In our guidance note Top Ten Best Practices for an ICO Founders’ Team: A View from the Cayman Islands, ICO founder teams and promoters looking at the Cayman Islands for incorporation of their company or companies were warned that, while the Cayman Islands had flexible pragmatic rules encouraging business and innovation, they also had stringent anti-money laundering (“AML”) and know-you-customer (“KYC”) requirements. In addition, other regulatory requirements may be applicable and the company and even its directors and founders may be held liable, under certain circumstances, for any misleading statements made in the White Paper or in additional documentation communicated to token purchasers.

Based on our experience of advising initial coin offerings (ICOs) and security token offerings (STOs) and of undertaking legal due diligence for institutional clients seeking to acquire tokens in ICOs and STOs, in this brief update, we discuss what we view as the five most important questions to discuss with Cayman Islands legal counsel, either prior to setting up, or as soon as possible thereafter, in order (i) to reduce your risk of contravening Cayman Islands law, (ii) to facilitate listing on crypto-exchanges, and (iii) to facilitate better relationships with other participants in the growing digital assets space (e.g. banks to open accounts, institutional investors and investment funds which will undertake due diligence as part of the process of acquiring tokens in an ICO or STO).

The constitutional documents of a Cayman Islands company, the Memorandum of Association and the Articles of Association (“Articles”), set out the governance rules and the powers of the Directors. However, the Directors also owe fiduciary duties and certain duties of skill and care under English common law. Among the principal fiduciary duties owed to the Company, the Directors are required to:

i. act, in good faith, in what they consider reasonably to be the best interests of the Company;

ii. exercise their powers under the Articles for the purposes for which those powers are conferred;

iii. avoid conflicts of interests or (where conflicts are permitted by the Articles) ensure that any conflicts are properly disclosed during Board meetings;

iv. exercise their powers independently, without subordinating to the will of others; and

v. not misuse the property of the Company and not make secret profits from their position as a Director.

The Directors should also acquire and maintain a sufficient knowledge of the business on a continuing basis and attend diligently to the affairs of the Company, duties which need to be carried out with reasonable care, diligence and skill. In addition, the Directors also have certain statutory obligations under the Cayman Islands Companies Law (2018 Revision) (the “Companies Law”).

Directors are generally not liable except in cases of negligence, fraud, breach of fiduciary duty, or an action not within their authority which is not ratified by the Company. They may be indemnified by the Company against personal liability for losses incurred arising out of the Company’s business, including in case of negligence and breach of duty (other than breaches of fiduciary duty), except in cases of willful default or fraud.

The Cayman Islands Monetary Authority (“CIMA”) has not issued statements or guidance on virtual currencies, blockchain technology, ICOs or STOs, other than a warning notice dated 23rd April 2018 which specifically flagged a number of risks specifically associated with ICOs and virtual currencies.

i. The Cayman Islands Securities Investment Business Law (Revised) (“SIBL”) defines securities by reference to a list of instruments, including shares and stock of any kind in the share capital of a company, debentures and any other instruments creating or acknowledging indebtedness other than certain exceptions specified, instruments giving entitlements to securities, certificates conferring rights with respect to securities, etc.

The term “instrument” refers to any record and specifically includes an electronic record as defined in the Electronic Transactions Law (2003 Revision), i.e. a record processed and maintained by electronic means.

Accordingly, CIMA may qualify coins/tokens issued on blockchain as stock or debt if the rights attached to the coins/tokens (as represented in the White Paper or the token sale documentation) resemble rights normally attached to equity interests or debt.

ii. In certain circumstances, a registration with or a license from CIMA may be required:

(a) under the Cayman Islands Money Services Law (Revised), if the coins/tokens issued could give access to money transmission or currency exchange services;

(b) under SIBL, if the coins/tokens may qualify as securities, for all persons engaging, “in the course of business”, in securities investment business, i.e. among other things buying, selling, subscribing for or underwriting securities as agent or principal, arranging deals, managing securities, or advising an investor on buying, selling, underwriting, subscribing for or exercising any right in securities; and/or

(c) under the Mutual Funds Law (2015 Revision) if the issuer of the coins/tokens is essentially a collective investment scheme and the coins/tokens are attached to redemption rights for investors.

All Cayman Islands companies with certain exceptions such as listed companies, certain companies registered or licensed in the Cayman Islands, companies which are promoted, managed or administered by certain regulated persons, etc. are required to maintain a beneficial ownership register (a “BO Register”) at the registered office.

The BO Register will record details of individuals holding (directly or indirectly):

i. more than 25% of the shares or interests of the company;

ii. more than 25% of voting rights of the company; and/or

iii. the right to appoint or remove a majority of the Board of Directors.

If none of the conditions above are satisfied, an individual will still be a beneficial owner and therefore reportable on the BO Register if he has the absolute and unconditional right to exercise or actually exercises, significant influence or control over the company (other than solely in the capacity of director or manager, professional advisor or professional manager).

Token issuers and other companies operating in the digital assets space may be deemed to be undertaking “relevant financial business” in the Cayman Islands, as defined in Schedule 6 of the Proceeds of Crime Law (2018 Revision). The definition includes (but is not limited to):

Acceptance of deposits and other repayable funds from the public.

Lending.

Financial leasing.

Money or value transfer services.

Issuing and managing means of payment (e.g. credit and debit cards, cheques, traveller’s cheques, money orders and bankers’ drafts, electronic money).

Financial guarantees and commitments.

Trading in (a) money market instruments (cheques, bills, certificates of deposit, derivatives etc.); (b) foreign exchange; (c) exchange, interest rate and index instruments; (d) transferable securities; or (e) commodity futures trading.

Participation in securities issues and the provision of financial services related to such issues.

