Lancelot: Investor Side Letters – Still A Gap In Cayman Between Legality And Reality

In 2012 and 2013 first instance decisions of the Cayman Islands Grand Court1 restricted the efficacy of side letters which may be routinely entered into between investors and investment managers of the fund they are investing in, seeking to vary rights attached to their issued shares (see Investor Side Letters: Mind the Gap). The Cayman Islands Court of Appeal (CICA) has now given its first judgment on the topic.2

Summary

In the Matter of Lancelot Investors Fund, Ltd, the beneficial owner of shares in a fund had sought to agree a shorter lock-up period for redemptions with the investment manager. At first instance, the Grand Court found that the side letter was not enforceable for want of authority or standing on both sides of the side letter:

side letters attaching rights to shares could only be enforced if entered into by the registered owner, the beneficial owner could not directly enforce its rights; and there was a lack of authority for the investment manager to bind the fund. In its judgment, the CICA has narrowed the gap to enforceability - accepting that in certain circumstances the beneficial owner could directly enforce a side letter attaching rights to its beneficially owned shares, although holding that the particular side letter in question still failed because the investment manager did not have actual or ostensible authority to sign it on behalf of the fund.

Whilst the appeal was unsuccessful, the CICA's purposive reasoning strengthens the position of a beneficial owner in pursuing recovery of its investment. Although the CICA expressly explained its reasoning in the context of a liquidation, it could also be logically extended to the situation of a company on the brink of insolvency and form the basis for arguments in cases where beneficial owners may otherwise be restricted from presenting a winding up petition - such as where a beneficial owner is forced to change its custodian which is then unable to present a winding up petition for six months from the date of registration.

The ruling also gives an indication of how the gap to enforcement can be further reduced. The CICA considered that, based on the documents and the "world's view" of investment managers, the investment manager did not have actual authority to bind the fund or transmit the decisions of its directors. The CICA's narrow view of the role of the investment manager was correct on the basis of that fund's documents, but may surprise many in the investment community, who view an investment manager as their primary point of contact and capable of negotiating binding commitments on behalf of the fund it manages.

An investment manager must therefore have actual authority (which could be contained in...