Copyright protection in the BVI (for “qualified persons”) and in the Cayman Islands (for “qualifying persons”) is automatic when such person creates an original work (once the work is recorded, in writing or otherwise) such as sound and music recordings; films; when you write a book or poem; or when you develop new software. By virtue of the Copyright (Cayman Islands) Order 2015 and Order 2016 (as amended), Part 1 of the U.K.’s Copyright, Designs and Patents Act 1988, subject to certain exclusions and modifications, was extended to the Cayman Islands. The BVI has implemented its own legislation in the form of the Copyright Act (Revised 2020) which is very similar.

Patent protection in the two jurisdictions is quite similar. As it is in other jurisdictions, in order to get patent protection, the invention must be: (i) new – i.e. the first in the world, (ii) useful – i.e. the invention must serve a purpose or provide a solution, and (iii) inventive – i.e. the invention must not be obvious to persons in the industry in which the invention is intended to be used.

Both the BVI and the Cayman Islands allow for the indirect registration of patents. Once a U.K. patent is granted, an application can be made in either of the Cayman Islands or the BVI to extend the scope of protection. In the Cayman Islands, there is no deadline for the filing of the application to extend rights, whereas in the BVI, rights must be extended within three years from the date of issue of the UK patent.

IP laws are designed to protect human creations. Generative AI (AI which generates text, images, speech, video or technical inventions based on user-inputted instructions) continues to increase in capability and grow in adoption. However, most copyright and patent laws, for example, do not yet explicitly address AI’s role in authorship or inventorship, leaving a legal void requiring attention.  Traditionally, the author or inventor is the person or organisation that creates the works. If now AI is responsible for content creation autonomously without any human input, the question is who owns the copyright protecting such content.

• For countries, such as the UK, this may be answered by the fact that computer-generated works will be owned by the person who made the necessary arrangements for the creation of the work.
• An overwhelming view in the E.U. is that AI cannot be a legitimate author. However, specific ways of using AI may result in a work that is protected for the user.

We expect to see governments across the world grappling with balancing strategies aimed at encouraging the development of AI and innovation while, at the same time, attempting to modernize IP and AI legal frameworks to account for AI.

Training generative AI involves using large bodies of IP-protected works/ data in ways that may be infringing under current laws. Governments seeking to “unlock” the potential of generative AI are now more often looking to legislate to permit text and data mining (TDM) of IP-protected data in order to train AI. The intellectual property in the data used to train AI models is growing as a subject of legislative discourse and is now a key issue in matters that have flooded courts across the world, whether use of copyright-protected materials to train AI models infringes copyright.

Training AI using personal data or protected IP also provides challenges to legislators worldwide. Over the next 2-3 years we expect to see increased regulatory scrutiny of companies that create or use AI technologies which have been trained using (i) personal data and/or (ii) information/data protected by IP rights. Regulators worldwide are now paying greater attention to balancing the benefits of AI against concerns about personal data and the protection of IP, and we expect that this will continue in the next few years.

AI programs usually qualify as IP with software or computer programs being literary works. In some countries however, copyright protection will not apply for functional aspects of AI such as algorithms or system designs. AI systems function however by processing human-provided instructions to generate problem-solving outcomes. This capability makes AI-based programs highly valuable from an IP perspective, as their innovative nature and diverse utility underline their significance of IP protection.

Who owns the copyright?

Copyright laws often require that there must be a natural person to whom copyright can be attributed and many jurisdictions including the Cayman Islands and the BVI, do not provide for “computer generated” works where no human author is involved. This creates a gap in the protection of AI-generated works, which are typically produced autonomously with little or no human intervention. Many copyright laws also require that “sufficient effort” must be expended to make any literary, musical, or artistic work original in character – which involves time, human labour, and skill. What constitutes sufficient effort for AI-generated content remains largely untested, raising debates about whether crafting prompts or editing AI output meets the thresholds. Additionally, if non-human entities are recognized as “authors” then copyright duration may become complex. Generally, copyright protection is granted for an author’s lifetime plus a period of time following, potentially leading to indefinite protection for AI-generated works.

The duration of copyright protection in the Cayman Islands varies depending on the nature of the work at issue. For example:

1. For Literary, Dramatic, Musical or Artistic Works: copyright expires at the end of 70 years from the end of the calendar year in which the author dies. However, if the author is unknown, copyright expires at the end of 70 years from the end of the calendar year in which the work was made or first made public
2. For Computer Generated Literary, Dramatic, Musical or Artistic Works: copyright expires at the end of 50 years from the end of the calendar year in which the work was made.
3. For Sound Recordings: copyright expires at the end of 50 years from the end of the calendar year in which the sound recording was made or first made public.
4. For Films: copyright expires at the end of 70 years from the end of the calendar year in which the film/movie was made or first made public.
5. For Broadcasts: copyright expires at the end of 50 years from the end of the calendar year in which the broadcast was made.