Advice to undertakings on capital structure, industrial strategy and related questions and advice and services relating to mergers and the purchase of undertakings.

Money broking.

Individual and collective portfolio management and advice.

Safekeeping and administration of cash or liquid securities on behalf of other persons.

Safe custody services.

Financial, estate agency, legal and accounting services provided in the course of business relating to (a) the sale, purchase or mortgage of land or interests in land on behalf of clients or customers; (b) management of client money, securities or other assets; (c) management of bank, savings or securities accounts; and (d) the creation, operation or management of legal persons or arrangements, and buying and selling of business entities.

The services of listing agents and broker members of the Cayman Islands Stock Exchange as defined in the CSX Listing Rules and the Cayman Island Stock Exchange Membership Rules respectively.

The conduct of securities investment business.

Dealing in precious metals or precious stones, when engaging in a cash transaction of fifteen thousand dollars or more.

The provision of registered office services to a private trust company by a company that holds a Trust licence under section 6(5)(c) of the Banks and Trust Companies Law (2018 Revision).

Otherwise investing, administering or managing funds or money on behalf of other persons.

Underwriting and placement of life insurance and other investment related insurance.

For a company undertaking relevant financial business, the Proceeds of Crime Law (2018 Revision) and the Anti-Money Laundering Regulations (2018 Revision) of the Cayman Islands (the “AML Regulations”) will apply, and the company will be required to take steps appropriate to the nature and size of their business to identify, assess, and understand its money laundering and terrorist financing risks in relation to a customer, the country or geographic area in which the customer resides or operates, the products, service and transactions, and the delivery channels.

The following AML procedures are required under the AML Regulations currently in force:

i. identification and verification (KYC) procedures for investors/purchasers;

ii. adoption of a risk-based approach to monitor activities;

iii. record-keeping procedures;

iv. procedures to screen employees to ensure high standards when hiring;

v. adequate systems to identify risk in relation to persons, countries and activities which shall include checks against all applicable sanctions lists;

vi. adoption of risk-management procedures concerning the conditions under which a customer may utilize the business relationship prior to verification;

vii. observance of the list of countries, published by any competent authority, which are non-compliant, or do not sufficiently comply with the recommendations of the Financial Action Task Force (FATF);

viii. internal reporting procedures; and

ix. other procedures of internal control, including an appropriate effective risk-based independent audit function and communication as may be appropriate for the ongoing monitoring of business relationships or one-off transactions for the purpose of forestalling and preventing money laundering and terrorist financing.

For all such companies, the AML Regulations also impose the designation of natural persons, at managerial level, to act as Anti-Money Laundering Compliance Officer (“AMLCO”), Money Laundering Reporting Officer (“MLRO”) and Deputy Money Laundering Reporting Officer (“DMLRO”). CIMA requires that a person acting as MLRO / DMLRO must (i) act autonomously; (ii) be independent (have no vested interest in the underlying activity of the investment fund); and (iii) have access to all relevant material in order to make an assessment as to whether an activity is or is not suspicious. The AMLCO role should be performed by someone at management level, who will be the point of contact with the supervisory and other competent authorities.

CIMA Guidance to the Cayman AML Regulations requires that an AMLCO must be a person who is fit and proper to assume the role and who:

i. has sufficient skills and experience;

ii. reports directly to the Board of Directors (“Board”) or equivalent;

iii. has sufficient seniority and authority so that the Board reacts to and acts upon any recommendations made;

iv. has regular contact with the Board so that the Board is able to satisfy itself that statutory obligations are being met and that sufficiently robust measures are being taken to protect the Fund against money laundering/terrorist financing risks;

v. has sufficient resources, including sufficient time and, where appropriate, support staff; and

vi. has unfettered access to all business lines, support departments and information necessary to appropriately perform the AML/CFT compliance function.

CIMA has the power to impose fines for non-compliance on entities and individuals who are subject to the AML Regulations, starting from approximately US$6,000 for a minor breach to fines of US$61,000 (for an individual) or US$122,000 (for an entity). For a breach prescribed as very serious, the fines may reach approximately US$122,000 (for an individual) and approximately US$1,220,000 (for an entity). If a breach is also a criminal offence, the imposition by CIMA of a fine will not preclude separate prosecution for that offence (or be limited by the penalty stipulated for that offence).

Beyond discussing with your counsel and understanding what are the continuing obligations of a Cayman Islands company, the duties of a Director, the applicable laws and required AML compliance, it is essential that token issuers and other companies operating in the digital assets space be aware of the solutions they may have under Cayman Islands laws for mitigating their risk exposure, such as indemnification agreements, specific provisions to be included in the Memorandum and Articles of Association, risk factors to be disclosed and other disclaimers, specific dispute resolution mechanisms, etc.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For specific advice, please contact your usual Loeb Smith attorney or either:

E ramona.tudorancea@loebsmith.com

E vivian.huang@loebsmith.com

E elizabeth.kenny@loebsmith.com

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The Anti-Money Laundering Regulations (2018 Revision) of the Cayman Islands (AML Regulations), have expanded the scope of Cayman Islands anti-money laundering regime (“AML”) significantly, including its application to investment funds generally, and specifically to (i) private equity funds and other closed-ended funds (e.g. venture capital and real estate funds) which are not registered with the Cayman Islands Monetary Authority (“CIMA“).

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The AML Regulations have introduced a new risk-based approach to AML in the Cayman Islands, including requiring persons subject to the AML Regulations including Cayman Islands investment funds to take steps appropriate to the nature and size of their business to identify, assess, and understand its money laundering and terrorist financing risks in relation to each investor, the country or geographic area in which each investor resides or operates, the types of individuals/entities that make up the investor base of the investment fund, source of funds (e.g. investment funds with lower minimum investment thresholds might pose a greater risk of money laundering, especially if the subscription proceeds are not coming from a regulated financial institution), and redemption terms.

