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23 July 2020
What is an SPC?
Treatment in insolvency situations
ABC Company (SPC) v J & Co Ltd
Additional case law
SPCs and litigation funding
Test for insolvency
Remedies for portfolio shareholders
Schemes of arrangement
May 2020 marked the 22nd anniversary of the Cayman Islands segregated portfolio company (SPC).(1) This article reflects on the first two decades of the SPC – in particular, the principles established by the courts concerning insolvent SPCs. These cases have posed some interesting and novel questions for the Cayman courts to resolve and the decisions have fleshed out the statutory provisions as regards the status, duties and powers of office holders appointed in connection with SPCs.
An SPC is an exempted company that is permitted to create segregated portfolios in order to legally segregate the assets and liabilities of the portfolios from each other and from the general assets and liabilities of the SPC itself. The use of these innovative legal structures has developed considerably since their introduction in May 1998. Initially limited to use by licensed insurers, they are now popular investment vehicles employed across the spectrum of financial services offerings whenever there is a need to set up a statutory ring fencing of assets and liabilities. The SPC structure is widely used by investment funds and captive insurers and in structured finance transactions.
Part XIV of the Companies Law (2020 Revision) provides for the establishment and operation of SPCs and their treatment in insolvency situations. Under the law, an SPC's portfolios do not constitute separate legal entities; however, in practical terms, they operate like separate limited liability companies and the assets and liabilities of each portfolio are ring fenced, with the effect that shareholders and creditors have recourse only to the assets of the particular portfolio to which their shares are allocated. Liabilities of one portfolio cannot be met by the assets of another or the general assets of the SPC where this is prohibited in the articles of association (which is the usual position). When a portfolio is insolvent, the courts may appoint a receiver to realise and distribute its assets. Official liquidators may be appointed only over an entire SPC. The effect of Part XIV is that the insolvency of one portfolio does not contaminate the other portfolios of an SPC. As can be seen from the below survey of cases, this principle has faced challenge but has ultimately been upheld by the Cayman courts.
In ABC Company (SPC) v J & Co Ltd, the Court of Appeal reversed the Grand Court's decision not to strike out a petition to wind up ABC brought on just and equitable grounds. The SPC had suspended the calculation of net asset value for several years and the payment of redemptions in a number of its portfolios. The investment manager was winding down the suspended portfolios so as to make distributions over time. The remaining portfolios (at least two-thirds) were still trading normally, accepting subscriptions and paying redemptions in the usual way. Nevertheless, a petition to wind up the entire SPC was filed by a shareholder in one of the suspended portfolios on the grounds that the SPC had lost its substratum and that it was just and equitable that it be wound up.
On appeal, the petitioner accepted that:
On a review of the SPC's articles of association and offering documents, the Court of Appeal held that the petitioner had no realistic prospect of establishing that, as a result of the failure of certain segregated portfolios, the SPC had ceased to carry on business in accordance with the reasonable expectation of its shareholders. Further, there was no other basis on which it was or could be said that the SPC as a whole had lost its substratum. This decision was the first case to affirm the proposition that the Cayman courts will uphold the statutory segregation of an SPC's portfolios.
In 2012 and 2013 the courts provided further welcome clarification of the status, duties and powers of receivers appointed over a portfolio. In the 2012 case JP SPC 1 and JP SPC 4, winding-up petitions were presented by the directors of two SPCs. A feeder SPC had six portfolios, one of which was the Axiom Legal Financing Fund (Axiom) representing 74% of the SPCs' investors. Axiom's only assets were its shares in Axiom Legal Financing Fund Master SP, the master portfolio. The assets of the master portfolio were receivables from loans made to numerous English law firms conducting class actions. Allegations had been made concerning the activities of the investment manager of Axiom and the master portfolio. Initial analysis suggested that the value of the loans had been overstated and further investigations were necessary. Notwithstanding the principles confirmed in ABC, one of the investors originally sought to argue that despite the health of the other unaffected portfolios, the whole SPC should be wound up. The investor ultimately agreed that the appropriate course was for receivers to be appointed over the Axiom portfolios, and receivership orders were subsequently made.