Copyright Protection and Deepfakes

Most IP laws are ill-equipped to address the challenges posed by digital replicas or deepfake technology. Copyright law generally is not fit for purpose in respect of deepfakes as the source material for many deepfakes either falls outside the scope of copyright protection or the copyright owner is not the individual who is harmed by the infringement. Possible causes of action presented by deepfakes include (1) copyright infringement (if a deepfake involves unauthorized use of copyrighted material), (2) trademark infringement (if it uses a registered trademark without permission), (3) the tort of passing off (if it misrepresents a product or service as endorsed by a well-known individual), (4) personal data privacy violations or (5) defamation (if the content defames an individual).  The issue of whether the outputs of AI models – particularly where they substantially reproduce source materials – may infringe copyright and who may be responsible for such infringement, is also unresolved.

Is the person who infringed: the user of the AI generated work without the rights holder’s consent or the AI developer or AI system owner? This ambiguity poses risks for businesses. If there is no clear proprietary right in AI-generated works, businesses may be exposed to unnecessary risk.

AI programs usually qualify as IP with software or computer programs being literary works. In some countries however, copyright protection will not apply for functional aspects of AI such as algorithms or system designs. AI systems function however by processing human-provided instructions to generate problem-solving outcomes. This capability makes AI-based programs highly valuable from an IP perspective, as their innovative nature and diverse utility underline their significance of IP protection.

Fair dealing exceptions

With respect copyright infringement, some jurisdictions such as the Cayman Islands, BVI, U.S., U.K., Australia, Hong Kong and Singapore provide fair dealing exceptions for particular activities, despite the fact that many other jurisdictions do not.

Under Cayman Islands law and BVI law, some of the fair dealing exceptions permitted are:

1. Personal copying for private use
2. Non-commercial research and private study
3. Text and data mining for non-commercial research
4. Criticising, reviewing and reporting current events
5. Use for parody, caricature and pastiche
6. Making backup copies, de-compilation, observing, testing and studying, and correcting computer programme errors.

Who is the inventor? Will the requirement for “novelty” remain?

Many patent laws require the inventor to be a natural person. This requirement could exclude AI from being independently recognized as an inventor. AI-driven innovations, such as those involving algorithms and machine learning processes, face challenges in meeting the criteria for protection as an invention. Under US patent law, for example, absent at least one human inventor, an invention is not patentable. Also, the criteria for patentability in many jurisdictions (including the Cayman Islands and the BVI) usually involves requirements for novelty, an inventive step and industrial applicability. These criteria raise questions about whether AI-generated inventions can ever meet the inventive step requirement, traditionally linked to human ingenuity. AI relies on algorithms and datasets to mimic human cognitive functions, enabling it to generate patentable inventions.

We expect to see a continuing updating of guidance as to the level and type of human contributions that are necessary to support patentability as new cases make their way through courts in various jurisdictions. A vital question that arises is whether AI can be regarded as a legitimate author of content that it generates or an inventor in case of patents, given the want of legal personality of the AI itself.

A particularly effective legal structure for an AI-driven entity is the Cayman Islands foundation company. Such foundation companies do not require shareholders, allowing them to function with a governance model that can be tailored to an AI’s decision-making models. Key advantages of using such foundation companies include the following.

• Legal recognition: foundation companies can provide a defined legal entity that can interact with traditional financial institutions, sign contracts and meet compliance obligations.
• Decentralised governance: the ability to structure the foundation company without shareholders allows for governance mechanisms that can adopt smart contract-based decision-making or AI-driven decision-making.
• Asset protection and Tax mitigation: foundation company can be tax resident in the Cayman Islands, hold and manage assets and ensure legal clarity in asset ownership.
• Regulatory compliance: foundation companies can be designed to comply with regulations, including AML and CFT requirements, making them suitable for global transactions.
• Economic substance rules: foundation companies limited by guarantee are specifically exempted from the economic substance rules and can therefore hold and even make profits from intellectual property without coming under the relevant economic substance compliance regime.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice on the matters covered above, please contact your usual Loeb Smith attorney or any of the following: 

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com
E: edmond.fung@loebsmith.com
E: vivian.huang@loebsmith.com
E: faye.huang@loebsmith.com
E: yun.sheng@loebsmith.com

A captive insurance company is a wholly owned subsidiary insurer that provides risk mitigation services for its parent company or related entities. In its simplest form, the ‘captive’, wholly owned subsidiary is incorporated to insure against one or more risks to which its parent company is exposed. It is essentially a form of self-insurance, which is put in place within a group corporate structure for a number of reasons. Captives are usually established in the context of a company’s risk management strategy and are typically put in place because those risks that are looking to be insured by the captive are either non-insurable or priced too high in the current market.

The captive insurance industry in the Cayman Islands recorded 42 new international insurer licenses in 2025, which was the second year in a row at that number, according to fourth-quarter data released by the Cayman Islands Monetary Authority (CIMA).

The data released by CIMA showed that at the end of 2025, the jurisdiction reported 693 Class B licences, 16 Class C licences, and 11 Class D licences, with an aggregate total of 720 licensed insurance companies in operation. These entities collectively wrote $51.2 billion in premiums and held $176.2 billion in total assets. The data showed that the premium volume reflected a 24 per cent increase compared to 2024, while total assets rose by 15 per cent over the same period.