Going forward all non-CIMA registered and unregulated investment funds will be required to comply with the same AML regime as CIMA registered and regulated funds.

Pursuant to regulations 3(1) and 33 of the AML Regulations, a Cayman domiciled investment fund must designate a natural person, at managerial level, to act as its Anti-Money Laundering Compliance Officer (“AMLCO”), Money Laundering Reporting Officer (“MLRO”) and Deputy Money Laundering Reporting Officer (“DMLRO”). CIMA requires that a person acting as MLRO / DMLRO must (i) act autonomously; (ii) be independent (have no vested interest in the underlying activity of the investment fund); and (iii) have access to all relevant material in order to make an assessment as to whether an activity is or is not suspicious. The AMLCO role should be performed by someone at management level, who will be the point of contact with the supervisory and other competent authorities.

CIMA Guidance to the AML Regulations requires that an AMLCO must be a person who is fit and proper to assume the role and who:

i. has sufficient skills and experience;
ii. reports directly to the Board of Directors (“Board”) or equivalent;
iii. has sufficient seniority and authority so that the Board reacts to and acts upon any recommendations made;
iv. has regular contact with the Board so that the Board is able to satisfy itself that statutory obligations are being met and that sufficiently robust measures are being taken to protect the Fund against money laundering/terrorist financing risks;
v. has sufficient resources, including sufficient time and, where appropriate, support staff; and
vi. has unfettered access to all business lines, support departments and information necessary to appropriately perform the AML/CFT compliance function.

In addition to having the AMLCO, MLRO, and DMLRO officers in place, investment funds are required to have the following AML procedures in place:

1. 1. identification and verification (KYC) procedures for its investors/clients;
   2. adoption of a risk-based approach to monitor financial activities;
   3. record-keeping procedures;
   4. procedures to screen employees to ensure high standards when hiring;
   5. adequate systems to identify risk in relation to persons, countries and activities which shall include checks against all applicable sanctions lists;
   6. adoption of risk-management procedures concerning the conditions under which a customer may utilize the business relationship prior to verification;
   7. observance of the list of countries, published by any competent authority, which are non-compliant, or do not sufficiently comply with the recommendations of the Financial Action Task Force;
   8. internal reporting procedures (involving the MLRO and DMLRO); and
   9. such other procedures of internal control, including an appropriate effective risk-based independent audit function and communication as may be appropriate for the ongoing monitoring of business relationships or one-off transactions for the purpose of forestalling and preventing money laundering and terrorist financing.

In order to allow non-CIMA registered unregulated investment entities (e.g. closed-ended funds such most private equity funds, venture capital funds, and real estate funds) not previously subject to the AML regime time to implement appropriate procedures (or delegation arrangements) to be in compliance with the new AML regime, the AML Regulations have been amended to provide these entities up until 31 May 2018 to assess their existing AML/CTF procedures and to implement policies and procedures which are in compliance with the AML Regulations.

The deadline to designate an AMLCO, MLRO, and DMLRO and to notify CIMA of the identity of such persons holding these roles is on or before 30 September 2018 for existing funds.

A Cayman Fund that is already registered with and regulated by CIMA will typically have delegated the maintenance of AML procedures on behalf of the Fund to a Fund Administrator, and should therefore check that the scope of its current delegation to its Administrator is sufficiently broad to cover the requirements of the AML Regulations (e.g. check (i) whether the AML regime being applied in respect of the Fund is the Cayman AML regime or the regime of jurisdiction recognized as having an equivalent AML regime, and (ii) if it is the latter, whether or not the relevant Administrator is actually subject to the AML regime of that jurisdiction¹).

Non-CIMA registered investment funds which now fall under the new AML regime and which have delegated maintenance of AML procedures on behalf of the Fund to a Fund Administrator should also check that the scope of delegation to its Administrator or investment manager is sufficiently broad to cover the requirements of the AML Regulations. Investment entities which have not appointed a Fund Administrator (e.g. because the investment manager maintains the AML procedures on the Fund’s behalf) should check the same matters outlined above and additionally, whether or not the delegate (e.g. the investment manager) has the requisite personnel (in terms of numbers, training, and experience) to maintain the AML procedures on the Fund’s behalf. The extent to which (i) the maintenance of AML procedures on behalf of the Fund, and (ii) the designation of AMLCO, MLRO, and DMLRO functions, can be delegated to a third party service provider should also be considered within the context of CIMA’s guidance on outsourcing.

The Monetary Authority Law (2018 Revision) gives CIMA the power to impose administrative fines for non-compliance on entities and individuals who are subject to Cayman Islands regulatory laws and/or the AML Regulations.

For a breach prescribed as minor fine would be CI$5,000 (approximately US$6,000). For a breach prescribed as minor the Authority also has the power to impose one or more continuing fines of CI$5,000 each for a fine already imposed for the breach (the “initial fine”) at intervals it decides, until the earliest of the following to happen:

(a) the breach stops or is remedied;
(b) payment of the initial fine and all continuing fines imposed for the breach; or
(c) the total of the initial fine and all continuing fines for the breach reaches CI$20,000 (approximately US$24,000).For a breach prescribed as serious, the fine is a single fine not exceeding: (a) CI$50,000 (approximately US$61,000) for an individual; or (b) $100,000 (approximately US$122,000) for a body coporate.

For a breach prescribed as very serious, the fine is a single fine of not exceeding: (a) CI$100,000 (US$122,000) for an individual; or (b) CI$1,000,000 (US$1,220,000) for a body corporate.

