The Impact Of Side Letters On The Constitutional Provisions Of Cayman Islands Funds

In Re Lancelot Investors Fund, KBC Investments Ltd v Varga (Unreported, Civil Appeal 27 of 2013, 27 April 2015) the Cayman Islands Court of Appeal (CICA) has delivered its judgment on an appeal from the Grand Court concerning the impact of side letters on the constitutional arrangements of Cayman funds. The judgment highlights some interesting and novel issues to be borne in mind by investors when engaging with funds.

The two critical questions raised were:

Whether a collateral agreement (a side letter) between the beneficial owner of shares in a hedge fund structured as a Cayman Islands exempted company, and the investment manager of that fund, was enforceable against the fund itself (raising questions of common law privity and standing); and Whether the side letter was enforceable when made between the investment manager and an individual institutional investor without the investment manager having either actual or ostensible authority to make it (raising issues of agency and contractual capacity). Contrary to previous decisions which contested the compatibility of side letters as enforceable agreements vis-à-vis the main offering private placement memoranda and articles of association (see the Cayman Islands case of Medley Opportunity Fund Ltd v Fintan Master Fund Ltd & Nautical Nominees Ltd [2012] (1) CILR 360) and the decision of the English Court of Appeal in Barbudev v Eurocom Cable Management Bulgaria Eood & Ors [2012] EWCA Civ 548), Re Lancelot Investors Fund expressly recognises that the counterparty's status as a mere beneficial owner does not in and of itself preclude the enforceability of a side letter operating in tandem with the fund's core constitutional provisions. The judgment holds that where a beneficial owner seeks to rely on ancillary terms contained within the side letter, creating new rights or modifying any existing rights, it may be enforced notwithstanding that the custodian/nominee who is the registered shareholder of the beneficial owner's shares is not party to it. The court did not however discuss stratified beneficial ownership and the effect this would have on the validity of a side letter, which could prove fertile ground for future litigation where there is a breakdown in investor relations coupled with stratified share ownership.

The CICA noted that a company, even when acting as an investment vehicle, is not required to take into account any custodian/nominee arrangements (and by extension any beneficial...