Cayman Court Rules Against In Kind Distribution Of Fund Assets

The recent decision of the Grand Court of the Cayman Islands ("the Court") in the case of FIA Leveraged Fund1 has laid down, for the first time, the principles applicable to an in specie (or in kind) distribution of fund assets to investors.

The documents which make up the contractual arrangements between a hedge fund and its investors commonly give management the power to satisfy a redemption request by distributing assets in kind rather than making a cash payment. This is the first time the Court has delivered a judgment regarding the manner in which that power is to be exercised.

The decision emphasised that the power must be exercised in a manner which gives commercial efficacy to the obligations owed by a fund to its investors, and in accordance with the fiduciary duties owed by management to investors. The purported exercise of the power in a manner which did not accord with those principles did not discharge the debt owed by the Fund to its shareholders, who were therefore entitled to have the Fund wound up on the ground of insolvency. The Court also held that the circumstances of the purported distribution in this case justified a winding-up on the just and equitable ground, on the basis that the Fund had lost its substratum (i.e. the purpose for which the Fund had been incorporated was incapable of achievement).

In this case, the petitioning investors (the "Petitioners"), three US pension funds, were owed redemption proceeds of US$144,500,000.

Rather than meeting the redemption requests in cash, the Fund sought to satisfy those requests by issuing promissory notes. The Fund's Offering Memorandum permitted shares to be redeemed in kind, and provided that the value of assets paid out in kind "shall be determined by the Board of Directors in consultation with the Investment Manager in its sole discretion."

The Petitioners were unsatisfied with the purported in kind redemption, and issued a winding-up petition. The petition asserted that they were unpaid creditors, that the Company was unable to pay its debts and it should be wound up pursuant to Section 92(d) of the Companies Law (2011 Revision) ("the Law"). Alternatively, they sought a winding up on the just and equitable ground pursuant to Section 92(e) of the Law, on the basis that the Fund had lost its substratum.

The question of whether the issue of promissory notes validly discharged the obligation to pay redemption proceeds did not fall to be determined because, following the...