Privy Council Decision Provides Certainty, But Creates Surprising Commercial Results In The Context Of Investors' Claims For Unpaid Redemption Proceeds

Further to our advisory issued in August 2016 (click here), a recent judgment of the Judicial Committee of the Privy Council1 (Privy Council), the ultimate appellate court of the Cayman Islands, has provided certainty for investors and insolvency practitioners alike with respect to the enforceability and priority to be afforded to investors' claims for unpaid redemption proceeds in the winding up of Cayman Islands investment funds.

The Privy Council decision is the most recent in the ongoing liquidation proceedings of Herald Fund SPC (Herald), a segregated portfolio company incorporated in the Cayman Islands which was one of the largest so-called feeder funds into the Madoff Ponzi scheme. The case involved an important point of statutory construction, namely how section 37(7) of the Companies Law operates in the context of significant unpaid redemption proceeds sought to be enforced several years after the discovery of the Ponzi scheme notwithstanding that, with the benefit of hindsight, those redemption claims (valued at almost $200m) were clearly based on a wholly fictitious NAV. The issue is one that has rarely confronted the Grand Court of the Cayman Islands (Grand Court) and certainly this was the first time it had been considered at the highest appellate level.

Decision

Affirming the rulings of the Grand Court and the Cayman Islands Court of Appeal (CICA), the Privy Council found that, as a matter of construction, section 37(7)(a) of the Companies Law does not apply to the claims of certain classes of Herald's unpaid redeemers in circumstances where, at the commencement of the winding up, the relevant redeemable shares had been "redeemed" in accordance with the terms of Herald's memorandum and articles of association i.e. the Redemption Date had occurred prior to any suspension being implemented, notwithstanding that payment had not been made (and was not due to be paid at that time).

The Privy Council found that "redemption" occurs on surrender of the status of shareholder, which is entirely a function of the terms of the contract of membership between a company and its members inter se - expressing the freedom that shareholders and a company have to shape their relationship as regards redemption or purchase of a company's shares. The Privy Council did not accept the Appellant's argument that "redemption" ought to have an autonomous statutory meaning (being the completion of the entire process of redemption, including payment), with...