1. Sections 3.61 and 3.62 of the CIMA Guidance on AML/CTF makes it clear that where a Cayman investment entity delegates AML/CTF compliance procedures to a delegate and that delegate is located in a jurisdiction with an equivalent AML/CTF and is subject to the anti-money laundering regime of that jurisdiction, CIMA will regard compliance with the regulations of such jurisdictions as compliance with the AML Regulations and Guidance Notes.

The Anti-Money Laundering Regulations (2018 Revision) of the Cayman Islands (AML Regulations) have expanded the scope of the Cayman Islands’ anti-money laundering regime significantly, including its application to investment funds generally, and specifically to (i) private equity funds and other closed-ended funds (e.g. venture capital and real estate funds) which are not registered with the Cayman Islands Monetary Authority (Cima).

The AML Regulations have introduced a new risk-based approach to AML in the Cayman Islands, including requiring persons subject to the AML Regulations (which include Cayman Islands investment funds) to take steps appropriate to the nature and size of their business to identify, assess, and understand its money laundering and terrorist financing risks in relation to each investor, the country or geographic area in which each investor resides or operates, the types of individuals/entities that make up the investor base of the investment fund, source of funds (e.g. investment funds with lower minimum investment thresholds might pose a greater risk of money laundering, especially if the subscription proceeds are not coming from a regulated financial institution), and redemption terms.

The scope of the AML Regulations is still defined by reference to “relevant financial business”. Persons undertaking relevant financial business in the Cayman Islands must comply with the requirements of the AML Regulations. The definition of relevant financial business that was included in previous versions of the anti-money laundering regulations has been removed from the AML Regulations and has instead been placed in Section 2 of the Proceeds of Crime Law (2018 Revision) (PCL). The definition continues to cover “mutual fund administration or the business of a regulated mutual fund within the meaning of the Mutual Funds Law (2015 Revision)” which covers all funds registered with and regulated by Cima. The definition had also covered and continues to cover investment managers licensed by or registered with Cima (e.g. those who have applied for and obtained status as an “excluded person” under the Securities Investment Business Law for an exemption from the requirement for a licence).

However, Section 2 and Schedule 6 of the PCL now extends the meaning of “relevant financial business” to cover activities which are “otherwise investing, administering or managing funds or money on behalf of other persons”.

The net effect of expanding the meaning of “relevant financial business” to include activities of investing, administering or managing funds or money on behalf of other persons is that now all unregulated investment entities are also covered and will need to maintain AML procedures in accordance with the AML Regulations.

Going forward, all non-Cima-registered and unregulated investment funds will also be required to comply with the same AML regime as Cima registered and regulated funds.

Pursuant to regulations 3(1) and 33 of the AML Regulations, an investment fund doing business in or from the Cayman Islands must designate a natural person, at managerial level, to act as its anti-money laundering compliance officer (AMLCO), money laundering reporting officer (MLRO) and deputy money laundering reporting officer (DMLRO). Cima requires that a person acting as MLRO/ DMLRO must (i) act autonomously; (ii) be independent (have no vested interest in the underlying activity of the investment fund); and (iii) have access to all relevant material in order to make an assessment as to whether an activity is or is not suspicious. The AMLCO role should be performed by someone who will be the point of contact with the supervisory and other competent authorities.

CIMA guidance to the AML Regulations requires that an AMLCO must be a person who is fit and proper to assume the role and who:

• has sufficient skills and experience;
• reports directly to the board of directors of the fund or equivalent;
• has sufficient seniority and authority so that the boardreacts to and acts upon any recommendations made;
• has regular contact with the board so that the board is able to satisfy itself that statutory obligations are being met and that sufficiently robust measures are being taken to protect the fund against money laundering/terrorist financing risks;
• has sufficient resources, including sufficient time and, where appropriate, support staff; and
• has unfettered access to all business lines, support departments and information necessary to appropriately perform the AML/CFT compliance function.

In addition to having the AMLCO, MLRO, and DMLRO officers in place, investment funds are required to have following AML procedures in place:

• identification and verification (KYC) procedures for its investors/clients;
• adoption of a risk-based approach to monitor financial activities;
• record-keeping procedures ;
• procedures to screen employees to ensure high standards when hiring;
• adequate systems to identify risk in relation to persons, countries and activities which shall include checks against all applicable sanctions lists;
• adoption of risk-management procedures concerning the conditions under which a customer may utilise the business relationship prior to verification;
• observance of the list of countries, published by any competent authority, which are non-compliant, or do not sufficiently comply with the recommendations of the Financial Action Task Force;
• internal reporting procedures (involving the MLRO and DMLRO); and
• such other procedures of internal control, including an appropriate effective risk-based independent audit function and communication as may be appropriate for the ongoing monitoring of business relationships or one-off transactions for the purpose of forestalling and preventing money laundering and terrorist financing.

In order to allow non-Cima registered unregulated investment entities (e.g. closed-ended funds such most private equity funds, venture capital funds, and real estate funds) not previously subject to the AML regime time to implement appropriate procedures (or delegation arrangements) to be in compliance with the new AML regime, the AML Regulations have been amended to provide these entities up until 31 May 2018 to assess their existing AML/ CTF procedures and to implement policies and procedures which are in compliance with the AML Regulations.

The deadline to designate an AMLCO, MLRO, and DMLRO and to notify Cima of the identity of such persons holding these roles is on or before 30 September 2018 for existing funds.

A Cayman fund that is already registered with and regulated by Cima will typically have delegated the maintenance of AML procedures on behalf of the fund to a fund administrator, and should therefore check that the scope of its current delegation to its administrator is sufficiently broad to cover the requirements of the AML Regulations (e.g. check (i) whether the AML regime being applied in respect of the fund is the Cayman AML regime or the regime of jurisdiction recognised as having an equivalent AML regime, and (ii) if it is the latter, whether or not the relevant administrator is actually subject to the AML regime of that jurisdiction ).