The Axiom receivers returned to the Grand Court to seek directions clarifying their duties and powers so as to bolster an (ultimately successful) application for their recognition in the United Kingdom under the UK Cross-Border Insolvency Regulations 2006, which have their roots in the United Nations Commission on International Trade Law Model Law on Cross-Border Insolvency. Ordinarily, receivers in their traditional role do not qualify for such recognition, but the regulations take a substance-over-form approach and require an assessment of the actual status, duties and powers of the office holder and thus whether relief is available. Further hurdles to the application were that SPCs as a concept are unknown under UK law and, consequently, so too are receiverships of individual portfolios. As such, there has yet to be an onshore bankruptcy case which recognises the segregation principle which SPCs embody.
Interestingly, and following on from the recognition of the Axiom receivers in the United Kingdom, the Grand Court recognised receivers of a foreign segregated account (the Bermudian equivalent to the segregated portfolio) for the first time in its 2019 decision of In the Matter of Silk Road Funds Ltd.(2)
In In the Matter of JP SPC 1 and JP SPC 4 (known as 'Axiom'),(3) the Grand Court removed certain doubts as to what powers would be available to the receivers of portfolios. The decision considered and compared in significant detail the statutory powers available to, and duties owed by, receivers appointed over a portfolio on the one hand and the powers and duties of liquidators of a Cayman company on the other. The decision has consequently provided a useful, detailed and thorough exploration of this area.
Statutory powers available under Part XIV of Companies Law
The statutory powers available under Part XIV of the Companies Law are as follows:
Axiom confirmed that the receiver of a portfolio will be considered as possessing duties akin to those of a liquidator of a Cayman company. Further, for most purposes, a receiver is to be attributed with the appropriate powers of a liquidator (confined in their application to the portfolio and its assets, shareholders or creditors). In particular, the following practical points emerge:
In subsequent proceedings to wind up the investment manager of the Axiom portfolios (Re Tangerine Investment Management Limited (April 2013 1 CILR 375)), it was argued that the Axiom receivers were not entitled to appear on another creditor's petition to wind up Tangerine on the basis that a portfolio had no separate legal identity to its SPC and that any debt would therefore be owed only to the SPC. The Grand Court firmly rejected these arguments. Despite the Axiom portfolios lacking separate legal personality, the court considered that the receivers had sufficient standing to be heard. Its reasoning relied on the significant statutory powers afforded to, and duties owed by, the receivers – in particular:
Interestingly, in Tangerine, the court went on to appoint one of the receivers jointly with the opposing creditors' choice of appointee as an official liquidator of the Axiom portfolios' former investment manager.
In Calibre SPC, which concerned the winding up of an entire SPC and its two portfolios on an insolvency basis, the Grand Court provided guidance as to which requirements of the Companies Winding-Up Rules (CWR) would apply as regards the individual portfolios (as technically only the SPC itself would be caught by the CWR). This was helpful as the Companies Law does not address the finer administrative details of what needs to be done in the liquidation of a portfolio. The Grand Court clarified that liquidators were to perform their statutory obligations contained in the Companies Law (and thus the CWR) in respect of each portfolio separately. This meant that, among other things:
In In the Matter of Primary Development Fund (Cayman) (SPC 2016 2 CILR 143), which related to the discharge of a receivership order, the Grand Court considered which options are available to receivers when a segregated portfolio has exhausted its assets though the remuneration of receivers and no assets are available for distribution to the creditors. Section 227(3) of the Companies Law provides that:
the Court may direct that any payment made by the receiver to any creditor of the company in respect of that segregated portfolio shall be deemed full satisfaction of the liabilities of the company to that creditor in respect of that segregated portfolio.
However, where no payment or only an offer of payment (which is rejected) has been made to the creditors, the court cannot make such a direction. The court advised that in these circumstances, the receivers could terminate the segregated portfolio under Section 228A(1) of the Companies Law, which provides that where a segregated portfolio has no segregated portfolio assets or liabilities, the SPC may, by resolution of the directors (or other authority provided for in the articles of association), terminate the segregated portfolio. The 'or' in this provision is to be construed disjunctively so that it is unnecessary for both conditions to be satisfied.
