Clawback Claims Against Redeemed Cayman Islands Fund Investors

Building on what is now a consistent theme in Cayman Islands law; the Privy Council's decision in DD Growth1 has further reinforced the serious challenges faced by liquidators of investment funds looking to clawback redemption payments from third party redeemers.

Importantly, the Privy Council has held that redemption payments made by an investment fund in breach of the applicable statutory provisions are not automatically void or repayable.

Background

DD Growth Premium 2X Fund ("DD Growth") was an open-ended mutual fund. In 2009, shortly before the fund was placed into liquidation, DD Growth paid US$23 million in redemption payments to RMF Market Neutral Strategies (Master) Limited ("RMF") (the "Redemption Payments"). DD Growth's NAV (on which the Redemption Payments had been calculated) had been massively overstated as a result of fraud and other redeemers received nothing. DD Growth was insolvent at the time of the Redemption Payments. The liquidators sought to claim the Redemption Payments back from RMF. The claim failed in both the Grand Court and the Cayman Islands Court of Appeal.

The DD Growth clawback saga initially included a voidable preference action. This claim was unsuccessful, largely because DD Growth's liquidators were unable to show that DD Growth's dominant intention in making the Redemption Payments was to prefer RMF over other creditors of the fund (a necessary element of a voidable preference).2

In their appeals, ultimately to the Privy Council, the liquidators focused their attention on another strand of their arguments. This was whether the Redemption Payments were unlawful as being made in breach of the old legislative provisions governing redemptions of shares and, if so, what did that mean for RMF? As the first aspect is now largely academic due to changes to the Companies Law made in 2011, it is the second aspect that is of key importance.

Were the Redemption Payments unlawful?

The Redemption Payments were unlawful having been made in breach of section 37(6)(a) of the Companies Law (2007 Revision), which, in short, prohibits payments out of capital by a company that is insolvent.

There were two aspects to this part of the Privy Council's decision. First, the Redemption Payments were payments "out of capital" for the purposes of sections 34 and 37 of the Companies Law (2007 Revision) (a payment "out of capital" including payments from share premium as well as par value).

Secondly, having held that the Redemption...