Law from the Cayman Courts’ Decision in the Liquidation of Adamas Asia Strategic Opportunity Fund Limited

Commencing the voluntary winding-up of a mutual fund is deceptively easy but, as soon as it is contemplated, the Fund Manager’s role and responsibilities change in subtle but very important ways.

Some of these responsibilities have had a timely airing recently in the Cayman Islands’ Grand Court and Court of Appeal’ decision in Adamas Global Alternative Investment Management INC, et al [FSD 232 of 2018; FSD 72 of 2019; and Civil Appeal No. 27 of 2019] in respect of the voluntary liquidation of Adamas Asia Strategic Opportunity Fund Limited (the “Fund“) which arose out of deteriorating relations between the Fund’s investment manager (the “Manager“) and the Fund’s only investor, the Public Institution for Social Security for the State of Kuwait (the “Investor”).

Background to the Case

In December 2017 the Investor made a sizeable redemption request which the Manager acknowledged. However, in August 2018, before the redemption had been effected, the Investor was informed that the Fund’s directors had declared a suspension of redemption requests to take effect from 2 October 2018. It was hoped that a special redemption of 14% of the Fund’s issued share capital would be made in November 2018 but this was cancelled on the grounds that an emergency existed as a result of which a disposal of the Fund’s underlying investments was not practically feasible – the Fund was invested in underlying funds that were themselves locked-up for more than a year (until December 2019).

The Investor was unhappy with the explanations given for the delays. There were also arguments about the extent to which the Manager would agree to waive its fees during the suspen-sion of redemptions.

By 9 December 2018 the Investor requested that, within 7 days, the Manager pass a resolution to commence the voluntary winding-up of the Fund and irrevocably appoint a liquidator of the In-vestor’s choice. Discussions continued and, on 23 December 2018, the Investor wrote to the Manager with an ultimatum that, unless the Manager passed the resolutions to wind-up the Fund and appoint the Investor’s preferred choice of liquidator, the Investor would petition the Court to wind-up the Fund on just and equitable grounds.

Shortly thereafter a winding-up resolution was passed by the Manager, which held the management voting shares in the Fund. However the Manager had decided to appoint a cheaper liquidator rather than the Investor’s much preferred option. The two sides had very different perspectives on whether, as a matter of law, a Manager could ignore the wishes of the Investor in a voluntary winding-up.

The Articles of Association of the Fund were typical of Cayman Islands’ mutual funds and other Common Law offshore jurisdictions. In particular, the Investor held non-voting, redeemable, “Participating Shares” (which participate in the profits but not the running of the Fund) and the Manager held “Management Shares” (that, in contrast, don’t participate in the profits but entitle the Manager to, among other things, pass resolutions to voluntarily wind-up the Fund and to appoint a liquidator for that purpose).

The judgment of the Grand Court observed that “There was no previous case directly on point which made it obvious that the holder of management shares in a Cayman Islands fund company is required, in the context of a contemplated solvent liquidation, to defer to the wishes of the participating shareholders.”

The legal argument in the Grand Court, and later in the Court of Appeal, centred on section 131 of the Companies Law, which states that:

“When a resolution has been passed by a company to wind up voluntarily, the liquidator or any contributory or creditor may apply to the Court for an order for the continuation of the winding up under the supervision of the Court… on the grounds that:

(a) the company is or is likely to become insolvent; or

(b) the supervision of the Court will facilitate a more effective, economic or expeditious liquidation of the company in the interests of the contributors and creditors.”

In common with most mutual funds, the Fund’s “contributors and creditors” (to which section 131 refers) included the Investor and the Manager. The Investor’s redemption request had not been implemented (so the Investor was still a “contributor” rather than a “creditor”). The Manager, on the other hand, was owed a small management/performance fee and so it was both a creditor as well as a modest contributor (by virtue of holding Management Shares in the Fund).

The Court’s Decision

In its judgment the Court of Appeal held that:

“the relationship between those holding the Management Shares and those holding the Partici-pating Shares radically changes when the fund is contemplating the cessation of business and a voluntary winding up. The exclusive power conferred on the Manager to resolve to wind up the company is conferred not for their benefit but for the benefit of the Participating Shareholders who, under the Articles, have the predominant financial interest in the proposed winding up…”

The Court of Appeal did go out of its way to reassure Managers that: “If a supervised liquidation might significantly delay or otherwise prejudice settlement of the Manager’s claims as a creditor, the Manager will of course be entitled to argue against a supervised liquidation for that reason.”

And in the Grand Court the judge pointed out that “no right thinking person could properly infer that the making of a supervision order [the Court appointing an official liquidator] cast doubt on the bona fides [good standing] of the Manager.”

One of the key point of this is decision by the Cayman Islands courts is a reminder that under generally recognized rules of winding up law, the way in which a solvent or insolvent fund should be wound up should be determined by primary reference to the interests or wishes of the fund’s economic stakeholders (which in a solvent winding up will be its investors). In any event, once liq-uidation is contemplated, fund directors (working with the fund manager) need to pay particular attention to the fiduciary duties they owe to shareholders and creditors.

For specific advice on the winding-up of Cayman Funds, please contact your usual Loeb Smith attorney or any of:

E: gary.smith@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vivian.huang@loebsmith.com
E: yun.sheng@loebsmith.com
E: faye.huang@loebsmith.com
E: santiago.carvajal@loebsmith.com