Non-CIMA-registered investment funds which now fall under the new AML regime and which have delegated maintenance of AML procedures on behalf of the fund to a fund administrator should also check that the scope of delegation to its administrator or investment manager is sufficiently broad to cover the requirements of the AML Regulations. Investment entities which have not appointed a fund administrator (e.g. because the investment manager maintains the AML procedures on the fund’s behalf) should check the same matters outlined above and additionally, whether or not the delegate (e.g. the investment manager) has the requisite personnel (in terms of numbers, training, and experience) to maintain the AML procedures on the fund’s behalf. The extent to which (i) the maintenance of AML procedures on behalf of the fund, and (ii) the designation of AMLCO, MLRO, and DMLRO functions, has been or is to be delegated to a third party service provider should also be considered within the context of Cima’s guidance on outsourcing.

The Monetary Authority Law (2018 Revision) gives Cima the power to impose administrative fines for non-compliance on entities and individuals who are subject to Cayman Islands regulatory laws and/or the AML Regulations.
For a breach prescribed as minor fine would be KYD5,000 (approximately US$6,000). For a breach prescribed as minor, Cima also has the power to impose one or more continuing fines of KYD5,000 each for a fine already imposed for the breach (the “initial fine”) at intervals it decides, until the earliest of the following to happen:
(a) the breach stops or is remedied;
(b) payment of the initial fine and all continuing fines imposed for the breach; or
(c) the total of the initial fine and all continuing fines for the breach reaches KYD20,000.
For a breach prescribed as serious, the fine is a single fine not exceeding: (a) KYD50,000 for an individual; or (b) KYD100,000 for a body corporate. For a breach prescribed as very serious, the fine is a single fine of not exceeding: (a) KYD100,000 for an individual; or (b) KYD1m for a body corporate.

Under the Grand Court Rules, interim payments can be requested by dissenting shareholders and granted by the Grand Court during the judicial proceedings initiated to determine the “fair value” of the dissenters’ shares under Section 238 of the Cayman Merger Law (Blackwell Partners LLC et al v Qihoo 360 Technology Co Ltd, interim judgement of 26 January 2017). This decision brought a significant development for minority shareholders in their quest to obtain the “fair value” for their shares in the context of a merger take-private.

Diligent minority shareholders typically learn of a merger take-private offer within days of the first press release by the company which announces the receipt of an offer by the board of directors and the formation of a special committee of independent directors (Special Committee) to review the offer and negotiate on behalf of the company. At this point several strategies become available:

• Activism and raising concerns. Minority shareholders may look towards activist shareholders or take a more active role themselves, either writing to the board of the company and/or communicating to the other shareholders through public media. Any concerns that the minority shareholders may have about the proposed merger should be raised at this stage. These may include (among others):

• • the merger not being in the best interest of the company;
  • the consideration being below the company’s intrinsic value taking account of the company’s market share;
  • the company’s market position;
  • specialist technologies;
  • the accumulated cash position; or
  • the holding of trading licenses relating to certain specialist areas or assets.

• Ideally, these concerns should be raised sufficiently early before any determination by the board of the company regarding the approval of the offer and recommendation to company’s shareholders, and the execution of the merger agreement. The aim of this approach is to ensure that the Special Committee will properly review the offer and obtain:

• • in-depth information about the valuation of company and the proposed financing and structuring of the merger, that may lead to an increase of the merger consideration negotiated by the Special Committee for the benefit of all shareholders; and/or

• • additional protections to benefit minority shareholders, such as “majority of minority” provisions in the merger agreement to secure a better bargaining position for minority shareholders leading to the shareholders’ meeting convened to approve the merger and the terms of the merger agreement.

• Looking for alternatives. If the target company received an offer from the management group or a group composed of the management and certain private equity sponsors (the buyout group), activist shareholders may try to look for an alternative buyer, generally inviting third party interest, or associate with other sponsors to initiate a counter-offer. This strategy is based on the assumption that the Special Committee will be bound by its fiduciary duties to take into consideration any additional offers received, which may place upward pressures on the initial merger consideration proposed by the buyout group. However, the effectiveness of this strategy is generally limited by the following factors:

• • if the buyout group, including the management team of the target company (generally in control of a significant number of votes), in the initial offer, clearly states that they do not intend to sell their shares in any alternative transaction, the interest of any third-party buyer is greatly diminished (an alternative offer may be deemed “hostile” by the management team of the target company, and the third party purchaser may invest significant time and money in the proposal with very limited chances of success); and

• • the Special Committee will not be able to pursue an alternative offer which lacks substance (that is, merger terms, financing, legal documentation, and so on) other than as a simple manifestation of interest.

• Blocking completion. Minority shareholders may seek to file for an injunction to stay or stop the progress of the merger on the basis that the directors of the target company are acting in breach of their fiduciary duties. This strategy is based on the fact that most merger agreements include, as one of the conditions to the closing of the merger, that no final order by a court or other governmental entity will be in effect that prohibits the consummation of the merger or that makes the consummation of the merger illegal. As such, if minority shareholders are successful in obtaining an injunction and such injunction has not been reversed and is non-appealable, then the merger cannot become effective. In some cases, however, the aim of this strategy is not to block the merger but to engage in settlement discussions with the target company and/or the buyout group.
• Exercising dissenters’ rights. Minority shareholders may choose to dissent to the merger under section 238 of the Companies Law, knowing that the target company must negotiate first and must file a petition with the court for judicial determination of the “fair value” amount to be paid (in the absence of an agreement with the dissenting shareholders as to the “fair value” of the shares). In some cases, the merger agreement may include a condition, as one of the conditions to the closing of the merger, that dissenting shareholders do not own more than a certain percentage (usually in the range of 1% to 5%) of the shares of the target company. When coupled with activism by dissenting shareholders, these clauses may put significant pressure on the buyout group and the management team of the target company.