The 693 Class B licences (mostly captives) in 2025, represented an increase from 670 in 2024 and 658 in 2023. Accordingly, captives licensed in 2025 by CIMA accounted for 96.25 per cent of all international insurer licensees in the Cayman Islands.

The Cayman Islands has historically been a jurisdiction for captive insurance companies and is currently one of the leading captive hubs in the world, both in terms of number of companies and total assets under management. This is a result of Cayman’s world-wide reputation as a highly professional, yet business friendly and well-regulated environment, with a philosophy of imposing proportionate, risk-based regulations and rules backed by consistency of enforcement.

The growing popularity of the segregated portfolio (SPC) structure in the captive insurance industry is partly due to the fact that such structures allow insurers to add additional participants in a reinsurance programme without risk of cross liability. In fact, a distinctive feature of all SPCs is that the assets and liabilities of each segregated portfolio (also referred to as ‘cells’) are, as the name suggests, segregated from one another.  Each SPC cell, however, does not have legal personality. Ownership of the underlying assets in the cells is through classes or series of shares in the SPC which are designated to that particular cell.

The SPC structure is often seen in the context of the so-called ‘rent-a-captives’, whereby those wishing to reap the benefits of a captive insurance company (either for their own insurance or reinsurance) while minimising matters such as time, upfront costs, and maintenance, can simply become shareholders in an existing SPC and ‘rent’ a cell. The participants in a rent-a-captive structure pay premiums and service fees into the cell and in return they get access to the capital base they need to underwrite the risk, as well as an entitlement to any distributions made out of that cell. The SPC structure provides smaller businesses with a lower-cost entry point into the captive market, thanks to reduced premium thresholds and significantly lower formation costs.

There are also Portfolio Insurance Companies (PICs) which can be seen as a slight variation of the SPCs mentioned above. A PIC is similar to an SPC except that its cells have separate legal personality.

Other forms of captives include ‘Association Captives’, which are insurance companies owned by an association to meet the insurance needs of its members, and ‘Agency Captives’, which are insurance or reinsurance companies owned by one or more insurance agents, used to insure against the risks of those agents or any of their clients.

Cayman Islands domiciled captivesoperate primarily as Single Parent Captives (‘Pure Captives’), Group Captives, or Segregated Portfolio Companies (SPCs), allowing for bespoke insurance solutions. Businesses utilise them to manage complex risks, reduce reliance on commercial insurance, retain underwriting profits, lower insurance costs, enhance the ability to tailor coverage for hard to insure or emerging risks, enhance greater control over coverage and flexibility in managing risks, and increase the ability to allocate costs to different business units.

The continued growth of Single Parent Captives indicates that captives are increasingly being used by organisations to cover cyber risks that are difficult to place, expensive, or excluded in the traditional insurance market. By creating a wholly owned insurance entity, companies can customise policies to fit their specific risk profile, retain underwriting profits, and bridge gaps in standard cyber coverage. Group Captives act as a collaborative, accessible entry point for mid-market businesses seeking control over insurance costs and risk management, acting as an alternative to traditional insurance and costly single-parent captives. By pooling resources, members gain direct access to reinsurance markets, transparency in underwriting, and the ability to earn dividends on unused premium, particularly in casualty lines. Going forward, it is anticipated that economic uncertainty, rising premiums, and emerging risks, will drive more businesses to seek collaborative solutions that offer stability and cost efficiency.

A Class B(iii) Captive in the Cayman Islands is a specialised insurance company that writes 50 per cent or less of its net premiums from related business, requiring a minimum capital of US$200,000. These Captives are ideal for group risks, joint ventures, or scenarios with significant third-party business. They have the versatility of being suitable for complex risks that do not fit the 95 per cent single parent threshold of Class B(i) captives and can be structured as a standalone company or as an SPC.

This article was first posted in the IFC Review.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific legal advice on the subject matter of this Legal Insight, please contact: 

Partner: Gary Smith
E: gary.smith@loebsmith.com

The main fiduciary duty that a General Partner owes to the ELP and the ELP’s limited partners as a whole is the duty of loyalty and good faith. Under Cayman law this is expressed as requiring the General Partner to act in good faith in the interest of the ELP. There is no specific guidance in the ELP Act as to the full extent of this duty. There are no decisions of the Cayman Islands’ courts that have  determined the full scope of the duty. However, as in other areas of Cayman law, it is reasonable to assume that the Cayman courts would refer to the decisions in English and Commonwealth cases, which are of persuasive authority if not binding authority, for guidance.

Prior to July 2014, a General Partner was under an absolute duty to act in good faith in the interest of the ELP. This duty could not be restricted, limited or varied by the terms of the Partnership Agreement between the General Partner and the limited partners. The requirement to act in the interest of the ELP often raises the issue of conflicts of interest for the General Partner, particularly when it acts as General Partner to more than one ELP.

