The Cayman Islands Segregated Portfolio Company Turns Sixteen

May 2014 marks the sixteenth anniversary of the Cayman Islands segregated portfolio company ('SPC'). This article takes a look back at the SPC's first decade and a half and in particular at the principles which have emerged from the first reasoned decisions of the Cayman Courts concerning the treatment of insolvent SPCs. The cases have posed some interesting and novel questions for the Courts to resolve and the decisions have put flesh on the bones of the statutory provisions as regards the status, duties and powers of officeholders appointed in connection with SPCs. However there are still some important unanswered questions surrounding the practical aspects of receivership, the rights of shareholders of an SPC and the rationale for the differences in the liquidation v receivership regimes, and these are also explored.

What is it?

An SPC is an exempted company that is permitted to create segregated portfolios in order to legally segregate the assets and liabilities of the portfolios from each other and from the general assets and liabilities of the SPC itself. The utilisation of these innovative legal structures has developed considerably since their first introduction in May 1998. Initially limited to use by licensed insurers, they are now popular investment vehicles employed across the spectrum of financial services' offerings wherever there is a need to set up a statutory ring fencing of assets and liabilities. The SPC structure is widely used by investment funds, captive insurers, and in structured finance transactions.

Treatment in insolvency situations

Part XIV of the Cayman Companies Law (2013 Revision) (the 'Law') sets out the statutory provisions providing for the establishment and operation of SPCs and their treatment in insolvency. Under the Law, the portfolios of an SPC do not constitute separate legal entities; however, in practical terms, they operate like separate limited liability companies and the assets and liabilities of each portfolio are ring fenced, with the effect that shareholders and creditors have recourse only to the assets of the particular portfolio to which their shares are allocated. Liabilities of one portfolio cannot be met by the assets of another; nor can they be met from the general assets of the SPC where this is prohibited in the articles of association (which is the usual position). When a portfolio is insolvent the Court may appoint a receiver to realise and distribute its assets. Official liquidators may only be appointed over the entire SPC. The effect of Part XIV should be that the insolvency of one portfolio would not contaminate the other portfolios of an SPC. As shall be seen below this principle has faced challenge, but has ultimately been upheld by the Cayman Courts.

ABC Company (SPC) v J & Co. Ltd

In 2012, in the matter of ABC Company (SPC) v J & Co. Ltd the Court of Appeal overturned a decision of the Grand Court not to strike out a petition to wind up ABC brought on just and equitable grounds. The SPC, essentially a multi-class fund, had suspended the calculation of Net Asset Value ('NAV') and the payment of redemptions in a number of its portfolios for a number of years; however its remaining portfolios (representing around two thirds of the SPC's NAV) were operating normally and accepting subscriptions and paying redemptions in the usual way. The investment manager was effectively winding down the suspended portfolios so as to make distributions over time before ultimately terminating them.

A shareholder in one of the suspended portfolios, unhappy with the soft wind-down, sought to have official liquidators appointed over the entire SPC on the basis that the SPC had lost its substratum (i.e. that its business purpose had failed) and it was therefore just and equitable that the SPC be wound up. In doing so, the petitioner relied on the line of Cayman cases which consider the issue of winding up funds on a loss of substratum basis, including Re Belmont Asset Based Lending1 in which the Grand Court had laid down the test as to whether a fund had lost its substratum where it is pursuing a soft wind down (and there is no express provision for such an eventuality in its articles). The cases establish that the position under Cayman law is that a fund cannot be said to be carrying on business as an investment fund within the reasonable expectations of its shareholders during a soft wind down as its ability to redeem shareholders and accept subscriptions has been terminated - accordingly the fund has lost its substratum in such circumstances and ought to be liquidated on just and equitable grounds.

At first instance in ABC, the Grand Court focused its analysis on the business of the suspended portfolios only, and ruled in favour of the petitioner. It relied on Belmont and found that the SPC had lost its substratum (despite the existence of the other healthy portfolios). The Grand Court considered that it was able to appoint liquidators over or grant unfair prejudice type remedies in respect of individual portfolios under section 95(3) of the Law (such relief includes the ability to order that the petitioner's shareholding be bought out, that derivative action may be pursued on behalf of the company, and more general orders providing for the regulation of company affairs compelling or prohibiting certain actions). This is surprising as there is no mention of such a jurisdiction within the Law, and these remedies are ordinarily...

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