Information can also be disclosed during court proceedings for a judicial determination of the “fair value” that could later lead to a securities class action in a US court or other jurisdiction where the target company was listed.

The interim judgement issued in Blackwell Partners LLC et al v Qihoo 360 Technology Co Ltd became very significant in the context of minority shareholders deciding whether to exercise their dissenting rights under section 238 of the Companies Law.

The judgment in the Blackwell Partners v Qihoo case has opened the door to petitions for interim payment being filed systematically by dissenting shareholders as part of the section 238 proceedings, at least in the amount of the merger consideration which is offered generally to the shareholders. This could potentially change the balance of power to some extent in the negotiations between the target company and the dissenting shareholders, possibly encouraging settlement earlier in the process or for higher amounts.

The security payment made to the court by the target company in the Blackwell Partners v Qihoo case was over five times the amount previously offered to the dissenting shareholders as “fair value”, and likely contributed to the decision of the court to grant an interim payment to the dissenting shareholders. However, it is possible that the absence of an agreement as to a security deposit paid into court would not prevent the court from granting interim payments.

The Grand Court Rules clearly state that the court retains full discretion with respect to interim payments and can order the defendant to make an interim payment of any amount the court thinks just, after considering any set-off, cross-claim or counterclaim on which the defendant may be entitled to rely (O 29, r 12, Grand Court Rules).

It seems unlikely that any interim payments ordered as part of Section 238 proceedings will exceed the merger consideration approved as part of the merger agreement. However, Blackwell Partners v Qihoo does not expressly preclude the possibility of relying on expert evidence to determine that the “just” amount for an interim payment should exceed the merger consideration.

Overall, it is still too early to tell the extent to which Blackwell Partners v Qihoo has or will impact dissenting shareholder strategies in the context of merger take-privates, and possibly contribute to the rising number of section 238 petitions in the Cayman Islands.

The ruling in Qunar Cayman Islands Ltd builds on the reasoning previously adopted by the court in the Blackwell Partners v Qihoo case and provides further guidance on interim relief available as part of proceedings initiated under Section 238 of the Cayman Merger Law.

The availability of interim relief is confirmed. The ruling in the Qunar Cayman Islands Ltd case followed the ruling in the Blackwell Partners v Qihoo case and confirmed that requests for interim payment can be made by dissenting shareholders as part of the section 238 proceedings, and that the court has jurisdiction to grant such payments, in an amount determined to be “just”. In the matter of Qunar Cayman Islands Ltd, the “just” payment was deemed to be equal to the amount of the merger consideration which had been offered generally to the shareholders by the company.

At this stage, it seems unlikely that any interim payments ordered as part of section 238 proceedings will exceed the merger consideration as approved as part of the merger agreement, especially if, as was the case in Qunar Cayman Islands Ltd, the request for interim relief had been made before any expert report was submitted on valuation issues. For the purposes of interim relief, however, the court appears willing and able to rely entirely on the company’s affirmations that the merger price represented the fair value of shares, without requiring dissenters to present any additional “fair value” evidence.

In Qunar Cayman Islands Ltd, and taking account that interim payments in the context of judicial proceedings initiated under section 238 of the Cayman Merger Law are a new development, the court decided not to grant the dissenters’ request that the company bear the costs of the application. However, in the future, it cannot be excluded that such request for costs may be granted by the court.

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Recent years have seen an unprecedented rise of the FinTech industry, i.e. financial technology businesses. According to the World Fintech Report 2017 , more than half of financial services users worldwide do business with at least one non-traditional service provider, while traditional financial services firms are desperately trying to foster innovation (and usually end up seeking partnerships with or outright buying out FinTech start-ups). According to the same report, venture capital funding in FinTech companies reached close to US$25 billion in 2015.

FinTech companies have experienced major growth in recent years mainly due to addressing the needs of financial institutions with respect to modernising payment services and improving customer experience in the digital age. As the industry matures, however, FinTechs will have to deal with attention from regulators, a wave of mergers and consolidations and a slow-down or drop in valuation, and they will need a more pragmatic approach to business development, with a stronger focus on IP management and exit strategies.

As one of the foremost offshore financial centres, home to 70% of the offshore investment funds, the Cayman Islands may soon become an attractive destination for FinTech entrepreneurs aiming to provide solutions for capital markets analytics, trading and portfolio management, as well as risk management and compliance. According to another recent report, a third of the hedge fund managers are already using some type of FinTech-related solutions for their investment strategies and are carefully monitoring the FinTech landscape to maintain their competitive edge. Overall, FinTech can flourish in the Cayman Islands through synergies with already established industries.

In the first issue of our series of legal insights on owning IP through a Cayman Islands structure, we explored some of the key benefits of the Cayman Islands Special Economic Zone (SEZ). In this second issue, we take a closer look at how the Cayman Islands protects intellectual property, with a focus on FinTech IP.

The Cayman Islands legal framework has been modernized to cover intellectual property rights in the digital age.

FinTechs generally own a combination of an established “brand” or “trade name” (including logos or icons) protected as registered or unregistered trademarks and original works including software and codes which in certain cases may benefit from copyright protection. In some cases, patents and industrial designs are also included. All these IP rights are protected under Cayman Islands laws to the same standards as in the UK.