Examples of where conflicts of interests can arise for the General Partner include:

1. The General Partner causes the ELP to:
   • co-invest with other ELPs (in which it is also the general partner) in only certain transactions that benefit the General Partner; or
   • co-invest in disproportionate amounts, which causes its interests to be no longer directly aligned with those of the limited partners of the ELP.
2. The General Partner causes the ELP to invest in a portfolio company in which the person(s) who control and/or own the General Partner, for example, the director(s) and/or shareholder(s) of the General Partner, have a personal interest.
3. The General Partner causes the ELP to purchase securities from person(s) who control and/or own the General Partner, for example, the director(s) and/or shareholder(s) of the General Partner.
4. The General Partner is responsible for valuing assets of the ELP where carried interest payable to the General Partner are based on such valuations.
5. Treatment of limited partners: the General Partner owes a fiduciary duty to the limited partners of the ELP as a whole. Therefore the General Partner should treat each limited partner of the ELP in a similar manner. It should not benefit one at the expense of the others. Different treatment of limited partners sometimes arises in the context of default by a limited partner in performing its obligations under the Partnership Agreement. For example, where the limited partner fails to pay its contributions to the ELP when a call on its capital commitments has been made.

Often the Partnership Agreement provides that where a limited partner fails to perform any of its obligations under, or otherwise breaches the Partnership Agreement (for example, where a limited partner fails to commit additional capital when called on to do so), that limited partner may be subject to or suffer remedies for, or consequences of, the failure or breach specified in the Partnership Agreement. Such remedies or consequences can include, for example, reducing, eliminating or forfeiting the defaulting limited partner’s partnership interest in the ELP. The ELP Act confirms that those remedies or consequences in the Partnership Agreement will not be unenforceable solely on the basis that they are penal in nature. This confirmation by the ELP Act reduces significantly the risk of those remedies or consequences in the Partnership Agreement being subject to legal challenge in the Cayman courts on the basis that they are penalties (that is, remedies that go well beyond a reasonable assessment and measure of the loss suffered as a consequence of the default) and may be unenforceable as a matter of Cayman law generally.

However, there is a risk of legal challenge by a limited partner where a General Partner fails to apply a clear and consistent approach to implementing such remedies in the Partnership Agreement against defaulting limited partners. The challenge could be based on the ground that the inconsistent implementation of such default procedures benefits one limited partner at the expense of the others or vice versa.

The ELP Act modified the scope of the fiduciary duty of a General Partner to act in good faith in the interest of the ELP. There is still an absolute duty on the General Partner of an ELP to act in good faith on matters concerning the ELP. However, the duty to act in the interest of the ELP is now subject to any express provision in the Partnership Agreement to the contrary.

The Partnership Agreement can therefore stipulate the circumstances in which the General Partner may act in the interest of a party other than the ELP (for example, see above, Duty to act in good faith in the interest of the ELP). Including these circumstances in the Partnership Agreement should make it easier for the General Partner to manage interests that compete against the interests of the ELP.

However, where the Partnership Agreement has no express provision to state in whose interest the General Partner must act in given circumstances, then the default position is that the General Partner must act in good faith in the interest of the ELP (that is, in the collective interest of all limited partners of the ELP).

A General Partner’s powers derive from the ELP Act and the Partnership Agreement governing its relationship with the limited partners. The General Partner is under a fiduciary duty to exercise its powers for the purpose(s) for which they are conferred in the Partnership Agreement. The purposes in the Partnership Agreement can be stated in general terms, for example, to undertake any lawful activity under the ELP Act, or to act as an investment fund. They can also be expressed in specific terms, for example, to invest in a portfolio consisting primarily of securities of companies in the renewable energy, renewables, clean technology, environment regeneration sectors and to engage in all activities and transactions as may be necessary, advisable, or desirable to carry out these activities. Where the Partnership Agreement of an ELP is, for example, negotiated with a large institutional investor or seed capital investor, the investor will more than likely seek to have the purpose(s) of the ELP stated in more specific terms.

The ELP Act states that all “rights or property of every description of the [ELP], including all choses in action and any right to make capital calls and receive the proceeds thereof that is conveyed to or vested in or held on behalf of any one or more of the general partners or which is conveyed into or vested in the name of the [ELP] shall be held or deemed to be held by the general partner and if more than one then by the general partners jointly, upon trust as an asset of the [ELP] in accordance with the terms of the partnership agreement” (section 16(1), ELP Act).

As the General Partner holds the ELP’s assets on trust, it follows that it should:

• Not make any secret profits from such assets or, without express authorisation, appropriate any benefits or opportunities that derive from such assets for itself.

• Disclose personal interest in contracts involving the ELP.

• Apply the ELP’s assets for the purpose of the ELP.