Finally, Re Centaur Litigation Unit Series 1 Ltd(4) concerned the substantial intermingling of assets between the segregated portfolios of Centaur Litigation SPC (CLSPC), an entity which formed part of a litigation funding business. CLSPC was involved in a substantial fraud involving a Ponzi scheme and the misappropriation of approximately $27 million. CLSPC held five segregated portfolios and, on applying the 'cash is king' principle (ie, tracing the cash from investors through each of the funds and on to the investments), there were a broad range of investment returns depending on the portfolio to which the investor subscribed (from 1% to 55% of the value of the principal investment). This was due to the fact that the funds invested in the later series were not used to fund legal cases but were misappropriated by management or used to prop up the Ponzi scheme. The investors had thought, based on the offering memorandum and master memorandum, that they were investing, together with the other segregated portfolios, in a 'master portfolio' of cases. CLSPC's liquidation committee argued that the intention expressed in these documents should be honoured – despite the fact that no master portfolio could have existed under Cayman law, or did in fact exist – and that the proceeds of all cases funded by CLSPC should be notionally pooled and allocated pro rata across the five segregated portfolios. The court held that it could not give effect to the master portfolio structure because:
Further, in any event, a pari passu distribution among the segregated portfolios would not be the fairest approach in the circumstances. The court held that there was no sufficient justification to depart from the cash is king approach to the distribution model.
The above review illustrates that Cayman Islands jurisprudence in respect of SPCs has developed significantly, providing greater certainty on the treatment of SPCs and their portfolios in insolvency situations. This will be of great assistance to practitioners and their clients which derive benefits from the SPC structure. However, some interesting questions remain, as do possible differences in treatment between receivers appointed over portfolios and liquidators appointed over Cayman companies. These are considered below.
Axiom made it clear that receivers appointed over portfolios, such as liquidators, possess the power to bring legal proceedings in the name of the SPC on behalf of the portfolio over which they are appointed. Liquidators have the benefit of seeking litigation funding from creditors (or, less commonly but increasingly, from unrelated third parties(5) in the business of providing litigation funding) to assist their recovery efforts; however, a receiver's ability to obtain funding from third parties is less clear. Confronting any recipient of third-party litigation funding in the Cayman Islands is the problem of whether these arrangements can be attacked as falling foul of the archaic, but still applicable, doctrines of maintenance or champerty. 'Maintenance' is the assistance or encouragement of proceedings by someone who has no interest in the proceedings or any motive recognised by the law as justifying interference. 'Champerty' is an aggravated form of maintenance, whereby the assistance is provided in exchange for a share of any fruits of the action. Should a litigation funding contract be found to involve maintenance or champerty, it will be treated as contrary to public policy and unenforceable. Creditors which provide a fighting fund for a liquidator need not fear falling foul of the doctrines (provided that they do not seek to usurp the liquidator's control of the action) as they are considered to have a legitimate interest in actions which may have the effect of swelling the size of the liquidation pot for ultimate distribution. The difficulty arises when the proposed litigation funder is an unrelated party.
An exception or safe haven has developed over time which protects liquidators and other office holders from the application of the doctrine of champerty by providing that a liquidator can sell legal claims belonging to the entity in liquidation to unrelated third parties for a share of the recoveries of the litigation.(6) The exception has been rationalised by the UK courts to arise as a result of the liquidator's statutory empowerment to sell an insolvent entity's assets coupled with their duty to realise the assets comprised in the insolvent's estate.(7) It is plainly arguable that the receiver of a portfolio should benefit from this safe haven in the same way as liquidators on the basis that, as established in Axiom, a receiver possesses an almost identical duty to realise the portfolio's assets and statutory power to sell those assets. However, the Cayman courts have yet to tackle this issue.