Modern copyright protection, including with respect to computer-generated works. The Cayman Islands have recently updated the copyright protection laws to bring them in line with the most recent developments under the UK Copyright, Designs and Patents Act 1988, as amended, which expressly includes computer programs, including any preparatory design materials, as well as databases, within the definition of “literary works” and therefore protects them as such for a duration of 50 years.

Stand-alone comprehensive trademark protection to replace current system of extension of UK/EU IP rights. At present, trademarks registered in the UK (or with WIPO with UK designation) or at the European level with the Office for Harmonization in the Internal Market (OHIM) may benefit from the same protection in the Cayman Islands by a simple filing with the Cayman Islands Register of Patents and Trademarks, without any substantive examination or opposition period. However, under The Trade Marks Bill, 2016, which is expected to be passed into law and enter into force in early 2017, a stand-alone mechanism for the registration of trademarks will allow companies incorporated in the Cayman Islands as well as foreign companies to obtain trademark protection without going through the UK.

Extension of UK/EU patents & industrial designs, and reinforced protection against “patent trolls”. Patents and industrial designs registered in the UK or at the European level can also be protected in the Cayman Islands subject to a simple filing with the Cayman Islands Register of Patents and Trademarks. In addition, the patent regime has now been amended to grant inventors additional protection against abusive challenges to their rights by “patent trolls”, i.e. entities that obtain patents for the purpose of suing those who innovate and develop new products. The Cayman Islands patent laws have now been amended to specifically prohibit bad faith infringement claims.

Confidential information (including “trade secrets”) is well-protected in the Cayman Islands as part of the law of equity.

As is the case with other industries, in addition to trademarks, patents and copyrighted works, a lot of the value of the intellectual property developed in the FinTech industry comes in the form of confidential information, especially proprietary information constitutive of “trade secrets”, i.e. information which is valuable for being secret and that a company protects from public disclosure. This is especially true for business methods, ideas and algorithms, which cannot be patented. Also, in some cases, confidentiality may be preferable to patent protection.

The law of the Cayman Islands, as it relates to confidentiality, is a combination of common law, rules of equity and statute, and is based heavily upon English law, which treats the protection of confidential information, including trade secrets, as part of the law of equity. Despite the lack of statutory provisions in English law9, several remedies (such as injunctive relief or damages) are available where trade secrets have been improperly acquired, disclosed or used. The Cayman courts will follow the established English case law on these issues10.

As a result, FinTech companies benefit in the Cayman Islands from a protection of their most important asset, intellectual property, substantially at the same levels as in the UK, including with respect to confidential information and “trade secrets”, provided that they made reasonable efforts to maintain secrecy.

Protecting IP rights in the Cayman Islands:

IP encompasses inventions, literary and artistic works, symbols, names and images used in commerce, and is currently the most important assets of many technology and industrial companies. The ability to protect and maximize the value of IP assets is therefore of strategic importance and often is one of the main factors which contribute to a company’s growth.

According to the most recent statistics from the WIPO IP Statistics Data Center, global patent applications in 2015 rose to 2.9 million, with more than 1 million inventions coming from China, while trademark applications reached about 6 million, almost half of them filed by Chinese companies. In a report from the U.S. Department of Commerce published in September 2016, more than 25% of the existing industries in the United States were defined as “IP-intensive”, and in 2014 they already accounted for more than a third of the total GDP of the United States.

Largely known as one of the premier offshore financial centres for hedge funds and other investment vehicles, Cayman is now trying to become a popular destination for IP migration but also development⁵. Businesses in areas related to innovation and technology can now be established in Cayman under the special rules of the Special Economic Zone (SEZ). The SEZ now includes more than 180 tech and knowledge-based companies and is rapidly growing due to entrepreneurs realizing that Cayman is a very attractive place to house IP-intensive businesses.

In the first of our series of legal insights on owning IP through a Cayman Islands structure, we will explore some of the key benefits of incorporating an exempted company as part of the SEZ.

For many of the IP-intensive industries, intangibles are the only fixed assets on a company’s balance sheet. Technology and media businesses develop their customer base all over the world. Such companies often start small, with a team of talented and dedicated people, and in their growing stage may be attracted to relocating in the Cayman Islands⁶ to benefit from its stable yet business-friendly legal framework.

The Cayman Islands exempted company is the preferred corporate structure for such businesses (no regulatory approvals, no need for resident directors, no requirement for an annual audit, and no need for an annual shareholders’ meeting).

In addition, the existing or newly incorporated exempted company may apply to be registered as a Special Economic Zone Company (SEZC), allowing it to benefit from specific advantages such as speeding up very significantly work permit applications for the employees to be relocated to the Cayman Islands or access to very good infrastructure and support services. The SEZ, offering a lean, flexible and tax-friendly regulatory environment in an all-inclusive package, often gives talented inventors and entrepreneurs the best solutions for growth.

Businesses in the following sectors may qualify to set up as an SEZC:

• Commodities & Derivatives
• Media & Marketing
• Internet & Technology
• Biotechnology
• Education & Training

 1.  No Prohibition on Financial Assistance

There is no prohibition in the Cayman Islands for an exempted company to provide financial assistance with regard to the acquisition of its own shares. This provides the founders of a company with significantly more flexibility to structure a deal to buy out a previous shareholder for example without the need to find a third party investor or to become extremely indebted. (The directors of the company owe however a fiduciary duty to the company to act in good faith in the best interests of the company in agreeing to provide the financial assistance.)

2.  No Taxes on Income, Disposal of IP Assets or Capital Gains

Remunerations paid to the employees and distributions to shareholders are not subjected to any tax in the Cayman Islands. There are also no taxes for the corporate income or any registration taxes or stamp duty to be paid on the transfer of shares (other than in relation to the transfer of shares in a company which holds real estate in the Cayman Islands).