A General Partner can minimise the risk of breaching its fiduciary duties to the ELP and thereby the risk of being sued by one or more limited partners by adopting some or all of the following:

1. Avoid conflict transactions or establish advisory committees (LPACs) or votes of limited partners to approve conflict transactions or waive conflicts. An ELP’s Partnership Agreement often provides for the establishment of an advisory committee of persons nominated by certain limited partners (LPAC) to adjudicate on, among other things, conflict situations involving the General Partner. The use of advisory committees is a good way of mitigating the risk of the General Partner being found to be in breach of its fiduciary duties for failing to deal with conflicts or dealing with them inadequately. The ELP Act confirms that, subject to any terms of the Partnership Agreement to the contrary, a member of the LPAC does not owe any fiduciary duty to the ELP or to the General Partner or to any of the ELP’s limited partners, in exercising any of its rights or otherwise in performing any of its obligations as a member of the advisory committee (section 24(2), ELP Act).
2. Clear and consistent policies. The General Partner should ensure that the ELP, where possible, adopts clear and consistent valuation policies approved by the ELP’s advisory committee. The General Partner should also ensure that the ELP, where possible, adopts clear and consistent policies for dealing with circumstances where limited partners default on their obligations in the Partnership Agreement (for example, failing to make contributions when a capital call has been made). An ELP which operates as a regulated investment fund registered with the Cayman Islands Monetary Authority is required to have policies and procedures for implementing and effecting good corporate governance. This can also help to mitigate risks of liability.
3. Internal compliance. The General Partner should establish clear internal procedures for identifying potential conflicts and dealing with them (for example, referral to the LPAC for consideration).
4. Restrict the scope of fiduciary duties by agreement. The Partnership Agreement can be drafted in such a way as to minimise or restrict the scope of certain fiduciary duties. For example, the ELP Act now permits the Partnership Agreement to set out circumstances in which the General Partner may act in the interests of parties other than the ELP (see above, Modification of duty to act in good faith in the interest of the ELP). The Partnership Agreement can also be used to clearly exclude fiduciary duty obligations of the General Partner in other areas but this will depend on the relative bargaining power between the General Partner and incoming limited partners and the degree of negotiation of the Partnership Agreement. However, the absolute duty on the General Partner to act in good faith in respect of the ELP cannot be excluded or eliminated.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us.  We would be delighted to assist.

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
E: elizabeth.kenny@loebsmith.com
E: vanisha.harjani@loebsmith.com
E: kate.sun@loebsmith.com
E: vivian.huang@loebsmith.com
E: faye.huang@loebsmith.com
E: yun.sheng@loebsmith.com

Parallel funds are investment vehicles structured to co-invest and divest alongside a main fund, with each structure being similar in many ways to the main fund in terms of strategy, investment policy, investment target, asset classes, risk management, etc. The major distinction between the different funds in the structure are typically the tax framework (capital gains, dividend, interest, etc.) or the intention of the investment manager to differentiate each fund vehicle based on their investor group.

For example, parallel funds may include an onshore fund or mid-shore (established in any jurisdiction, e.g. Singapore or Hong Kong) and a standalone Cayman fund, both being managed by the same investment manager, with similar investment objectives and strategies, making identical investments but having different structures and a different pool of investors (e.g. US investors in one Cayman structure or Delaware structure, Japanese investors in a Singapore domiciled fund structure, and other non-US investors based in Asia in another Cayman-domiciled fund structure), in order to cater for a tax efficient framework or regulatory requirements based on investors’ jurisdiction of domicile.

Parallel funds are often established by private equity (PE) fund managers to complement the main fund and address legal, tax, regulatory, accounting or other considerations from specific investors who are interested in the investment objective and strategy.

Parallel funds versus master-feeder funds. Parallel funds are distinguishable from master-feeder structures in that the feeder funds invest directly into the master fund, thereby pooling all investments in the master fund. With parallel funds, separate investment funds invest directly in the same investment deals or asset classes, but they are kept as distinct entities with no pooling of capital into a master fund.

What are the key benefits and advantages offered by parallel fund structures?

Using parallel funds provides a number of benefits to investment managers, including:

1. Flexibility, allowing investment managers to tailor investment strategies and structures based on investor profiles, offering different fee structures or liquidity terms;
2. Tax efficiency, providing a tax efficient way to invest without triggering adverse tax consequences in jurisdictions with stringent regulations; and
3. Regulatory compliance, allowing investment managers to adapt to varying regulatory environments, ensuring compliance.

However, it would be wise to note that parallel fund structures do not come without risks, including:

1. Operational issues – the investment manager may need to manage multiple funds across jurisdictions;
2. Different regulatory requirements – creating more administrative responsibility and complexities in terms of operations and compliance, increasing cost; and
3. Investor relations and fees – managing communications and reporting between different investor classes, and dealing with different structures and fees can cause confusion and increase the administrative burden.

When structuring parallel funds, consideration needs to be given to:

1. Investment strategy alignment to ensure that funds can invest in the same underlying assets without conflicts of interest;
2. Fund documentation, drafted to address the specific needs of each fund while ensuring consistency;
3. Management and fees, ensuring transparency; and
4. Legal and tax advice to ensure compliance with all relevant laws and regulations, and optimise the tax impact for investors.

When considering the Cayman Islands for a parallel fund structure, its robust legal framework, absence of taxes on investment funds and their investors, and flexible regulatory environment make it attractive for investment managers and investors alike.

This article was first published with Asia Business Law Journal. https://law.asia/cayman-islands-parallel-funds-growth-benefits/

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Article, please contact us. We would be delighted to assist.

Vanisha Harjani
E: vanisha.harjani@loebsmith.com

An investor in a fund that is structured as an ELP is issued with limited partnership interests (“LP Interests”) in exchange for their capital contributions. The general partner of an ELP (“General Partner”) is required to maintain a register of partnership interests containing certain prescribed information in respect of each limited partner (“Register”).