The critical issue is whether the funding agreement:
The features which are likely to be significant include:
(a) the extent to which the funder controlled the litigation… (b) the ability of the funder to terminate the agreement at will… (c) the level of communication between the funded party and the lawyer… (d) the prejudice likely to be suffered by the defendant if the claim failed… (e) the extent to which the funded party was provided with information about... the litigation… (f) the amount of profit the funder stood to make… (g) whether or not the fund was a professional funder and/or was regulated.(8)
The test for the appointment of a receiver over a portfolio is in effect a balance sheet insolvency test: an order may be made where the assets attributable to that portfolio are or are likely(9) to be insufficient to discharge the creditors' claims in respect of that portfolio. In contrast, the insolvency test applied to any Cayman Islands' company on an application for its winding up is the traditional cash-flow test – namely, can the company meet its debts as they fall due? A receiver could therefore be appointed over a portfolio which would otherwise be considered solvent were it an individual company. In Axiom, the portfolios were not insolvent on a cash flow basis, but they were likely to be insolvent as a result of imminent future lending obligations and so, because of the lower insolvency threshold, they could be put into receivership. The reasoning behind this apparent difference in treatment is unexplained,(10) but the wider gateway may go some way to mitigating the fact that a shareholder in a portfolio is not entitled to petition to wind up a portfolio on just and equitable grounds.
Where a shareholder of a company can demonstrate that it would be just and equitable for the company to be wound up, the court has jurisdiction to grant unfair prejudice-type relief under Section 95(3) of the Companies Law (discussed above). ABC has confirmed that it is impossible to appoint a liquidator or receiver over an individual portfolio on just and equitable grounds even if such grounds exist. This therefore leaves stakeholders with no ability to seek the alternative remedies that would be available to a shareholder of a company where grounds to wind up exist. There does not appear to be any basis for this distinction and this may well be the subject of future legislative reform.
Like any Cayman company, SPCs can enter into a scheme of arrangement on behalf of the entire company.(11) A scheme is a court-supervised compromise made between a company and its creditors or members whereby an arrangement can be made binding on such persons provided that certain safeguards are met. Schemes are common in the Cayman Islands, but it remains unclear whether a portfolio would have standing to enter into a scheme in its own right or whether an SPC could enter into a scheme on behalf of one or more of its portfolios. Interestingly, the cell of a Jersey protected cell company (similar to an SPC) has been found by the Jersey Royal Court to possess such standing, although unlike in the Cayman Islands, the relevant Jersey company statute provides that a protected cell is to be treated, for all purposes, as if it were a company and it can be liquidated independently of its cell company (see Re Ashburton Global Funds PCC, January 2014). In the Cayman Islands, it is probable, under the Axiom principles, that an SPC could enter into a scheme on behalf of one or more of its portfolios (which was the position in Jersey prior to the Royal Court's decision in Ashburton).
The SPC structure is firmly established in the Cayman Islands and the jurisprudence over the past 22 years indicates that the segregation principle will be upheld and that receivers of insolvent portfolios are to be considered as possessing the standing and powers of a liquidator, as regards their portfolio and its affairs. There has yet to be any substantial onshore test or confirmation of the SPC segregation principle and there is still uncertainty as to the legality of third-party funding of receivers of a portfolio to bring claims on behalf of the portfolio. However, the past few years have provided answers on the treatment of portfolios when there has been a substantial intermingling of assets and in relation to the discharge of a receivership order.
(1) In 2015, several years after the creation of the SPC, Section 5 of the Insurance (Amendment) Law 2013 was implemented, providing for subsidiary companies held by a portfolio in regulated structures to carry on insurance business without the need for a separate licence. This development provided flexibility in managing the risk element in insurance.
(7) In ICP Feeder Fund & ICP Master Fund (unreported 4 April 2014), the Cayman court reviewed the applicable principles regarding litigation funding for liquidators and reaffirmed that the position in the Cayman Islands was the same as in the United Kingdom.
(9) Although there are no Cayman authorities on this issue, the degree of probability necessary to satisfy this test is likely to be 'more probable than not' following Re AA Mutual International Insurance Co Ltd  EWHC 2430 (Ch).
(10) The test for the appointment of a receiver over a portfolio is similar to the UK test for the appointment of an administrator under the Insolvency Act 1986, where an administrator may be appointed if the company in question is or is likely to become unable to pay its debts and the administration order is reasonably likely to achieve the administration's stated purpose. The rationale for the wider gateway in the case of administrators arguably stems from the fact that administration (which is the UK equivalent of US Chapter 11 proceedings) is intended to give a company breathing space and allow for the possibility that a corporate rescue, scheme of arrangement or otherwise more advantageous outcome can be achieved for creditors should the company eventually be wound up. There does not appear to be any similar justification for the broader gateway afforded to portfolios as the process of administration does not exist in the Cayman Islands.
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