and, if appropriate, past members between themselves."
Indeed, this was one of the arguments advanced by the fund but rejected by the court, which held that the critical issue was whether the redeeming shareholder's claim to the redemption proceeds was made in its character as a member. Following its reasoning above, the court held that because the redeeming shareholder was no longer a member, it could claim only as a creditor and therefore was not caught within the language of Section 197. No argument appears to have been advanced as to whether a redeeming shareholder could have been both a creditor and still a member, in line with the analysis of the Cayman court in Strategic Turnaround.
The court considered the type of situation that Section 197 was designed to catch, stating that:
"The reference in section 197 to past members is intended, in my judgment, to catch, by way of example, transferors of shares who have reserved the right, against their transferees, to dividends, etc, referable to the period during which the transferor held the shares."
In light of this judgment, it would be prudent for BVI funds to reconsider the drafting and effect of their own articles and whether they should be amended better to suit their lender's requirements, which are likely to include subordinating redeemed investor's rights to the assets of the company on insolvency behind third-party unsecured creditors.
The judgment in Western Union is currently subject to appeal.
For further information on this topic please contact Kieron O'Rourke or Tim Clipstone at Harney Westwood & Riegels''s Grand Cayman office by telephone (+1 345 949 8599), fax (+1 345 949 4451) or email (email@example.com or firstname.lastname@example.org). Alternatively, contact Ross Munro at Harney Westwood & Riegels's Tortola office by telephone (+1 284 494 2233), fax (+1 284 494 3547) or email (email@example.com).
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