Before a lender takes security over LP Interests, it must first undertake detailed due diligence in order to ensure that the security that is available matches its expectations.

First, it should review the relevant provisions of the limited partnership agreement relating to the ELP (“LPA”). LPAs usually contain either an outright prohibition on the creation of security over LP Interests or in the very least require the prior written approval of the General Partner to the creation and subsistence of the security. There is often no express contractual requirement for the General Partner to not ‘unreasonably withhold or delay consent”. Therefore, early and transparent engagement with the General Partner is essential.

A further consent may be required from the General Partner as LPAs also typically restrict the transfer of LP Interests without the General Partner’s consent. A lender will therefore wish to obtain consent upfront to any transfer of title in the relevant LP Interests in the event that the security is enforced.

In addition to reviewing the LPA, a well-advised lender will also insist on reviewing any side letters and the subscription application that may have been entered into by the limited partner with the ELP to ensure that the provisions to the LPA dealing with the creation of security have not been modified. To the extent that a side letter does not exist, the lender should obtain representations and warranties to this effect from the limited partner in the finance documents.

Finally, the lender should also review the Register (to ensure that the security provider does in fact hold title to the LP Interests that are to be the subject of the security) and, in the case of a corporate security provider, its register of security interests to ensure that no prior security interests subsist over the LP Interests. To the extent that any security interests are revealed to already exist, the prior security interests will need to be redeemed prior to concluding the funding. Alternatively, a deed of priority or intercreditor deed could be entered into with the other secured party.

In addition to legal due diligence, the lender should also make enquiries of the ELPs records of capital contributions to ensure that any and all capital commitments have been fully funded (or will be so funded with the financing to be provided).

Under Cayman Islands law, there are no prescribed particulars for how security over LP Interests is created and perfected. That said, the security document that will be entered into to create security over the LP Interests follows a format that will be familiar in finance transactions in other jurisdictions. In particular, the security document will:

• be in writing;
• be signed by the limited partner granting the security (usually as a deed);
• contain a full and detailed description of the LP Interests that will be the subject of the security. In addition to the LP Interests themselves, the security created will also extend to all ‘related rights’ to the LP Interests, such as rights to any distributions and the ultimate return of the invested principal;
• contain details of the amount to be secured by the document. Typically, this will not be a specific monetary amount but will instead be expressed to be either ‘all monies owing by the limited partner to the lender’, or ‘all monies owing by the limited partner to the lender under the finance documents’; and
• specify the powers and entitlements of the lender in the event of a default by the limited partner which results in the security becoming enforceable. The events of default themselves will typically be listed in the accompanying facility letter or loan agreement.

In addition to the security document, a limited partner providing security will also provide the required consent(s) from the General Partner (as noted above) and a signed, undated instrument of transfer relating to the secured LP Interests, with the transferee left blank. Any enforcement transfer remains subject to the transfer restrictions contained in the LPA and the terms of the security document.

A person granting security over LP Interests is required to provide written notice of the creation of the security to the ELP at its registered office. Such notice must specify the agreement pursuant to which security is granted, including its date, the names of the parties and details of the LP Interests that are the subject of security.

In practice, a well-advised lender will insist on the chargor having dialogue with the ELP prior to conclusion of the financing so that the form of notice is agreed in advance and promptly served. As between competing security interests over the same LP Interests, priority is determined by the time at which written notice of the security is received at the ELP’s registered office. The ELP is required to maintain a register of security interests in respect of each such notice that it receives.

The lender will also typically require a written acknowledgement from the ELP as confirmation this requirement has been met as well as a copy of the duly completed register (or an extract therefrom).

If the limited partner providing the security is itself a corporate entity or an ELP, depending on its jurisdiction of incorporation it may need to make filings and update registers of its own in order to remain compliant and to ensure the security remains valid and enforceable.

No stamp or other taxes are typically payable in respect of either the grant of security over LP Interests or any subsequent transfer of LP Interests where the security is enforced save where the document is executed in, or brought into, the Cayman Islands.

In the event of a continuing default by the chargor, the holder of the security over the LP Interests may enforce it in accordance with the terms of the security document. Security documents will usually permit the securityholder to sell the charged LP Interests or appoint a receiver in respect of the same.

However, the securityholder’s rights under the security documents are only part of the overall analysis. Well-advised lenders should, from the outset of the financing, carefully review whether the terms of the LPA adequately accommodate an enforcement scenario and, where necessary, seek appropriate amendments or consents.

LPAs are commonly drafted so as to restrict the transfer of LP Interests without the consent of the General Partner. A secured creditor will therefore typically require either: (i) the General Partner’s advance consent to transfers arising upon enforcement of the security; or (ii) sufficiently broad provisions within the LPA itself permitting transfers of LP Interests by a secured creditor or receiver on enforcement.

