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Privy Council decision in Strategic Turnaround case provides welcome clarification for hedge fund participants

 

GRAND CAYMAN (December 21, 2010) – On 13 December 2010, the Privy Council issued its judgement in the case of Culross Global SPC Limited (“Culross”) v Strategic Turnaround Master Partnership Limited (“STMP”). In a decision which will be welcomed by most if not all of the hedge fund industry, the Privy Council overturned and clarified certain controversial issues arising from the widely publicised earlier decision of the Cayman Islands Court of Appeal.

The facts of the case were that Culross had subscribed for shares in STMP, a feeder fund registered in the Cayman Islands in a typical master/feeder fund structure. In October 2007, Culross gave notice to redeem all of its shares. STMP confirmed that Culross’s redemption request had been accepted and approved and that Culross would be paid 90% of the redemption proceeds within 30 days after the agreed redemption date of 31 March 2008. Then, on 17 and 22 April 2008, STMP’s board resolved to suspend the calculation of NAV and the redemption and issue of shares. STMP proceeded to calculate its NAV for the redemption date of 31 March 2008 and on 14 May 2008 Culross was notified of the redemption price applicable to the redemption of its shares as at 31 March 2008. Despite this, STMP subsequently refused to pay any part of the redemption price to Culross. It initially asserted that this was because the effect of the suspensions declared on 17 and 22 April 2008 was to defer STMP’s obligation to pay the redemption price to Culross, such that the agreed price was not presently due and payable. Subsequently that position shifted somewhat, in that STMP asserted that under the terms of its Articles of Association the effect of the suspension was that Culross would only be entitled to be paid a redemption price calculated at the NAV applicable on the redemption date next following the lifting of the suspension.

Culross presented a Petition to wind up STMP in June 2008 which STMP immediately applied to strike out. Its application was refused by the Grand Court of the Cayman Islands and STMP appealed to the Court of Appeal. In its judgement delivered in December 2008, the Court of Appeal held that STMP had a power to suspend the payment of redemption proceeds after the redemption date, but before payment of those proceeds, that STMP had exercised that power by its resolutions passed on 17 and 22 April 2008, and that this had the effect of making Culross only a prospective creditor. Although it did not strike out the Petition (it allowed it to proceed on an alternative just and equitable ground), the Court of Appeal’s finding meant that Culross did not have the status of an actual creditor owed a debt which was presently due and payable. As such, Culross could not seek a winding up order on the ground that STMP’s failure to pay the agreed redemption price demonstrated its inability to pay its debts. Culross was granted leave to appeal by the Privy Council, having earlier been refused such leave by the Court of Appeal. The appeal was heard in November 2010.

The most controversial aspect of the Court of Appeal’s decision related to its findings that redemption was a process which was not completed until the fund had paid the redemption proceeds and removed the name of the redeeming investor from the register of members, and that until that process was complete, the redeeming investor would be both a creditor and a member of the company. The Court of Appeal had drawn support for that conclusion from a series of 19th-century cases before the English courts concerning the rights of members seeking to withdraw from building societies. The Privy Council found no support in any of the 19th-century cases for the proposition contended for by STMP and accepted the submission by Culross that the redemption of the shares had occurred on the agreed redemption date, and that from that time Culross was simply a creditor of STMP until paid its redemption proceeds.[1]

The case also raised an interesting issue in relation to the position where there is a divergence between the wording of a company’s Articles of Association and its offering documents. In this case, the Confidential Explanatory Memorandum (“the CEM”) issued by STMP made reference to a power to suspend payment of redemption proceeds. Although STMP’s Articles of Association contained detailed provisions dealing with STMP’s power to suspend the calculation of NAV and the redemption and issue of shares, there was no express reference in the Articles to a power to suspend payment of redemption proceeds.

The Court of Appeal had held that the power referred to in the CEM had been incorporated into the Articles by virtue of Article 17. Article 17 expressly provided that, subject to the Articles, shares would be “issued” on the terms referred to in the CEM. The Court of Appeal took the view that this wording was sufficient to incorporate into the statutory contract embodied by the Articles any term of the CEM relating to redemptions of shares because, on the Court of Appeal’s reasoning, the terms on which shares are issued would include the terms on which they might be redeemed. It therefore held that the power to suspend payment of redemption proceeds referred to in the CEM had been incorporated into the Articles and was a power which could be and had been utilised by STMP to withhold payment of the redemption proceeds to Culross.

The Privy Council however held that the true meaning of Article 17 was that only those terms of the CEM which identified the terms of subscription of shares, in particular as regards timing, numbers, par value and price could be said to be incorporated into the statutory contract. The provisions of the CEM which referred to redemptions and the suspension of redemptions were merely (and purportedly) descriptive of the effect of STMP’s Articles, and as there was in fact no power to suspend the payment of redemption proceeds (as distinct from a power to suspend redemptions) referred to in the Articles, the reference to such a power in the CEM mis-described STMP’s powers of suspension and was of no legal effect as against investors such as Culross.

The Privy Council was not willing to allow STMP to rely on its own mis-description of its own Articles against its investors and accordingly held that STMP had no power to suspend the payment of redemption proceeds to an investor after the redemption of that investor’s shares had occurred. It therefore found that Culross was an actual creditor for the redemption price and should be at liberty to petition for STMP’s winding up on the basis that its failure to pay that price demonstrated STMP’s inability to pay its debts.

John Lawless, a member of the Executive Committee of the Cayman Islands Fund Administrators Association said:

"The finding of the Court of Appeal and the Grand Court that a redeeming investor such as Culross could simultaneously be a creditor of the fund for the redemption proceeds and still be the holder of the shares which he had applied to redeem had caused considerable difficulty for fund administrators as this was totally inconsistent with global operational best practice so this is a most welcome clarification of the position of investors who have applied to redeem their shares."

Ross McDonough and Guy Manning of the Cayman Islands law firm of Campbells acted for Culross. McDonough observed:

“It was a long hard road that we had to travel to get there, but it is gratifying to see that the view that we and our client always took of its case has prevailed. The Privy Council’s decision is helpful in a number of respects and clarifies major areas of uncertainty which had been created in the fund industry by the Court of Appeal’s judgement. It also sends a warning message to those drafting funds’ constitutional documents to ensure that the rights and obligations of investors and the fund are properly set out in the appropriate documents. In particular, practitioners will have to ensure that any power in relation to redemption of shares, including powers to suspend redemption, are fully and properly set out in the fund’s Articles of Association. It also seems from the Privy Council’s judgement that in the event of any conflict between the provisions of the Articles and the fund’s offering documents, the provisions of the Articles are highly likely to prevail.”

For more information on this release contact Ross McDonough at rmcdonough@campbells.com.ky or Guy Manning at gmanning@campbells.com.ky.

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