3.  More Flexibility for Distributions

Under the Cayman Islands Companies Law, the company has a greater latitude in distributing profits as dividends. For example, a sale of a portion of the IP assets could result in a dividend distribution, but also a simple revaluation of the IP assets on the balance sheet (provided that the valuation is not speculative). Also, the company is permitted to use its share premium account to fund the payment of dividends (provided that the company remains solvent thereafter).

4.  IP Protected by Commercial Confidentiality

The accounts and financial statements of the Cayman Islands exempted company are not filed or published and the corporate documents are not available to inspection by the public, therefore providing a high degree of commercial confidentiality, which is often critical for IP asset protection. Before the company reaches critical mass and is ready to go public, no competitor will be able to glean any information from management reports or financial statements.
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Cayman Islands holding companies, operating companies, and investment funds structured as companies pay dividends and make other distributions to shareholders and investors all the time, but what are the Cayman Islands’ rules governing the payment of dividends and making of distributions? In the first of our series of legal insights on the payment of dividends and other distributions1 by Cayman companies, we explore the concept of “profits” and how “profits” are calculated under Cayman Islands law.

Under Cayman Islands law, even though the shareholders are the owners of a Cayman company the property of that company belongs to the company and not to its shareholders. For this reason a company cannot simply pay or distribute its property to its shareholders. There are legal requirements to be followed in order to ensure, among other things, that the Directors of the company do not, for example, find themselves personally liable for authorising an unlawful dividend or distribution2.

The legal position is that dividends and other distributions of a Cayman company may be paid out of profits or from the company’s share premium account. However, where dividends or other distributions are to be paid from the company’s share premium account, there is a solvency test which must be passed (i.e. immediately following the date on which the distribution or dividend is proposed to be paid, the company must be able to pay its debts as they fall due in the ordinary course of business)3.

Distributions of capital are also permitted by means of the redemption of redeemable shares or the company purchasing its own shares. Under section 37(3)(f) of the Companies Law4, shares may be redeemed or purchased (A) out of profits of the company, (B) out of the share premium account, or (C) out of the proceeds of a fresh issue of shares made for the purposes of the redemption or purchase, or (D) out of capital if (i) it is authorised by the company’s articles of association and (ii) provided that it passes the solvency test (i.e. immediately following the date on which the payment out of capital is proposed to be made the company must be able to pay its debts as they fall due in the ordinary course of business).

Cayman Islands law as it relates to the payment of dividends out of profits is largely judge-made law. There is no statutory definition of “profits” in the Companies Law and no authority of the Cayman Islands courts which may be looked to for guidance as the meaning of “profits”.

In determining what constitutes “profits” of a Cayman company for the purposes of paying dividends and making other distributions to shareholders and investors5 it is necessary to look at the rules laid down by English case-law authorities based on the English Companies Act 1948 and also earlier English Companies law statutes which are of persuasive authority in the Cayman Islands. Subsequent statutes in England (e.g. the Companies Act 1985 which has been superseded by the Companies Act 2006) and the case-law authority based on such subsequent enactments would not necessarily be regarded as persuasive authority in the Cayman Islands since the Cayman Islands Companies Law is based, in the material part, upon the Companies Act 1948 (and its predecessors) and has not been amended subsequently in a manner analogous to the legislative amendments introduced in England.

In practice, “profits” is normally taken to mean the accumulated retained earnings or profit of previous years which have not been capitalised by a bonus issue or transferred to the capital redemption reserve, shown on the company’s balance sheet, plus all net trading profits shown in the profit and loss account for the current financial year6.

In light of the rulings in the English case-law authorities based on the English Companies Act 1948 and also earlier English Companies law statutes, it would appear that the following rules can be applied as a guide with regard to how the Cayman Islands’ courts would determine the question of how profits in a Cayman company are to be calculated for the purposes of making lawful dividend payments and other distributions:

1.1 A loss made on fixed assets does not have to be recovered before treating a revenue or income profit as available for distribution to shareholders and it is not legally essential to make any provision for depreciation. Sums written off out of past profits as depreciation of fixed capital may be applied as profit available for distribution if on a revaluation of the fixed assets no depreciation has in fact taken place.

1.2 Losses of circulating assets (i.e. trading stock) in the current accounting period must be made good however for otherwise there is no profit.

1.3 A realised capital profit on the sale of fixed assets may be treated as a profit available for distribution at any rate if there is an overall surplus of fixed and circulating assets over liabilities. However best practice is probably to revalue all fixed assets before making this assessment.

1.4 An unrealised capital profit on a revaluation of assets may also be used to fund a distribution to shareholders. However caution must be exercised by the Directors in this situation because an unrealised capital profit may well involve speculative matters of valuation and in the event that a lesser amount is achieved on actual sale a question may always arise as to whether or not the Directors acted properly in arriving at the valuation.

1.5 Losses, even revenue losses on circulating assets (i.e. trading stock/assets being used up in the business) made in a previous accounting period need not be recovered, if there were no profits carried forward into that period to make them good, since such losses are then categorised as losses of capital.

1.6 A distribution to shareholders can be made provided there is a profit on the current financial year of the company regardless of capital losses of a prior financial year. In other words, for the purposes of this rule each accounting period is treated in isolation .

1.7 However, in contrast to the above-mentioned rule, past profits (retained earnings) from a previous financial period may be carried forward and used to fund a distribution in the current financial year.

This Guidance Note is not intended to be a substitute for specific legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and general guidance only. For more specific advice please refer to your usual Loeb Smith contact or:

E gary.smith@loebsmith.com

E ramona.tudorancea@loebsmith.com

E elizabeth.kenny@loebsmith.com

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