This issue is particularly important because, in an enforcement scenario, the General Partner may not necessarily take a position aligned with the interests of the lender. Lenders will therefore wish to ensure that the LPA does not confer overly broad discretion on the General Partner in a manner that could frustrate or materially delay the enforcement process.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific legal advice on the subject matter of this Briefing, please contact:

Partner: Robert Farrell

E: robert.farrell@loebsmith.com

Whilst there are no statutory requirements as to the type of legal entity that should be used in the establishment of a closed-ended fund pursuant to the Act, the type of entity most commonly used for this purpose is the Exempted Limited Partnership (“ELP”). Whilst other types of corporate vehicles can be used, such as a Cayman Islands Exempted Company, these are more commonly deployed in the context of an open-ended investment fund pursuant to the Mutual Funds Act (As Revised).

If a closed-ended fund (referred to under the Act as a private fund) is structured as an Exempted Company, it will be the directors of that company who operate it. However, as part of the registration of the fund with the Cayman Islands Monetary Authority (“CIMA”), it will be necessary to ensure that there are at least two directors appointed; this is known as the “four eyes principle” to ensure proper corporate governance and investor protection and is a prerequisite for registration as a private fund with CIMA.

If the fund is established as an ELP, the two-director rule does not apply directly to the ELP as ELPs do not have separate legal personality and therefore do not have directors. An ELP must, however, have a qualifying “general partner” who operates the ELP on behalf of the limited partners. It is at the general partner level that the “four eyes principle” will apply in this context and so a general partner must also have at least two directors.

Presently, it is not necessary for the directors of a private fund (or the directors of a general partner of an ELP which is registered as a private fund) to be registered pursuant to the Directors Registration and Licensing Act (As Revised).

Only closed-ended funds that fall within the definition of a “private fund”, as defined in the Act, will be required to register with CIMA under the Act as a private fund and will be regulated as such. The Act defines a “private fund” as:

“…a company, unit trust or partnership that offers or issues or has issued investment interests, the purpose of effect of which is the pooling of investor funds with the aim of enabling investors to receive profits or gains from such entity’s acquisition, holding, management or disposal of investments, where –

(a) the holders of investment interests do not have day-to-day control over the acquisition, holding, management or disposal of the investments; and

(b) the investments are managed as a whole by or on behalf of the operator of the private fund, directly or indirectly…”

The term “investment interest” is defined in the Act as an interest in the issuing vehicle which carries an entitlement to participate in the profits or gains of the vehicle and which interests are not redeemable or re-purchasable at the option of the investor.

Whether a particular structure will fall within this definition and be subject to regulation can be highly nuanced. We therefore recommend that you speak with an experienced Cayman Islands investment funds attorney to determine whether your proposed project would be regulated or whether an exemption from registration might be available.

For example, the Act itself contains a list of “non-fund arrangements” which are not considered to be “private funds”. The list of non-fund arrangements is extensive and quite broad in remit but we would specifically highlight the following non-fund arrangements:

• Joint ventures;
• Proprietary vehicles;
• Holding vehicles;
• Debt issues and debt issuing vehicles;
• Structured finance vehicles; and
• Sovereign wealth funds.

It should also be noted that single investor funds will also fall outside of the remit of the Act on the basis that where there is only one investor, there will not be any “pooling of investor funds” as required by the above quoted definition of “private fund”.

Where a particular project falls within the definition of a “private fund” and where it is not a “non-fund arrangement”, the corporate vehicle will be required to apply to CIMA for registration as a private fund under the Act.

In order to be registered under the Act, the fund will need to submit a completed application to CIMA via its online portal together with supporting documentation, including its offering document (which should contain, as a minimum, the information specified by CIMA in its Rules on Content of Offering Memorandum) and evidence of the appointment of an auditor and an administrator.

The application must (per section 5 of the Act) be submitted to CIMA (together with payment of the applicable registration fee) within 21 days after its acceptance of capital commitments from investors for the purposes of investments (although the application can be submitted at any time before capital commitments are received). The fund must be registered with CIMA as a private fund before it receives any capital contributions from investors.

In addition to the above, there are certain other key obligations with which private funds must comply.

Where the fund makes any change (or becomes aware of any change) which materially affects any information that was delivered to CIMA as part of the fund’s registration as a private fund, it must file details of the change with CIMA within 21 days of the change taking effect or of the fund becoming aware of the change. Whilst the Act only requires ‘material’ changes to be notified to CIMA, in practice CIMA tends to be notified of all changes given what is ‘material’ is open to interpretation.

Private funds must also file an annual return with CIMA and pay an annual registration fee in order to maintain its registration.

The Act requires that private funds have in place certain mechanisms and safeguards relating to an annual audit of the fund, the valuation of the fund’s assets, the safeguarding of the fund’s assets, cash monitoring and the identification of securities.

