Cayman Court Dispenses With The Houldsworth Rule

• Published date: 26 July 2023
• Law Firm: Ogier
• Author: Mr Corey Byrne and Gemma Lardner

Misled or defrauded shareholders may rank equally with creditors in liquidations of insolvent funds

In the recent decision of Re HQP Corporation Limited¹ the Grand Court of the Cayman Islands declined to follow the 19^th century English House of Lords decision of Houldsworth v City of Glasgow Bank² and found that claims for misrepresentation were not only provable in the liquidation of a company but also rank equally with other unsecured claims. The decision has resolved long-running uncertainty around the status of claims of shareholders who are victims of misrepresentation or fraud, affording them equal status with ordinary creditors of a company in liquidation.

Facts

Re HQP Corporation involved two shareholders of a fund (the Petitioners) who presented a just and equitable petition against HQP Corporation (the Company) following disclosure of admitted fraud including misrepresentation of financial data and falsification of documents.

The Company was subsequently wound up, following which, the official liquidators made an application for directions from the Court in relation to, amongst other things, the admissibility and ranking of claims by the Petitioners for damages for misrepresentation in relation to their subscription for shares in the company (the Misrepresentation Claims).

The liquidators sought directions as to two questions in relation to the Misrepresentation Claims:

1. Whether the Misrepresentation Claims could be made, in principle, in light of the decision in Houldsworth (the Houldsworth Question); and
2. If the Misrepresentation Claims could be made in principle, how such claims would rank in the liquidation of the company (the Ranking Question).

The rule in Houldsworth

In Houldsworth, the House of Lords found that a shareholder's only remedy against a company which had fraudulently induced the claimant to purchase securities in the company was rescission of the contract and restitutio in integrum (restitution) for the value of the shares. However, such remedies become unavailable as a result of the winding up of the company, meaning that the claimant's action cannot be maintained. The rationale for the rule in Houldsworth is, because the claimant remains a member when a company is in insolvent administration, they cannot also claim damages in relation to its shares.

The Houldsworth rule was widely criticised and was later abrogated in England by statute.³ However, in the later House of Lords decision of Soden v British and Commonwealth...