• Audit – the fund must engage an approved Cayman Islands auditor to prepare its audited financial statements annually. CIMA maintains a list of the approved auditor firms who are able to provide this service. Such audited financial statements must be filed with CIMA within six (6) months of the end of each financial year of the fund.
•  Valuation of fund assets – the assets of a private fund must be valued periodically. What is considered to be an appropriate period between valuations will depend on the asset class(es) in which the fund is invested. However, valuations should, as a minimum, be carried out at least annually. Each valuation must be carried out by an independent and suitably qualified professional valuer who is familiar with the relevant asset class. If the valuer is not independent, then CIMA reserves the right to have the valuation independently verified at the cost of the fund. Otherwise, if the valuation of assets is carried out by the fund itself or by its investment manager, the valuation function must be independent from the portfolio management function of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors.
•  Safeguarding of the fund’s assets – private funds are, generally speaking, required to appoint a custodian to hold, in segregated accounts maintained in the name of the fund, the fund’s assets which are capable of physical delivery or capable of registration in a separate account except that the private fund shall not be required to appoint a custodian if it has notified CIMA and it is neither practical nor proportionate to do so, having regard to the nature of the private fund and the type of assets it holds. The duty of custodian appointed is to verify the fund’s title to its assets based on information provided by the fund together with any externally available information. If a custodian is not appointed, the verification of the fund’s title to its assets must be carried out either by the fund’s administrator or by the fund itself or its investment manager. In the case of title verification by the fund or its investment manager, the title verification function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors in the fund.
• Cash monitoring – private funds are required to appoint any of an administrator, custodian or the investment manager to (1) monitor the cash flows of the fund; (2) ensure that all cash has been booked in cash accounts maintained in the name of the fund; and (3) ensure that payments made by investors to the fund for the purposes of investment have been received. If such monitoring is not undertaken by an independent third party, CIMA reserves the right to have the cash monitoring verified at the cost of the fund. In the case of cash monitoring undertaken by the fund or its investment manager, as above, the cash monitoring function must be independent from the portfolio management of the fund and any conflicts of interest are required to be identified, managed, monitored and disclosed to investors in the fund.
•  Identification of securities – if the private fund in question regularly trades securities or holds them on a consistent basis, it must keep records of the identification codes (such as ISIN codes or CUSIP codes) of those securities that it trades and holds, and such records must be made available to CIMA on request.

In addition to its obligations under the Act and guidance issued by CIMA, private funds are also subject to other obligations under the laws of the Cayman Islands in relation to matters such as FATCA / CRS compliance and, in respect of anti-money laundering legislation and regulations.

• FATCA / CRS – Private funds tend to be classified as ‘Reporting Financial Institutions” for the purposes of FATCA and CRS. Each private fund is therefore required to undertake detailed due diligence on each of its investors (which is typically undertaken on its behalf by its administrator). The fund must also provide information to the Tax Information Authority of the Cayman Islands in respect of each of its investors who constitute ‘reportable accounts’.
• Anti-money laundering – Private funds conduct “relevant financial business” for the purposes of the Proceeds of Crime Act (As Revised) and the Anti-Money Laundering Regulations (As Revised) (being together the “AML Requirements”). Private funds are therefore required to have robust policies and procedures in place to ensure that the AML Requirements are adhered to. The fund must have a detailed Anti-Money Laundering Compliance Manual which contains detailed guidance on the policies and procedures that must be followed in carrying out the fund’s activities, ranging from the onboarding process for investors, record-keeping, processes for the reporting of suspicious activity and other risk management matters.
• Beneficial ownership – The Beneficial Ownership Transparency Act (“BOTA”) requires Cayman Islands exempted companies, ELPs, and limited liability companies to maintain a beneficial ownership register unless an alternative route to compliance applies. Under the BOTA, alternative routes to compliance are available to categories of legal persons such as private funds and each private fund will be required to provide its corporate services provider in the Cayman Islands with:

1. written confirmation of the category into which it falls; and
2. the required particulars specific to it.

The private fund is required to appoint a principal point of contact (“PPoC”) who is responsible for responding to any request for beneficial ownership information received from the Cayman Islands Competent Authority (“Competent Authority”) in relation to the private fund. The PPoC must be licensed in the Cayman Islands and will be required to provide the requested beneficial ownership information to the Competent Authority within 24 hours of a request being made, or such other timeframe as may be stipulated in the request.

Each private fund must also appoint three (3) officers to assist with compliance with the AML Requirements; these are the anti-money laundering compliance officer, money laundering reporting officer, and deputy money laundering reporting officer.

On the basis that private funds are a form of investment fund, private funds that are registered under the Act are not ‘relevant entities’ for the purposes of the International Tax Co-operation (Economic Substance) Act (As Revised). Whilst, therefore, private funds will not be required to demonstrate the extent of their ‘substance’ in the Cayman Islands, they will nonetheless be required to make an annual notification under this legislation to confirm their status as an investment fund.

If you are considering establishing a private fund in the Cayman Islands, it is imperative that you have experienced Cayman Islands legal counsel by your side to assist you in navigating the legislative, regulatory, and compliance landscape. We have a strong reputation for our technical excellence, responsive, forward-thinking and insightful approach to advising clients on offshore Investment Funds and would be happy to be your trusted advisor on the formation, launch and ongoing advisory of your Cayman Islands private fund.

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This publication is not intended to be a substitute for specific legal advice or a legal opinion. If you require further advice relating to the matters discussed in this Briefing, please contact us.  We would be delighted to assist.

E: gary.smith@loebsmith.com
E: robert.farrell@loebsmith.com
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E: vanisha.harjani@loebsmith.com
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E: faye.huang@loebsmith.com